California Water Service Group (CWT) 2008 Q4 法說會逐字稿

Good day ladies and gentlemen. Welcome to your year end and fourth quarter 2008 earnings results conference call. (Operator Instructions)

I would now like to introduce your host for today's conference call Mr. Marty Kropelnicki You may begin sir.

Thank you, Kevin. Good morning everybody and welcome to our year end and fourth quarter earnings conference call for California Water Service Group. With me today is Pete Nelson, President and CEO of the company. I would like to remind everyone that a replay of today's call is available starting at the end of the day, and available until approximately April 27th, and the replay is at 888-266-2081, I.D. 1322231.

Before looking at the results for the year end and the quarter I would like to take a brief moment to talk about forward-looking statements. 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 stock holders, as well as all interested parties, to carefully read and understand the company's disclosures on risks and uncertainties found in our Form 10-K, Form 10-Q, and other reports filed from time to time with the Securities and Exchange Commission.

Now, lets take a look at our year end results. I will starting off for the full year and then we'll talk about the quarter. For the 12 month period ended December 31st, revenue was $410.3 million, up 443.2 million or 12% from $367 million in 2007. The change in revenue is attributable to a couple main things. First and foremost the company had $42 million of rate relief. We had $4 million in sales to new customers and the net effect of the RAM and the MCBA, so the water rate adjustment goes in the modified cost balance account was a positive $2 million, that equals $48 million. That $48 million was partially offset by sales to existing customers which declined $2.2 million in approximately $2.6 million in other declines that we saw. So, the net effect is the $43.2 million. Water production costs for the quarter were as follows-- for the year were as follows. Purchased water for the year was up 4.7 % or $4,9 million to $112 million. Purchased power was up 8.2 % or $2 million to $26 million, and pump taxes were up 9% or $739,000 to $8.9 million. Maintenance for the quarter or for the year, excuse me, maintenance for the year was $19 million up $600,000 at 3 % from 2007. Depreciation was $37.4 million, up $3.8 million or 11 % over the same period last year, and income taxes were up $6.6. million or 37 % over 2007.

Property and other taxes increased approximately $1.2 million or 8.5 % to $14.8 million, and net operating income was $57.5 million up 30 % or $13.3 million for 2007. In other income and expense, other income and expense decreased 111% or $4.6 million, primarily due to one, no property sales in the fourth quarter as compared to the fourth quarter of 2007, that was approximately $0.08 a share. And, at $3.8 million market to market adjustment associated long term investments held by the company that approximated 11 %, so it was a negative $0.11 per share adjustment. Net income for the year was $39.8 million or $8.6 million-- excuse me $39.8 million up $8.6 million or 28 % over the same period last year. We'll now look at the fourth quarter. Fourth quarter revenue was up $14.2 million or 17 % to $100.1 million. Including the revenue the increase were as follows: . we had $13.8 million in rate increases. $2.3 million of sales to new customers and a net RAM/MCBA adjustment was $900,000. This was partially offset by $1.6 million in decreased sales to existing customers and $1.2 million in other decreases. Operating expenses for the fourth quarter was $88.7 million, up 17 % or $12.8 million over the fourth quarter of the previous year. Purchase water cost increased 7.2 % or $1.8 million to $26.4 million., while purchase power increased 32.4 % or $1.5 million to $6.2 million. Pump taxes for the fourth quarter were 25.6-- went up 25.6 % or $366,000 to $1.8 million. Other production costs, which include pension, healthcare, chemicals, filters and customer accounts receivable increased 22 % or $5.4 million to $30.6 million.

Maintenance expense for the quarter increased 40 % or $1.7 million to $6.1 million. while depreciation increased 14 % or $1.2 million to $9.6 million. Taxes, other than income, increased 18 % or $600,000 to $37 million. which includes property taxes. and fourth quarter other net income was down $2.1 million primarily due to the no property sales in the fourth quarter and a mark to market adjustment within the fourth quarter of approximately $0.05 a share. Fourth quarter net income was $7.3 million. or $0,35 per share. With that I will turn it over the Pete Nelson to comment on a regulatory update and I'll come back and talk about the balance sheet

Thanks very much Marty. Good morning everyone. I will touch on three areas today. One is, I will do a quick rate case review and I think I'll organize that in past, present and future rate cases. Then, I'll talk about the acquisitions we were able to make last year, 2008. Then I'll just spend a little time on the water supply situation in California because I'm asked about that every day.

First rate cases. Past rate cases. Last year we had two major rate cases that were passed. One was our 2007 general rate case, which was approved July 1st. that granted us $33 million in new revenue for eight of our 24 operating districts and $14 million in corporate headquarters costs which was reflected in all 24 of our rate making districts beginning in July last year. The second proceeding was what we called a conservation proceeding. This was also approved July 1st. This one directed us to implement the decoupling mechanisms-- the water revenue adjustment mechanism and the modified cost balancing account that Marty referred to. This case also directed us to implement tiered rates in California, so the impact of this decision was two-foal. One was to remove the disincentives to us to promote conservation and water efficiency and secondly to mitigate the impact of varying sales or customer usage on revenue. We think all of these cases in 2008 were decided very constructive they are all consistent with the California Water Action Plan, which we see as good public policy. So, to present rate cases, or rate case, there is one proceeding that's ongoing. That's what's called the cost of capital proceeding. What this proceeding does is it sets the allowed return on equity for three of the California water companies: Cal Water, Golden State and California American. We are currently the 10.2 return on equity allowed and we requested a 12.57 in this rate case.

This case should be setting the return on equity allowed for the years 2009, 10 and 11. There was a proposed decision issued in December last year which is a 45-page document and it recommends a 10.2 % return on equity allowed for all three companies, which will be no change for us. This proposed decision, and I'll understate the case, we are less than enthusiastic about it. We filed comments in January and our comments ran some 37 pages, which we can get you a copy of if you'd like to read that. We took issue with several areas in the proposed decision, including the allowed return on equities and the risks that are faced by water utilities, especially when compared to the California energy companies risks and their allowed returns. This case is still in process.

The commission can either put this proposed decision on the agenda and vote it out. or another commissioner could propose an alternate decision called an alternate proposed decision or an APD. This could be posed by any one of four commissioners. it could not be opposed by the assignment commissioner, which is Commissioner John Vaughn. Obviously, the route we prefer is the alternative proposed decision. The commission also added a phase two to the cost of capital. and this phase two is looking at the current state of the economy in the U.S. and does that economic condition right now have any impact on our allowed cost of capital or cost capital and allowed returns? And, it is also looking at for the years of 2010 and 2011 should there be some mechanism in place to adjust the allowed return on equities the way they do to the energy companies in California? So the entire case is still in process. I definitely will stay tuned there, you should all stay tuned, it is an important case and we'll see how it goes.

The future: we have one rate case we'll be filing this year, major rate case, which is our 2009 general rate case. The official filing date is July 1, for rates effective January 1st, 2011. This is an 18-month processing. This will be the first time we will file the entire company, all 24 rate making districts and the headquarters or the corporate costs at one time. Then this transitions us to a three-year rate case cycle which will begin January 1, 2011, which also is called for in the water action plan.

Second issue is acquisitions. 2008. Most of our activity and acquisitions was in Hawaii on two islands. On Maui we acquired an 800 customer waste water system that is called [Pukaloni] and on the big island, principally on the Kona coast, we have made several acquisitions. We acquired what I'll call the [Waikoloa] systems which is both water and waste water serving Waikoloa resort and Waikoloa village, it's about 2,000 customers there. We also purchased through [Kukiwa] system which is adjacent to Waikoloa, serves about 250 customers. We also purchased an operating contract company called Island Utility Services, which has a number of operating contracts up and down the Kona coast. Our investment in Hawaii for acquisitions last year was in the neighborhood of about $30 million. This establishes us with these acquisitions, with a sizable footprint and operations on the big island.

Also, back in California on a much smaller scale we agreed to purchase two publicly owned systems on the San Francisco peninsula here, both are adjacent to our operating district that we call [Bear Gulch], but this is about 500 customers. pretty routine, pretty small potatoes compared to the Hawaii acquisitions. The last item is water supply in California and what the potential looks like for possible rationing this year. The short answer is we don't know yet. The supply situation in California really varies region by region, northern California, the Valleys, southern California, the Bay Area, each region deals with supply pretty much on their own although there are some restrictions that are new in the last two years for how much water can be moved from north to south. It is a pretty complicated issue. From a precipitation standpoint, I'd say we are much better off today than we were a month ago, because it has been raining pretty steady the last few weeks.

In fact, it is looking more like a normal weather year from a rainfall point of view. But, nonetheless, we are preparing for the possibility of mandatory rationing any place in the state. My guess is if it did happen it would occur region by region, that would be a local decision. Any rationing scheme we would implement would be approved by the California Public Utilities Commission. We'll have to wait and see, and see how the rainfall looks this late winter and spring. Obviously it is a good timing to have the decoupling or the water revenue adjustment mechanism and the modified cost balancing account-- it is a good time to have those two mechanisms in place which really allows us to promote conservation and water efficiency. Now we'll go to the balance sheet and I'll turn this back to Marty..

Thanks, Pete. Couple items of the balance sheet we want to talk about. First and foremost company funded CapEx or capital expenditures for the year which are investments made and property plant equipment that are used in serving customers was approximately $97 million. That was up 29.3 % or $22 million from the 2007 budget. Our five year compound annual growth rate on CapEx budget is about 12. 4 %. We ended the year with a work in progress balances of $81 million that's up 84 % or $37 million from where we were in 2007. Net utility plant for the year. We ended the year with a $1.1 billion in net utility plant. That's up just about $100 million from where we were in 2007. And our five year compounding growth rate for net utility plant is approximately 8 %. We ended the year with approximately $40 million outstanding on our line of credit and our cash flow from operations for the year was approximately $93 million positive. We thought that was a good year from a cash flow perspective for the company.

Looking ahead into 2009, we anticipate our capital spending for the year to be between 100 and $120 million. Couple things that make it difficult to forecast is the (inaudible) process and when you actually finish a plant getting final signoff. So we have a $20 million range there between 100 and $120 million. The company's balance sheet finished the year strong. We are very happy with the cash flow. We are very happy with the receivables. We have seen a modest increase in our bad debt expense, but our bad debt expense of the year was approximately one half of 1 %. That's up slightly from about one third of 1% the previous year. So we've seen a little bit of increase there, but we think all things considered equal that's actually not too bad. We figure the balance sheet is in good shape going into 2009 and we are keenly focused on getting the CapEx budget in the ground for 2009. With that, Kevin, why don't we open up for questions please?

(Operator Instructions) our first question comes from Jim Lykins from Hillard, Lyons

Good morning everyone.

Good morning, Jim. How are you? are you?

Good thanks. First of all. I was wondering if you could talk about with the increase in expenses, I'm just wondering if the decoupling and the modified cost balances accounts are working as advertised? First of all

Sure. I think I'll take that one. Yeah, I think if you think about our business, you can break it down into three lines, you have revenue, you really have cost to good soul, which would cover your production cost and you have your other expense items. the RAM really is going to take care of the revenue line, the difference is in adopted revenue versus your actual sales, the modified cost balance account is really going to cover the cost on your production line, so then you do have to drop down to where your other expenses are.

I think, for the year, what I think was interesting in doing my analysis, if you look at where the changes came from in the revenue, that the difference between the -- when we talked about the increase of revenue at $43.2 million, the net RAM MCBA adjustment was $2 million, which is just about equal to the decline in sales to existing customers. that will tell me we are tracking about right. The big increase that you saw on the expense lines in operating expenses really had to do with increased pension, costs, healthcare costs and the change that we saw in the bad debts going from one third of a point to half a point in bad debt expense, as well as increased water production costs

uh-huh. Okay. And with some of these costs, I know you cited in your press release, water mains, reservoirs, pumping and also the health and welfare. Do you think some of these are more one time in nature? Or are we looking at more of a run rate at these levels going forward?

I think it depends on what happens. I mean obviously medical costs, I think generally speaking are deflating a little bit right now across the U.S. so that works to our advantage. Obviously with the market results that you have seen in some of our nonqualified plans we have had negative market to market adjustments. Those are things that have to get factored actuarily into our plan expenses for next year.

I think it depends really on what happens. Can the Stock Market go any lower? Can that increase our expense to our pension plan? Potentially, but it is hard to see it going any lower than the current level if you compare it to historical lows and what the falloff has been. I think those are the things you'll have to watch in our business. What's going to happen with healthcare and what's going to happen with pension extension and then really what happens with other production costs

Okay And on last one, I'll let someone else ask a question. You gave a really detailed explanation on what's going on in California right now, but can you give us an update on anything happening or-- that we might look for in 2009 on the regulatory front in the other states?

Sure, Jim, I'm take that one. The other states are obviously New Mexico, Hawaii and Washington. We do plan to file rate cases in all three of those states in 2009 for all the customers in all those states. of course, they are small potatoes compared to California but we'll be asking for rate relief all over

Okay. is it or can you give us any idea of when or the amounts right now or is it too premature?

Too premature. we haven't put the cases together yet

Okay. All right. Thank you, gentlemen

Thanks, Jim

Our next question comes from Tim Winter with [Jessup, Lamont].

Hey Marty and Pete congratulations on the year, very strong

Thanks, Tim

I was wondering if you could talk a lit it bit more about the $0.11 item for the year and the $0.05 for the quarter? What that was and --

Sure. That pertains to long term investments held by the company which basically are corporate-owned life insurance policies that are used to fund part of our Surf program. The other portion has to do-- we have a nonqualified deferred compensation plan. So, as the values of those life insurance -- the cash values of life insurance policies go up and down because they are basically invested in mutual funds we have to record the gain or loss.

Okay. Okay. And I was wondering if you'd talk a little bit about what kind of economic impact you are seeing on residential, commercial, industrial sales? If there is any impact on industrial sales?

Tim, we haven't really seen -- it is hard to tell what causes customers to use less water, could be conservation, it would be weather, it could be the economy, but we are not seeing a huge drop in usage at all from our customer base. Just not happening. I think Marty gave you the numbers on the drop in customer usage for the quarter, it is just not that significant

Okay. Great, thanks, guys

Sure, thanks Tim

Our next question comes from Dave Parker with Robert W Baird

Good morning. I echo Tim's comments. Congratulations on a good quarter

Thanks, Dave

Maybe, Marty and I got a question for you too, Pete. But like you went through with the RAM mechanism. can you talk about the impact for increased costs? Particularly that are recovered through balancing accounts like your water acquisition costs?

Sure. Most of those costs -- keep in mind we changed July 1st, we used to have the ICBAs and under ICBAs incremental cost balances accounts, the company expensed any change in cost and it flowed through the income statement. If-- we would then put it into an off balance sheet balancing account that would grow and accrue interest and we'd have to file for rate relief from the commission. So, it is off the books. .

As of July first with the MCBA those costs are booked on a monthly basis and they actually flow through the income statement. If you look in the press release on the income statement, excuse me, on the balance sheet. If you look at the-- under current assets under receivables under other, there is a $2 million receivable that's been booked which is a net effect of the MCBA and the RAM. And so, the differences, as we have changes in these production costs that are different than are adopted, these amounts actually get booked on the balance sheet and they are accounted

As of July, would that change in the way that you either recognize pluses or minuses to quarterly earnings? What's the change there, too, Marty?

Well, the change there, basically it is being booked, so your net effect for the two mechanisms, the net would be the $2 million that I referenced, which would be approximately $0.06 a share.

Right , Okay that's all I was trying to get to. You had a fair amount of increase which should have been collected through the mechanisms, is that

Right

For you Pete. Is there additional color, the cost of capital debate, I guess, seems to have dragged on a little bit longer than my expectations. can you give us any color there, Pete? And is California current budget crisis playing any impact or role there?

Dave, I don't see the California budget crisis having any role here. the commission has done a good job isolating this issue for water utilities. And, it is still in process. What's going to happen next? I can't predict. I think we made a very good case for the problems we have with the proposed decision. and, in fact, I think the record is very good from the proceedings about the reasons why we think allowed ROE should be higher than they are currently. But it's really up to-- it is in the commissioner's lap at the moment to either vote out this proposed decision or propose an alternate. We are waiting to see what happens there

Okay. great. Thank you very much.

Our next question comes from Heike Doerr, of Janney Montgomery Scott

Good morning, nice year, thanks, guys. Pete first question for you. Can you go into a little bit more detail on this mechanism that would adjust the allowed ROE in 2010 and 2011?

Well, there is no mechanism adopted yet. I haven't seen any. I haven't done much homework on the electric and gas industries mechanism. I'll speculate, which I hate do, but I will. If there is a major change in the cost of capital, be it, bond interest rate or something, the commission is considering some kind of a mechanism to adjust allowed ROEs up or down to kind of follow that. How that's going to play out we don't know yet, but probably the-- maybe the best model you can look at is what the energy companies have in state here, because that's the only model that the commission has to look at.

Okay. Part of the water action plan had been implementing an infrastructure mechanism, we call is it a disk in many states. We haven't heard any of you really talk about that is that thing that's still in the works?

Well, we did propose a version of the disk mechanism in our 2007 general rate case. We call it the infrastructure investment mechanism, or something, I can't remember the acronym.

Right a new acronym

A new acronym So,we'll probably be-- we haven't filed our '09 rate case yet. We are not exactly sure what we will propose there in this area. Our rate cases in California do look out three years and looks to capital cost going out for the years 2000, in this case 11, 12, 13. In a sense you've got a little bit of a disk mechanism already in the general rate case plan. It is not high on our priority list. not as high as cost of capital is right now.

Okay. and Marty, if you could humor us with perhaps a little pension utility pension accounting lesson. I see that the amount that your pension and post retirement benefit liability has gone up, you have put a similar amount into regulatory assets. How should we be thinking about that as we think about how it flows through the income statement and/or a future cash contribution?

Okay. Everybody get out their calculators here comes the (inaudible) Well, first of all, we'll file our 10K either Friday or Monday. In the back of the 10K and the footnotes you can look up actuarial assumptions for any publicly traded company that has in their 10K they have to put the assumption they use for their plan and the funding status of the plan. So, for any of us that have pension plans I always recommend going there. And the footnote is kind of confusing, but in essence you have to look at is the year end evaluation.

You look at the difference in the net asset values within the plan compared to the projected benefit obligation. To the extent that that delta is greater than 25%, then you pick up increased amortization cost in the funding for the following year. Obviously with the stock market results being so bad and most pension plans being invested in the stock market you can expect to see increased funding happening in 2009. For us, we anticipate that our funding is going to be about $22 million, which is just about the amount that we have in rates. So, despite the market looking bad, the good news is our 2007 general rate case our actual forecast appear to be pretty accurate.

That wasn't so scary.

No, it is not. I mean, again you read the footnote. it is a little scary, the thing to focus on is really what's the difference between the net asset value of the plan versus the projected benefit obligation. I believe it is the five year amortization of that delta

Okay. just a final housekeeping question. As we look at year-over-year depreciation you were in the low double-digits from 2007 to 2008. Should we be expecting a similar depreciation as CapEx continues in '09?

You know, yes, but maybe a little bit lower. There is a couple of things going on there. As Pete mentioned we did acquire these contracts from IUS. Those contracts have a shorter life and typical utility assets so therefore we are picking up more amortization expense from those contracts. That's issue number one. issue number two, and you'll see this on our balance sheet, we now have good will associated with the one of the acquisitions, We have to, as part of the [Fasby rules] we have to study that good will and get an actuarial evaluation from an independent third party evaluation firm. There could be some allocation too of intangibles from the good will of that acquisition. So, I think, give or take a full point is probably where we'll end up. but we have to do that evaluation study first to see where we come out

Thanks. appreciate your help this morning

Thanks, Heike.

(Operator Instructions) There are no furtherer questions at this time

Great. Well, just in closing we want to thank everyone for what was a very good year for Cal Water. We appreciate everyone's support and their interest in the RAM/MCBA that we implemented through the year. Obviously for us, all eyes are on 2009. We are keenly focused on our 2009 general rate case for the entire California Company. and then we'll be working on the rate cases for our subsidiary companies in the other states. Again, thank you for your support in 2008, and we look forward to working with everyone in 2009. Thank you

Ladies and gentlemen this does conclude's today's presentation, you may now disconnect.