California Water Service Group (CWT) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2009 earnings results. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder this conference is being recorded.

I would now like to turn the conference over to your host post today, Pete Nelson, President and Chief Executive Officer. Please begin, sir.

Good morning and welcome, everyone, to Cal Water's second-quarter conference call.

For those of you who regularly call in you will probably notice that this voice doesn't sound like Marty Kropelnicki's and it's not. It's me. Marty is off work today and we has got Calvin Breed, our Controller, Assistant Secretary, and Assistant Treasurer, pinch hitting for Marty. I think most of you know Calvin, so you will hear his voice and it will sound familiar to you.

We are going to still follow a similar process to the past quarter conference calls. First we will start with the disclosure and the financials from the income statement. That will be Calvin. I will come in talk about some items that I think that are important, mostly rate making items and a small acquisition. And then we will go back to Calvin for the balance sheet and wrap up, and then we will go to questions from the audience.

Now I will turn this over to Calvin for the income statement and financials.

Good morning. Before I begin, let me say that a replay of today's proceedings will be available from July 30 through September 28 at 888-266-2081 with an ID number of 1369368.

Before looking at this quarter of results we would like to take a few moments to cover the forward-looking statement. During the course of the 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 stockholders as well as interested parties to carefully read and understand the Company's disclosures on risk 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 let's look at this quarter's statements. Revenues for the quarter were $116.7 million, which is an increase of $11.1 million. This is made up primarily of rate increases of $19.2 million and new customers added $3.4 million, which primarily resulted from our acquisition in Hawaii in the third quarter of last year. Sales to existing customers and other changes resulted in a decline of $11.1 million.

The WRAM and MCBA impact was a net decrease $0.4 million. I may point out that last year was a quarter that was pre-WRAM and MCBA and it was a very strong quarter. If you look at quantities of water sold, last quarter -- last year's quarter was 37.4 million CCF and our adopted 2009 CCF were 32.9 million and our actuals were 32.8 million. So we had a very strong quarter last year because of water usage.

As far as water production, the quantity increased or, excuse me, decreased 11% while costs increased 3.4% to $41.7 million from $40.3 million. This is made up of purchased water increases of 2.8% to $31.7 million, which was primarily the result of increased cost from our water wholesalers. Purchased power increased $8.9 million to $7.6 million. Again, that reflects increased power costs from our operation in Hawaii. And then pump tax decreased slightly by $135,000 and that was due to lower quantities of water pumped from our company wells.

As far as administrative and general expenses, they increased $1.4 million or 40.1% and this is due to increased expenses for the employee benefit plans, which are made up of our pension, healthcare, retiree healthcare, and workers' compensation. Other operations increased $1.6 million or 12.3% to $14.3 million. And this change was made up of four major changes -- an increase in water treatment costs, which are chemicals and filter material replacements; communication costs; software maintenance costs; and then increased operating costs from our Hawaii acquisition.

As far as maintenance expense, maintenance expense decreased $0.6 million or 13% and that was due primarily to fewer main and service repairs compared to the prior year. Depreciation expense increased $1 million or about 11% to $10.3 million and this was due to an increase in utility, plant, and service.

Income taxes increased $0.3 million or 5% to $6.8 million due to higher pretax income for the quarter. This resulted in total operating expenses increasing $9.6 million or 11% to $100.7 million.

Net other income was $1.5 million or an increase of $1.1 million due to favorable adjustments to the market value of the investments associated with our benefit plans. Net interest expense increased $600,000 or 13% to $5.3 million as a result of higher long-term debt outstanding during the quarter. This resulted -- all of this resulted in earnings per share increasing 21% to $0.58 per share from 48% or $0.48, excuse me.

At this time I will turn it back over to Pete to discuss CRC and other matters.

Thanks, Calvin. In the second quarter I have two rate filings that are important to us. One is the cost of capital, which we did get a decision in the second quarter, and the second rate issue is our all company general rate case. And I will talk about each of the two.

First, cost of capital and it seems like a long time ago that I talked about a proposed decision on cost of capital and I think the proposed decision came out late last year. But just so everybody is on the same page, this proceeding sets our adopted return on equity and our adopted equity ratio. In the years past the cost of capital was part of general rate cases and now those are separate proceedings. So we have got water companies statewide going in for cost of capital in a separate proceeding from their general rate cases, which I think is a good move to do that.

So in May 6 this year -- this is second quarter -- we did get a decision and the bottom line is the decision maintained our most current equity ratio -- I'm sorry, our most current return on equity of 10.2%. So that is no change there. The decision also set our adopted equity ratio at 53% equity. That is a bit lower than our last adopted, which was 57%.

That change will have a pretty small impact on the bottom-line earnings. I think when you pencil that out it's maybe $0.02 a share for the year, and we will keep asking for a higher equity ratio I imagine the future to get us back to the 57%.

So now the cycle for return on equity cost of capital is every three years. We will file again in 2011 for ROEs effective in 2012.

Now to the 2009 general rate case, which is our most current filing. We filed this on July 2. This is the first time that the entire company, all of 24 rate-making districts and the corporate headquarters, costs are filed at once. This is an 18-month process now, which would be for rates effective January 2011, and I see this as the last transitional rate case to get us on a three-year, all-company, calendar year schedule.

And that should make life a lot easier for those financial analysts out there who have been trying to figure out rate changes when they happen in July for one-third of our districts every three years. That is pretty tough to analyze and to predict.

For this rate case some of the particulars -- we are asking for $70.6 million in new annual revenue for the first year, 2011, and then attrition increases for 2012 and 2013. And attrition really covers inflation for expenses and then new capital items that are started or have a major impact in the succeeding years. So each of the years, 2012 and 2013, our attrition request is for about $25 billion in each of those two years.

Now the drivers for the rate case, pretty straightforward -- capital, our need to invest capital in infrastructure continued to increase; benefits, which includes pension, healthcare, and employee benefits; labor costs, employee labor costs, we are asking for more employees largely due to increasing water quality regulations; and then conservation. And I will talk about each of those very briefly.

First, capital. That is a pretty straightforward mix of infrastructure projects, supply, treatment, storage, distribution, metering; nothing too unusual there. In the benefits area we are taking a little bit different approach here for benefits. We are asking for a balancing account treatment for pension and healthcare costs.

When you step back and look at what general rate cases try to do is they try to predict the expenses out of future periods and then try to match rates, what is called revenue requirements, to the expense. Now in the case of pension and healthcare costs these are pretty unpredictable, pretty hard to forecast what pension costs and healthcare costs are going to be in 2011, 2012, and 2013 -- up to four years out. And these are in major dollar amounts in magnitude.

So we think it's reasonable that these should be covered with balancing account treatment, which is not a precedent-setting request. Electric and gas utilities have in large part in California some part of their pension healthcare costs covered by balancing accounts. So we are not breaking new ground here.

Just a reminder what a balancing account is, it collects actual cost in the current period and then we file for full recovery of those costs in a later period. That is a change for us in the benefits area.

Conservation; this is a large part of our rate request, $16 million of the $70 million, and that is a little more than 20% of the general rate case is for conservation. Main driver here is public policy.

Both the California Public Utilities Commission and the governor and the state legislature have set a public policy goal and you may have heard the term 20 by 2020. What that means is the public policy for the state is in water is to achieve a 20% per capita reduction in water use by the year 2020. You do the math on that and it's about a 1.5% reduction in per capita use each year between now and 2020.

To achieve that statewide requires major conservation expenditures. There is a lot of details still to be worked out in the public policy goals -- how does that translate to regions and customers, commercial, residential, and industrial. So a lot of details are being worked out.

But nonetheless the state policy is pretty clear, the 1.5% reduction per year per capita to achieve 20% by 2020. We have a lot of programs in our conservation application -- retrofit devices, toilets, showerheads, water audits, education programs -- all kinds of things to achieve that 1.5%.

We are also asking for a rate base treatment for some of our conservation programs as we would for a new supply, say a new well, a new supply program. We think these conservation programs are going to yield long-term benefits to customers, and so the cost should be incurred and revenue requirements should also be matched as a long-term expense.

You may have read in the press release and Calvin mentioned that the WRAM and modified cost balancing account is in place, has been for a year now. We think it's working as it was designed to remove the disincentive to promote conservation. So we think now is the time to move from removing a disincentive to installing some kind incentive for conservation programs.

Just a reminder, this is an 18-month process here so it may be a while before there is more information on the status of the rate case. Usually it has been a 12-month process; this is one stretched out. But, again, we have got all 24 of our rate-making districts and headquarters costs in this rate case and we are right now the sole, large rate water company in for a rate case. So it's a major issue.

The last quick item you saw in the press release we disclosed a small acquisition in the second quarter. This is the Skyline County Water District Public Agency. It's only 465 customers on the San Francisco Peninsula here. This will not move the financial needle; it's more of a strategic move on our part to enlarge our footprint to the west. And it's just a good system, good assets, good employees and it fits well into our existing systems on the Peninsula here.

So that is rates and small acquisition. I will turn this back to Calvin for balance sheet and questions.

All right, I just have a few comments. Our net utility plant as of June 30 was 1.145 billion and that is up 33 million or 3%. Our company-funded CapEx expenditures for the quarter or year-to-date of $51 million compared to $38.5 million, that is a 32% increase. Work-in-progress is at $117 million as of June 30, and that is up from $80 million as of 12/31/08. That is an increase of 46%.

As far as debt equity, we did complete a debt offering in April of this year for $100 million so our equity and debt percentages now are 52% equity, 48% debt. That compares to ratios at year-end of 58% equity and 42% debt. We did use a portion of those proceeds to pay down the Company line of credit borrowings, which were $40.5 million, and we also retired one first mortgage bond.

The Board did declare dividends yesterday that will be paid on August 21 and that is our 258th consecutive dividend. The dividend rate is $0.0205 per share. Our Standard & Poor's debt rating on our first mortgage bond is AA-.

With that, that concludes management's comments and we will now open it up for questions.

(Operator Instructions) Jim Lykins, Hilliard Lyons.

Good morning, everyone, and congrats on the quarter. First thing I wanted to ask you about is the 20 by 2020, if you can refresh our memory on some of the specifics of the decoupling mechanism. Does that have to be renewed at some point in time and is there any reason to think that that would not cover the 1.5% per year reduction?

Good question, Jim. We believe -- in fact this is exactly the situation that the water revenue adjustment mechanism on the modified cost balancing accounts, the WRAM MCBA mechanism, was designed to address. So good timing actually for the Commission to adopt that mechanism before the 20 by 2020 public policy pronouncement.

The challenge is to achieve the reduction in usage. You probably recognized that a lot of the fixtures over the last 20, 25 years have been low flow or water efficient fixtures -- toilets and things like that and showerheads. So it's not going to be easy to achieve the next 20% reduction, which is huge.

There is still a lot of details to work out about how do you apply this. But, no, we are very pleased that decoupling is in place and working and proven as we try to reduce usage.

Does that have to be renewed at some point in time?

You mean the modified -- the WRAM MCBA?

Yes.

No, it's part of the regulatory process now so it's an in-place mechanism. And it is part of adopted policy. The water action plan adopted by the Commission in December 2005 very clearly says that public policy is to have a decoupling mechanism to remove that disincentive for water companies to promote conservation.

Okay. Pete, you were talking about how difficult it can be to predict some of the pension and benefits costs. I am just wondering if you could give us a feel for how we should be thinking about admin at least through the rest of '09 and maybe even '10 if you wanted to go out that far.

You mean for pension and healthcare costs?

Your admin costs. Should we be thinking of those being in line with what we have seen in the first half?

Let me have Calvin take a stab at that one.

Yes, for the first half of the year we have put in our actuarial estimates into -- we have received and those will be updated annually. But currently our pension expenses are about $23 million for the year and our retiree group health is about $3.2 million for the year.

Okay. And one last question and I will let someone else ask a question. But I am just wondering if the budget issues in California might be increasing some acquisition opportunities. And maybe if you could just maybe talk in general terms about what your appetite is right now and what you are seeing out there.

Well, we have not seen a rush for public agencies, for water districts to look for other alternatives. The state budget crisis -- I won't say it's soft but it has kind of got about another Band-Aid on it. And, of course, we are always out there looking for operating agreements that make sense for us in acquisitions.

The Skyline County Water District was pretty small. It couldn't survive on its own really so that one made a lot of sense for them to sell to us. Now I am not expecting a huge influx of new business from this. Generally, cities and water districts are pretty proud about running their systems and being able to sustain themselves. Anyway.

That is okay; that is helpful. Thank you, gentlemen.

Tim Winter, Gabelli.

Congrats on the quarter. Can you guys talk a little bit about how the cost of capital proceeding will work going forward? Will there be an annual adjustment to the step rate increases to make sure you are at the 10.2%

Then also, how is phase two of this proceeding? If you could provide some color how that is scheduled to play out.

Morning, Tim. Good questions. The cost of capital, there is no mechanism to check our actual earned ROE versus the adopted; I haven't seen that. And the phase two Tim is referring to is some mechanism that if borrowing costs spike up or spike down to give us some protection so we can raise or lower the adopted return on equity so we can cover that. That is still in discussions. We don't have a decision yet from the commission.

There are precedents in the electric and gas business where there is, I would say, kind of a collar on adopted ROEs and earned ROEs. So in case inflation spikes, say, that we can go back and request an adjustment to ROE. So more to come there, Tim. It might be in the third quarter we have a decision there.

Okay. And then is there any update to your capital expenditure budget going forward? Are you still at roughly $85 million a year?

Currently, our estimate is between $100 million and $120 million for the year.

And how does that factor in contributions?

That is company funded CapEx, so it does not include developer funded. We have seen a reduction of activity in the developer area.

Okay, thank you.

(Operator Instructions) [Jonathan Reeder], Wells Fargo.

Good morning, gentlemen. Following up on Tim's question on the earned ROE, do you have what your earned ROE for the trailing 12-month period was in California since we have had all these regulatory improvements? Are we hitting the 10.2%?

I am looking at Calvin here.

I am going to speculate, I think it's about 10.9% trailing 12 months. So it's close.

Yes, correct.

Okay. So you are actually a little above that? I guess can you kind of go into detail at all, like, what has allowed you to go above? Is it just the change in the equity ratio at all now?

I am looking at Calvin here. We may have to get back to you, Jonathan, on that one.

Okay, that is fine. As far as the other income increase this year, that was some kind of mark to fair value. Can you explain that again?

Yes, that is what we call mark-to-market adjustment. I think Calvin has got the number there.

We have a trust-owned life insurance associated with some benefit plans. And as Marty (inaudible), Pete mentioned we do monitor that on a quarterly basis. This past quarter we had a $1.8 million increase in the market value, whereas in the prior year's quarter we had a reduction because of the decline in the market. And there was about a $300,000 reduction in the second quarter of last year.

Okay. And then I don't know if you can discuss at all as far as the second half of the year kind of what you are seeing as the year-over-year EPS drivers. So far are you guys are tracking pretty well from an EPS growth perspective, but I know the second half should be a little more challenging because you don't have the effects of the WRAM as well as the 2007 GRC. Is there anything else really besides the step increases that you highlighted in the release?

I will say, no, and you are exactly right about the 2007 general rate case. That decision was July 1 last year, so quarter-to-quarter changes increasing rates from the '07 GRC conclude the second quarter here. I take the WRAM MCBA, I make that a separate issue. I don't see that having an -- it's hard to tell what customer usage will be the third and fourth quarter. And I know you are looking at adopted numbers to predict revenue, which I think you can do.

Okay. And the last question, the decrease in water usage by existing customers that you guys highlighted being down $11.1 million, does that I guess kind of -- does that jive with what you were forecasting as far as what the adopted revenues were or was that offset by the WRAM? I guess I am just a little bit confused on how exactly that works.

It can be very confusing because there are three periods we are comparing here. First is the second quarter '08, the second quarter '09 usage. And second quarter '08 was very hot and dry here; it was a good production quarter, good usage quarter, free WRAM quarter. So the comparison to actual usage last year to this year is lower.

Then for modified cost balancing account and WRAM you are comparing the adopted usage to the actual usage. And that is pretty close. For whatever reason the rate case predicted usage and it's probably based on historical numbers to what the actual was.

So you see WRAM MCBA being kind of flat, but actually usage prior year to this year dropped quite a bit date. It's pretty much as we expected. I haven't seen anything unusual there.

So that $11.1 million was just in relation to the strong Q2 '08 that you guys had highlighted?

Exactly. And that is pre -- the last pre-WRAM quarter.

Okay. All right, that makes sense. I appreciate the help today.

(Operator Instructions) Heike Doerr, Jamie Montgomery Scott.

Good morning, congratulations on a strong quarter. Quick housekeeping question, I am wondering how we should be thinking about the tax rate going forward. I know this quarter and last quarter it was 36%. Last quarter it was, I think, below 34%. What is driving that down and how should we be looking at that going forward?

The tax rates -- of course you would have to pick up not only what is in operations, but also down in other income. We do anticipate our tax rate probably in the 38% overall basis for the year.

So does the decline in the tax rate have anything to do with the mark-to-market that is happening related to your trust-owned life insurance or are those not related?

It's not related. The difference between the statutory rate and the effective rate is really some permanent what we call Schedule M items and it's primarily we get a deduction for the qualified production activity deduction. And so that is really what is driving the difference.

If you understood that, Heike, I am impressed, because I don't understand it.

Okay. So we will just think 38% is a reasonable level going forward. How should we be thinking about the swings associated with the trust-owned life insurance? The $1 million was a large amount in the quarter.

Yes, that is obviously difficult to predict. If you can predict the stock market, then you should --

I guess that is what my question is. Is it stock market correlated?

Yes.

Okay, thanks for your time.

(Operator Instructions) I am not showing any other questions at this time.

Okay. Thanks everyone for calling in and thanks especially to Jim and Tim and Jonathan and Heike for your questions. We appreciate those and your participation.

Have a great end of the summer and look forward to everybody being on the third-quarter conference call. Thanks a lot.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.