California Water Service Group (CWT) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2008 earnings results conference call. (Operator instructions)

I would now like to introduce your host for today's conference, Mr. Marty Kropelnicki, Vice President and Chief Financial Officer of California Water Service Group. Sir, you may begin.

Thanks, Devon. Good morning, everyone, and welcome to the third quarter earnings call for California Water Service Group. With me today is Pete Nelson, President and CEO.

As a reminder, a replay of today's discussion will be available from October 31 through December 29 at 888-266-2081, ID 1285532. Before looking at the results and discussing results for the quarter, we want to take a brief moment to read our normal forward-looking statement Safe Harbor provision.

During the course of this conference call, the Company may make certain forward-looking statements. Because these statements deal with future events, they are subject to various risks and uncertainties, and actual results could differ materially from the Company's current expectations. Because of this, the Company strongly advises all current shareholders, as well as all interested parties, to carefully read and understand the Company's disclosures on risks and uncertainties found in our Form 10-Q, Form 10-K, and other reports filed from time to time with the Securities and Exchange Commission.

Having said that, let's go on and look at the income statement for the quarter. After the income statement, Pete will give an update on what's happening on the regulatory side, then I'll come back talk about the balance sheet.

Revenue for the quarter increased $17.8 million, or 15.7% from $113.8 million to $131.7 million. Embedded in that change, we had rate relief of $18 million resulting from the conclusion of the '07 general rate case. Revenue from new customers added $1.1 million. The net WRAM/MCBA adjustment added $1.2 million. And then, revenue by existing customers decreased approximately $0.5 million.

And then, with the implementation of the WRAM, we have a prospective change in that we pull Commission fees out prior to the WRAM. We used to include that in revenue and expenses. We've pulled that out, and that amount was about $1.8 million.

The net effect of all these changes, it was about a $17.9 million change.

Going down the line, on the production costs, operating expenses for the quarter under water production costs, water production costs increased 3.1%, or $1.4 million, to $46.4 million. Of that amount, purchase water increased 3.3%, or $1.1 million, to $33.8 million, primarily driven due to cost increases in purchase water.

Purchase power was up 1.3%, or $122,000 and $9.3 million, due to increased pumping and well production. And pump taxes increased $203,000, or 6.5%, to $3.3 million.

Under admin and general expenses, admin and general expenses are up 1.8%, or $262,000, to $14.9 million. Other Operations increased 10%, or $1.17 million, to $12.9 million. Other Operations, the breakdown in there, you had increases in the water quality costs associated with chemicals, filters, conservation and bad debt.

Maintenance expense for the quarter was down approximately 9.7%, or down $400,000, to $3.8 million. Depreciation and amortization increased 10.6%, or $900,000 and $9.3 million, primarily due to the increases in property plant that we implemented last year.

Income taxes for the quarter was up 60.3%, or $5 million, to $13.5 million, primarily due to the new rate relief and higher revenue levels that we achieved in the quarter. And property taxes and other taxes increased 6.3% to $3.9 million.

Net operating income for the quarter increased 52.6%, or $9.2 million, to $26.8 million.

Going down the line, other income and expense decreased about 153%, or $1.2 million, to a negative $408,000, primarily due to a negative market adjustment associated with our non-qualified retirement plans. And interest expense was down slightly, primarily due to last year, we had more cash in the bank at higher interest rates, and we also had more capitalized interest this year.

Net income for the quarter increased 61%, or $8.3 million, to $22.1 million. And fully diluted earnings per share was at $1.06 per share for the quarter, compared to $0.67 the previous year.

With that -- that's the income statement -- Pete, I'll turn it over to you.

Okay, thanks, Marty, and good morning everyone. I will cover rate-making, because that is the issue this quarter, for a couple of reasons, and Marty mentioned these.

First is, we had a major rate case implemented July 1, which is the first day of the quarter, and also, to a lesser degree, on July 1, we changed the way we recognize revenue and production costs, essentially decoupling sales from revenue. So I'll talk about two proceedings that are in place now, and the impacts on our results. And then a third proceeding, called the cost of capital, that's ongoing, and we expect to have that wrapped up by the end of this year.

All three cases are really part of implementing a good public policy document for water utilities in California. That's been in place almost three years, and those of you who have been following us, you know that's the California Water Action Plan, which speaks to streamlining the regulatory process and strengthening conservation programs, among other things. And you'll see those themes kind of woven through here.

So, to the first proceeding, the 2007 general rate case. This one covered eight of our 24 rate-making districts and headquarters, our corporate costs. This decision, as you saw, added $47 million of annual revenue to the Company starting July 1.

Now, that $47 million breaks down to two pieces. First is the $33 million, which reflects in those eight general rate case districts, and it also reflects those eight's allocation of headquarters or corporate costs.

But then, the second piece is probably more significant, because it's a change, and that is, $14 million, which will be reflected in the rates of the other 16 districts for the headquarters or corporate costs allocation. And this is a change, which allows the corporate headquarters costs -- for example, healthcare, pensions, benefit costs, things like that -- to be reflected in all 24 rate-making districts without delay. Which to me, and I think when you think about it, seems only fair, because the -- and it makes sense, because the -- there's agreement that these corporate costs, these headquarter costs are reasonable and prudently incurred, and as such, they should be reflected in the rates without any delay.

Now, I'll call the 2007 general rate case, to put it into perspective, our transition rate case, because we're going from the past, which was our 2006 [five/four] general rate cases, from an old method, where we would file eight of our 24 districts each year -- they are each on a three year cycle -- for general rates, and then we'd file our corporate, or headquarters rate case every three years. But that rate case, for corporate headquarters costs, would be phased in -- reflected in rates only as subsequent districts came in for their general rate cases.

And what this created is a lag in rates reflecting corporate costs, and when you do the math, that could be up to seven years, to have corporate cost increases fully reflected in rates throughout the system. So that's the past.

The present, I'll say, is the 2007 general rate case -- eight of 24 districts, plus headquarters costs reflected in all 24. And we're transitioning to the future, which is our 2009 general rate case. This is going to be one rate case for the entire Company, and we're preparing that now.

The dates on the 2009 general rate case, or the proposed application, will be filed May 1, 2009. The official filing is July 1, 2009, and if all stays on schedule, new rates would be in effect January 1, 2011 for the entire state, plus all the headquarters costs.

So, just in summary, 2009 -- that that rate case for us completes the Water Action Plan's objective, to streamline the general rate case process.

Now, the second proceeding I mentioned is the conservation proceeding, and this is important, because it changed the way revenue is recorded, as Marty mentioned. We're now decoupled, sales from revenue. And this is also effective July 1, so it covers the entire third quarter.

There is three significant changes that come out of the conservation proceeding for us, and the first is the Water Revenue Adjustment Mechanism -- acronym of WRAM. This mechanism, as you probably know, decouples sales from revenue.

Now, for the third quarter, revenue was less than that adopted in rate cases, so the WRAM effect was $3.5 million of under-collected revenue -- and I'll emphasize under-collected.

The second mechanism is called the Modified Cost Balancing Account, which is really a companion to the WRAM for water production. This essentially balances out the differences of water production costs that we actually incur from the production costs adopted in rate cases.

Now, for the third quarter, water production was lower than that in adopted rate cases, to the tune of $2.3 million. I'll call that over-collected expense. That flows back to the rate-payer.

Now, to get the net effect, you've got to do the -- I'll consider both mechanisms. You've got the WRAM, $3.5 million under-collected, and then the Modified Cost Balancing Account, $2.3 million over-collected. So the net is $1.2 million in an under-collected position, and that's how you get the $1.2 million added to revenue for the quarter as a result of the decoupling mechanisms.

So I think you can see that by far, that the change in the financial results in the quarter are due to the 2007 general rate case, and not so much the new decoupling mechanisms.

Another important outcome of the conservation proceeding was, we installed tiered rates, or conservation rates, or increasing block rates, throughout the state during the quarter. And these three rate mechanisms -- the WRAM, the Modified Cost Balancing Account, and the tiered rates -- all are designed to remove the disincentives for water utilities in the state, to promote conservation and to encourage customers to be efficient with their water use.

So now, July 1 this year, we're in a good position to really gear up our conservation water efficiency programs, which you see as good public policy, and we're in the middle of doing that right now. And it also looks -- if you could tie them in, because we're in the middle of a dry, dry year here in California.

The third proceeding I mentioned is the cost of capital, where the authorized return on equity is set for us. If this proceeding stays on schedule, because it's in process right now, we should have a decision late in the fourth quarter, for implementation July 1, '09. You may recall our current adopted return on equity is 10.2%. In this proceeding, we asked for a 12.57%. The staff position from the Department of Ratepayer Advocates is recommending 9.0%. So where the final decision ends up is really anybody's guess.

That's the rate-making part. We did mention in the press release our acquisition of the West Hawaii Utilities, so I'll mention that. This is a water and wastewater systems on the Big Island, serving Waikoloa Resort and Waikoloa Village. It's a good fit with our earlier acquisition earlier this year, of the Island Utilities Services, which was a contract operator, with contracts on the Kona Coast of the Big Island. And for us, the Waikoloa Systems looks like our anchor tenant on the Big Island, and we expect to establish our office and headquarters in the Waikoloa service territory.

So now I think I'll turn this back to Marty, to do the -- to go over the balance sheet.

Thanks, Pete. Just a couple of highlights from the balance sheet we wanted to share with everyone today, consistent with how we've talked about in the past.

Net utility plant was up approximately 12%, from $991 million at the end of Q3 last year, to $1.1 billion this year. Again, we continued on the quest to get all of our projects done on schedule and on time.

Company funded capex through the -- capital expenditures through the Q3 were approximately $75 million. Of that amount, approximately $70 million was CalWater, the California utility, and about $5 million came from our affiliates.

Work in progress for the quarter ended up 40% higher, or $35 million higher, to $112 million. And so we'll try to close out as much of that as we can here in the fourth quarter.

A couple things on the balance sheet. As Pete talked about, our Waikoloa acquisition, we do have approximately $4.6 million in goodwill that you'll see on our books associated with the Waikoloa acquisition.

Overall, we continue to believe that the Company is well capitalized and well funded, despite the credit crisis and everything that we've been seeing, and the Company has taken a very conservative approach to our money management, starting as early as last year, when the commercial paper market started having some problems. And so we continue to believe that we are well capitalized to weather the storm, up to and including the $40 million temporary line increase we got in September from our bank.

So with that, Devon, we'll open it up for questions from the callers, please.

Thank you. (Operator instructions)

Our first question comes from Jim Lykins of Hilliard Lyons.

Good morning, everyone.

Hey, Jim. How you doing?

Good, thanks, and congrats on a great quarter.

Thank you.

First of all, I was wondering if you could just, with the credit crunch, give us a feel for what any impact could be, and also because of that, if there have been any -- or there could be any changes in your dividend policy.

You know, the Company has had a long history of dividends, and increasing that dividend. At this point, we don't foresee any changes. We are very proud of our heritage. I think the most important thing I could share with you is just that we started preparing to be in a defensive huddle with the credit crisis in August of last year, early August, when the commercial paper market started to have some problems.

So, we feel the Company was ahead of the curve in implementing some procedures and changes and processes, to be ready for the downturn.

So at this point, I don't see anything that frankly is going to affect us. Obviously, the longer term issue is one's ability to go to the market and to raise capital, whether it's debt or equity. S&P reaffirmed our A+ rating in September, which we think is good and appropriate -- A+ stable.

Obviously, you see the financial results -- California Water was very aggressive with the Water Action Plan. That was published by the CPUC.

So we think we're in good shape. You know, it's hard to have a crystal ball. Who knows what's going to happen? They came out this morning that there was a contraction in GDP in the third quarter, but I think from our standpoint, from the things that we can control within the Company, we think we're very well positioned.

Well, what about on the acquisition side? Has the credit crunch maybe given you some additional opportunities to make some acquisitions that might not have been possible before?

You know, on the acquisition side, we still have our same principles. We like to buy acquisitions that are accretive.

Certainly, in a down economy, sellers' expectations might come down a little bit, that could potentially help us. But as you know, Jim, in a regulated entity, you can only pay so much and still make money on it.

And we're watching that. I'll tell you, we have not seen a flurry of new deals come through our offices, but we are always out there looking.

Okay. And can you tell us if you're still looking at about $90 million for capex for the year? I'm just wondering, can you give us the 2009 capex estimate yet, too?

You know, we're currently in our budgeting process now. I don't have the exact number for '09, because the engineers haven't given it to me yet. We usually go through a pretty rigorous process of looking at how much we have in rates, versus how much we can actually get done.

What I can tell you, and this is in our cost of capital, is from 2008 through 2012, we estimate $577 million. So I would anticipate next year's number being between $100 million and $115 million, just kind of ballparking it right now.

Okay.

In terms of what we can accomplish this year, as we've talked about in the past, capital projects can be very lumpy. There's permitting issues, there's getting sign-off issues, getting the supplies, getting the steel, getting the concrete, getting it done, and then getting it put into production.

Our WIP balance right now, at $112 million, is very high. Obviously, I want to -- and the team wants to get as much of that into the ground before January 1. Our target, our internal target, was $90 million to $100 million. I think we'll hit that. We might even slightly exceed that for the year. All the projects that we do, we have rate recovery on.

Okay. And one last question, and I'll let someone else ask one. Can you just tell us what that $40 million in notes payable was, that showed up on the balance sheet?

$40 million in notes payable? You know, I'd have to look that up, Jim. Part of what happened here with the WRAM -- and actually, this is a good thing to talk about. The WRAM itself, we have to do the WRAM accounting at the district level. So for every district, we have a WRAM, and we have a Modified Cost Balancing Account, and we have to close that out.

So our close, we lost about five days this quarter, so we're moving relatively fast on that. I'll look that up and I'll get back to you on that.

Okay. Thanks, Marty.

Okay, thanks, Jim.

Thank you. Our next question comes from Jonathan Breeder of Wachovia.

Good morning, gentlemen. Great quarter. Kind of caught me a little off-guard, I wasn't expecting it to be that good, but clearly, the GRC is having its impacts.

One question I have is, other than the step increases you have coming from the 2006 and 2007 GRCs, is there going to be any other California rate relief prior to that consolidated filing and becoming effective in 2011?

We have -- Jonathan, this is Pete. We do have attrition rates coming into effect July '09, and then again, July 2010.

First of the year, sometimes our wholesale providers change their costs, but that's rolled into the Modified Cost Balancing Account, so you wouldn't see that necessarily in revenue.

But that's if -- from here on, until the general rate case in 2011 rates is attritioned, for the general rate cases already been decided.

Okay. You had mentioned before that there's the potential for -- I think it was like a, you know, one of the general office filings, just in standalone in 2009. That's not going to happen?

No. No, no. Now we're going to file the entire system, 24 districts plus general office, July 1 next year.

Right, okay. The 10.2% ROE -- do you guys pretty much have that in place in all of your districts, now, correct? Or, some might be at like 10.16%?

It's -- yes, very -- for a very, very few number of customers, it's a little lower, but I'd say, overall, it definitely is 10.2%. I would use 10.2%.

Okay. And did I mishear you, Pete? Did you say that the cost of capital, the new ROE, was going to go in effect July 1, not January 1?

The cost of capital is January -- if it stays on schedule, January 1, 2009 would be the new return on equity adopted numbers.

Right, okay. And then, can you talk a little bit about, maybe, Q4? Last year, you guys reported $0.39. What was, like, the weather impact, and conservation during that period?

You know, if you pull the [crutch list] from Q4, we break out where the changes in revenue come from. We don't have it here in front of us.

What's going to be difficult, comparing last year to this year, is you have three new mechanisms in place. And we have that prospective change where we broke out the PUC fees, and we're accounting for those differently. And we will do that again on the Q4 call.

Conservation last year, we were spending some money, but it wasn't as significant as we're spending now.

Okay. And then lastly, Marty, can you give -- I kind of missed it, up front, that breakout you gave of the Other Revenues, the $1.2 million? I understand it's -- I guess, the majority is just the WRAM and the MCBA, but --

Yes, actually, the -- you're talking about the third item I gave, which was the -- that's the net WRAM/MCBA adjustment. So we over-collected -- or, we under-collected on the revenue side, so we had -- we came in below our adopted number. But then, with demand being lower, our production costs lower, and that has to get given back. So the net amount was $1.2 million.

And you said, existing customers were down $0.5 million?

Correct.

Okay. Thank you, guys.

Okay, thanks, Jonathan.

Thanks, Jonathan.

Thank you. Our next question comes from Michael Gresens of Robert W. Baird.

Good morning, and congratulations.

Hey, good morning, Michael.

Morning, Michael.

Wondering about the seasonality of the tiered rates, and how that affected not only the third quarter, but seasonality of revenue over the rest of the year?

Good question. Let's back up a little bit and talk about methodology, the way we established our WRAM. As you know, we have a bell-shaped curve, and we use three years of our historical data to study that.

So under the WRAM, the adopted revenues will follow a similar type curve, so clearly, in Q3, which is our peak demand period, peak demand quarter, we had more revenue coming from our Tier 3 than what we've had in the past in terms of quantifying that, frankly, but the WRAM's new to us. We're still working to understand that.

But I don't think I have an answer for you, other than we did have a fairly good sized amount of revenue coming from our Tier 3 customers, so people who bumped into the Tier -- the third tier based on consumption.

Okay. And can you remind us -- remind me, at least, what the attrition increases are scheduled for, for 2009, on the pre-2007 GRC cases?

Yes, I'd have to look those up, Jonathan, and again, I would call your attention to what's in the Q and what would be in the K, because we try to give disclosure around that.

Okay. All right. Thank you.

Thank you. (Operator instructions) Our next question comes from -- excuse me if I pronounce this wrong -- Heike Doerr of Janney Montgomery --

That's pretty close. Good morning, gentlemen. Congratulations on a strong quarter.

You know, Heike, it could be worse. You could have Kropelnicki.

But that's your last name, Marty.

I wanted to go back to the line of questioning that Jonathan had started. Can you tell us how we should expect to hear from you each quarter what the WRAM impact was? Will you do it similar to you did it this time around?

Can you repeat the question, please?

Will you tell us each year -- each quarter, what the net effect was, and what part of that was on the revenue side, and what part of that came in on the Modified Cost Balancing Account side?

You know, potentially -- I mean, part of it again is, it's new for us, and we're working it through with our public accountants, Deloitte, in terms of what our appropriate disclosures need to be.

Obviously, we have -- well, as a water company, we're, I think, one of the first in the nation or in the country to have a WRAM/MCBA, but we're looking at what the electric and gas have done in their disclosures, to try to manage that.

From our perspective, from a management perspective, we want to give as much transparency as possible to the analysts and to the people on the Street, so they understand it.

Okay, that's helpful. We appreciate it. And this decrease of about $0.5 million of revenue from existing customers, does that translate into you not really seeing much of a conservation impact in this quarter?

You know, Heike, it's hard to tell what usage is reflected by conservation or weather. It's just -- it's impossible to tell. All we know is, the customers used less water than they did last year.

But, I mean, $0.5 million isn't really much of a difference, right? In the grand scheme of things?

No, it's not. So I would say, in general, no, we don't see a huge move to people conserving water. But I expect that to change as we get our programs in place and geared up, and if the state goes through another dry winter, I expect a real focus on conservation.

Okay. And Marty, could we have a little bit more detail? Perhaps I'm not familiar with this. The Commission fees -- what is that? Can you refresh our memory?

Sure. We collect fees on behalf of the Commission, to fund the Public Utilities Commission. And so, it's really not revenue, and it's kind of a mixed bag. About half the utilities do it one way, and about half do it the other way.

In the past, it's been in revenue, and it's been an expense, so net/net, it's zero to the Company. What we did with the WRAM, because we have all these new components in revenue, we completely pulled that out. And so, it's not in revenue, it's not in expense. We just collect that money and we give it to the Commission.

Okay. And as a final question, do you anticipate any pension funding needs that may have changed in the last couple of months, given the market swings?

You know, how did you know I liked actuarial work? Yes, the Board asked the same question yesterday.

Our pension expense for this year is nailed -- it's done. The way it works from an actuarial perspective is, at the end of the year, you do an evaluation and you look at your PBO, your Projected Benefit Obligation, and you compare that to the net asset value of all the assets held in the plan. To the extent there is a 10% differential between the two, and I think for this year, for most companies, including CalWater, that will be the case, then that delta, that amount of underfunding, will get amortized in over the next 15 years. And at the end of every year, you do this valuation study, part of FAS 87 and part of FAS 106.

And so, I think that will be a common theme going into next year. I will tell you, as part of the '07 general rate case, we did recover all our pension costs. So I think that's something we have to watch, and it's to be determined.

And getting back to the point I made earlier when Jim asked the question, CalWater -- we were keenly watching that commercial paper market and what was happening. Our contribution to the pension plan last year, we put in the money market. It was not fully invested, and the contributions we made this year, we left in the money market.

So, while our plan is down, we're not down as far as the Dow and the S&P are. We're about -- we're only down about 20%. I think the markets have been down about 30%, 33%.

Great, that's helpful. Thanks for your time.

Sure. Just one quick follow-up I had for Jim Lykins, who asked the question, the $40 million? We have $40 million outstanding on our line of credit right now, so that's what that is.

Thank you. (Operator instructions) Our next question comes from Tim Winter of Jessup & Lamont.

Congratulations, guys. It's nice to see that it's finally flown to the bottom line.

I was wondering if you were able to calculate what the earned ROE was for the trailing 12 months, for the California properties? And then secondly, how they're going to apply the cost of capital, with the new allowed returns to the existing rate structure?

You know, the first -- the answer to the first part of your question is, no, we have not calculated it on the trailing 12. We typically do that calculation at year-end, since we are on a 12/31 year-end basis.

In terms of how they will apply it, I think they will be consistent with how they've done it in the past, which is, we will look at how we performed, and any change in ROE will take effect on -- hopefully, January 1, or when it's adopted.

So will they adjust rates with using the starting point, your most recent allowed ROEs, or your earned ROEs, as the starting point?

It would be our allowed -- allowed ROEs.

Okay, and that would probably be effective January 1?

You know, that's the goal that the judge is driving for, and the Commission. But again, it's a regulatory process, and that's subject to changes based on their schedule. We don't really control that. All the testimony is in, all the final briefs have been filed. It's being reviewed by the Commission now, and now we're waiting for the -- a draft decision, which is scheduled to come out sometime the end of November.

Okay. And that draft decision is coming from the Commission itself, or from ALJ -- who is that coming from?

It technically comes from the ALJ.

Okay. Thank you.

All right, thanks, Tim.

Thank you. (Operator instructions) I'm showing no further questions at this time, sir.

Great. Thanks, Devon. Well, that's kind of the update for now. Obviously, we have a bunch of new mechanisms. We will know more and probably talk more about these, once we get used to working with them. We're pretty tight with our data this quarter, because it's all new.

But we appreciate everyone's great support. We look forward to talking about these mechanisms at the end of the year. And more importantly, I think we look forward to promoting efficiency within the state of California, and pushing the Water Action Plan as far as we can get it.

So everybody have a great day, and thank you.

Thanks much, folks.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program -- you may all disconnect. Thank you and have a nice day.