California Water Service Group (CWT) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the California Water Service Group third quarter 2010 earning results. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. And as a reminder, this conference is being recorded.

I would now like to turn the conference over to Martin Kropelnicki. Sir, you may begin.

Thanks, Tammy. Good morning, everybody, and welcome to the third quarter 2010 conference call for California Water Service Group. With me today is Peter Nelson, President and CEO.

I'd like to remind everyone that a replay of today's discussions will be available from October 28th through December 27th, at 1-888-266-2081, ID number 1484282.

Before discussing the results for the quarter, I'd like to take a few minutes to discuss forward-looking statements. In particular, 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 stockholders, as well as all interested parties, to carefully read and understand the company's disclosures on risk and uncertainty found on our form 10-Q, 10-K, and other reports filed from time to time with the Securities and Exchange Commission.

Having said that, let's take a look at the quarter. And then I'll turn it over to Pete to talk about some of the evolving issues with the PUC.

Revenue for the quarter increased $7.2 million or 5.2% to $146 million. Included in that number was a gross WRAM adjustment of $11 million, and the WRAM's the water rate adjustment mechanism associated with revenue. And an $8.6 million negative MCBA, which is a modified cost balancing account, which has to do with the product cost, where actual production costs were below adopted numbers. That gave us a net $2.4 million increase to income.

Operating expenses for the quarter were $5.4 million, increased by $0.4 million or 4.7% to $120.5 million.

I'll briefly go through the production cost breakup between purchased water, purchased power, and pump taxes. But please keep in mind these are all covered by the MCBA. During the quarter purchased water increased 14% or $5.1 million to $40.5 million. Purchased power increased 8% or $750,000 at $10.8 million. And pump taxes went down 6% or $200,000 to $3.3 million. Again, all three of those components are covered by our MCBA, our modified cost balancing account.

A&G for the quarter went down $1.3 million or 6.8%, driven by lower legal costs, outside services, and overall the company keeping the operating budget very tight for 2010.

Other operations increased 1.7% or $300,000 to $14.9 million. This is partially due to transmission distribution costs, partially offset by a decrease in uncollectible accounts as well as increased use of surface water and chemicals and filters associated with that surface water.

Maintenance expense for the quarter increased 10% or $450,000 to $4.9 million, all associated with our work on mains.

Depreciation and amortization for the quarter increased $600,000 or 6.6% to $10.9 million, really driven by the 2009 capital improvement program and the plant that we put in service during 2009.

For the quarter, income taxes went down $592,000 or 4.4% to $12.8 million. This is due to two things. Primarily, one, the true up as we filed our tax return. We have to file a true up associated with our tax provision. As well as the company finished a comprehensive deferred tax review.

Property taxes and other taxes for the quarter were up 4.2 -- were up 4.2% or approximately $200,000 to $4.5 million, associated with just the property taxes and franchise taxes associated with the new property and equipment put in rate base.

Net income -- net operating income for the quarter increased 7.35% or $1.7 million to $25.8 million. Other income and expense for the quarter was $1 million, about the same as last year. And interest expense for the quarter increased 17% or approximately $900,000 due to higher borrowing on our line of credit which was approximately $56 million outstanding at the end of Q3. Almost all that money has gone into our capital program for 2010.

Net income for the quarter increased 4% or $800,000 to $20.4 million. And earnings per share for the quarter were 4.3% higher or $0.04 per share higher, to $0.98 over the same period last year.

So if we go to 50,000 feet and look at the components here, usage was down, which was offset by higher purchased water costs. The WRAM, MCBA seem to be working fine. And as we started 2010, as we told everyone, it was a stretch here for the company, given the fact we have some of our districts that have now gone 3.5 years without rate relief.

While it's a tight year from the EPS perspective, we believe our operating trends continue to be strong, especially on the A&G lines and our CapEx programs. And we believe we've positioned the company really well going into 2011.

With that, I'll turn it over to Pete, and I'll come back and talk about the balance sheet.

Okay. Thanks, Marty, and good morning everyone. I'll be wrapping up, I hope, two important procedures that I've talked about several times in the past. Both are important to the company's financial position going forward and both I know are important to you analysts on the call.

So the first is the 2009 general rate case. There has been a new event there in that the Administrative Law Judge issued his proposed decision yesterday in this case. And the second item is a revision to the water action plan, which I'll call Water Action Plan II. And as you recall, this document sets the policy, the public policy, for regulating water companies in California. Both of these, as I said, are very important to the company, they're important to the Commission.

In fact, the Commission has spent a lot of time on both these procedures in the last few months, especially in the last month or two. And that's partly because we have at least two commissioners, and maybe three commissioners, who will be leaving the Commission at the end of this year. One is Commissioner Bohn and the second is Commissioner Grueneich. Both are termed out, and we expect them to be leaving the Commission. A third commissioner, Commissioner Ryan has not been confirmed by the State Senate. So that's a possible change there, but we're not quite sure yet. Commissioners Simon and Peevey are in the middle of their term, so we expect them to stay on.

So as I said, we expect two or three new commissioners to be appointed sometime next year by the new governor, and that's important to get these cases approved before the end of the year.

So I think I'll start with the Water Action Plan II. It's on the Commission's agenda to be approved today, actually. And that's good news. The revisions that we've seen and the current Water Action Plan II on the agenda today is very good, very reasonable. If you recall, the first version of this was adopted in December 2005. And this does set the policy for regulating water companies. The revision's been in the works for months and there's been several versions out for comment. And we -- I must say that the Commission's been very good about asking for comments and suggestions and then considering those comments as the plan evolved in the draft stage.

The old version, Water Action Plan II, was 28 pages. The new version's 35 pages. I really don't see any major departures from the original -- the current policy. The current -- the Water Action Plan II proposal really does just continue the current policies, maybe put more teeth into them.

It has a few things that I think are worth noting from a financial perspective in the proposed draft, Water Action Plan II. One is to encourage -- in fact, I'll use the words encourage or consider in each of these. One is to encourage financial incentives for investment in infrastructure, especially that needed for water quality. Another is to look for incentives to encourage conservation and consider financial rewards for utilities when conservation goals are met, and penalties, of course, on the other side when conservation goals are not met, and opportunities for higher earnings resulting from successful conservation efforts and a possible sharing of savings with customers.

There's also parts of the plan that talk about decision making streamlining at the Commission's level. That's always a good policy. Also, the plan includes provide incentives for large utilities to take over smaller systems. And also consider offering incentives to promote company acquisitions. It could include surcharges for capital improvements or an adjustment to the allowed rate of return for the acquiring utility. Those items were in the first plan. I don't think they played out too strongly. But they're continuing to be policy for the Commission if this is adopted today.

So that's -- overall I'd say the double (inaudible) in the details. The way the policy is put in place is as each water company makes an application to the Commission, usually in the form of a general rate case, each company seeks to apply certain parts of the policy in the proceeding. And then that's kind of worked through as the proceeding goes on and ends up in a decision that is applying the policy in a specific case.

So overall, I'd say that the process was good, the plan looks good, it's workable, it's balanced, and it's on the Commission's agenda today. And we can get you a copy probably this afternoon or tomorrow when that's finalized. That's good news.

The second issue, and I hope this is the last time I talk about this one, is our 2009 general rate case. We are in the final sprint to the finish here. This has been an 18-month or more process. And I still think it's the largest rate case for a water company in California history. As you know, this rate case covers all of our California rate-making districts and our headquarters or corporate costs. It does exclude the cost of capital which is a different proceeding taken up at a different time.

Commissioner Bohn's the assigned commissioner, and he has several proceedings he's trying to wrap up this year. And we know, in fact, he said, it's his desire to get all of his cases decided before he leaves the position at the end of the year.

So yesterday the Administrative Law Judge issued his proposed decision in the case which basically recommends adopting the all-party settlement that we've all agreed to. And this is an agreement between the Commission staff, us, and the interveners.

Some elements of the proposed agreement are worthy of note. One is that we're looking for annual revenue -- an annual revenue increase of $25 million beginning the first of next year. That number has changed over time as this case has proceeded because in the original case we included what we expected to incur in the way of wholesale water costs and some production increases in costs and some offsets and some inflationary increases. And as time has gone on, some of those increases have been accepted and adopted and put into place. And so today the revenue increase we're looking for for the first of the year, for general rates, is $25 million.

There's also, in addition, those $7 million in future revenue we expect as a series of capital projects that are identified in the case get completed.

If you step back and look at how the rate case process works, what the rate making process tries to do is look ahead and try to determine what's reasonable expenditures in capital and expense items and predict those out three or four years.

Now, some of the capital and expense items are found to be reasonable and prudent and necessary. But it's uncertain when the timing will be for those capital projects and it's uncertain when the costs will be incurred or when the costs will go up. And so there's some rate making mechanisms, some called it advice letters for the capital projects, so that when these capital projects are finished then we file an advice letter with the Commission and ask for a rate recovery at that time. That's the $7 million I talked about.

On the expense side, we've got the same mechanisms or the same kind of concepts going on. There are a couple of opportunities for us on the expense side that are new approaches that are in the proposed agreement. One I'll talk about is pension costs. These costs are very difficult to predict, difficult to control, and so the proposed decision includes a balancing account for pension costs which allows us to book those pension costs in real time.

The second item is new to us also which is a memorandum account for healthcare cost increases that are a result of federally mandated changes in healthcare. Now, a memorandum account means you collect those costs and you apply for recovery later for the prudently incurred costs as a result of federally mandated healthcare changes.

I think those are both good mechanisms, both are reasonable, and we think that the entire proposed decision is reasonable. We are beginning a 30-day comment period today. And we expect this to be on the Commission's agenda for either December 2nd or December 16th, and look for a decision then.

So those are the two proceedings, looking forward to wrapping those up.

I think I'll go back to Marty now for the balance sheet or more information on financials.

Actually, two quick comments on the GRC settlement that's coming through. One, Pete here pointed out pension expense and the difficulty in predicting that. As we start the year, we have a pension estimate that our actuaries put together and that we use that our FAS 87 expense throughout the year. And then you true it up later in the year.

In Q3, we got a revised estimate from our actuaries based on the new census data and we booked a $780,000 adjustment within the quarter for our pension expense. So that hit in the quarter. And, well, it goes back to really January 1st, it was based on new information like new employees and things like that. Certainly, the pension balancing account would [midify] -- or mitigate some of that volatility with that number, and the FAS 87 expense is covered by that pension balancing account.

In addition, as part of the general rate case settlement and with all parties being signed off, there were a couple of contested assets associated with some of our smaller districts. And during the settlement process we agreed to cap what was in rates associated with these two projects in particular. And as a result we have a capping what's in rates, we had a reduction that we had to charge for the income statement of about $600,000 a share -- excuse me -- $600,000 period, which comes out to about $0.02 a share. So between the pension and the settlement, we had these adjustments equal to about $0.04 a share in the quarter.

So looking forward to getting the pension balancing account put in place.

A couple other points I'd like to highlight on the balance sheet. The company finished the quarter with net utility plant at $1.28 billion. That's up approximately from -- 9% from last year when we were at $1.175 billion at the end of Q3. Company-funded CapEx, we've spent about $79 million through September 30th, 2010. So we're going into the final stretches with our program. As you may recall, we have a fairly aggressive program to do between $120 and $130 million for the year.

Our work-in-progress, our construction work-in-progress balance finished the quarter at $141 million. So these are incurred dollars spent associated with capital projects as we build them. And once they're built, they're taken out of construction work-in-progress and put into rate base. That's up approximately 12% over Q3 of last year, which was $126 million.

Net cash flow from operations was a positive $78 million. And as I mentioned earlier, we're about $56 million on our line of credit.

So having said that, why don't we open it up, Tammy, for questions from people on the call, please?

Certainly. (Operator Instructions) Our first question is from Garik Shmois of Longbow Research. Your line is open, sir.

Hi. Thank you. Good morning.

Morning.

Just I have two questions. The first one is in regards to the Water Action Plan that you mentioned. Just wondering, it sounds similar to the existing plan. But given that, as you mentioned, it seems like it has more teeth in it, is it going to change any way that you approach the business either with respect to the capital budget or M&A or the way that you promote conservation efforts?

Garik, good question. It will not change what we do. I think it gives us more support for going further in conservation. But it doesn't change, our business or our approach to capital or expense.

Okay. And I just have one more question on the administrative expense. You've been doing a good job controlling it there. Was there any expenses that are rolling off that were related to the general rate case coming to an end that we should factor in as we model out over the next couple of quarters? And/or do you think that the expense run rate at these levels is a pretty good number to use?

Yes, that's a good question. I'll take that one. If you look at our SG&A, our A&G, depending on what you want to call it, really you're seeing the function of A, we kept the operating budgets flat. In fact, parts of the operating budgets we cut back this year going into 2010 because we knew it would be a stretch year. That's number one. So we kept our budgets very lean this year.

Number two, the company is spending a larger amount on capital projects. And the labor associated with those capital projects, as well as the benefit costs, get charged through to that asset. So, and when I talked about this pension estimate, although you see the decline in A&G, that $1.3 million, the pension cost also flows through there. So your decline in A&G would have been even higher if we didn't have that write off going through there for the revised estimate.

So it's hard to say where we'll level out at going into 2011. We're currently in our budget process right now and we'll have the budgets rolled up. And when we get to the February conference call, I'll certainly be able to give you more guidance on that. But really it's about keeping the operations kind of lean and mean as we went through 2010.

Okay. Great. Thank you very much.

Thank you. Our next question is from Heike Doerr of Janney. Your line is open.

Thank you. Good morning, gentlemen.

Hi, Heike.

Good morning, Heike.

Marty, can you tell us what the mark to market long-term [insurance policy] swing was in the quarter? Was there one this quarter as there have been in past quarters?

There is one every quarter. And what Heike's talking about is the company has certain benefit plans. And down in other income and expense we have assets and liabilities associated with those plans. And one of the -- or two of the plans have a Rabbi trust. And those Rabbi trusts are wrapped with a thin layer of life insurance. And behind that trust and behind that life insurance there are investment assets. And so we're required to true up the cash surrender value associated with the life insurance. But behind that is a bunch of investments or mutual funds.

So for the quarter, the mark to market was $1.4 million positive. And that compares to a $1.7 million positive in Q3 of last year. On a year-to-date basis, for the nine months ended, it's $1.3 million positive compared to $2.9 million positive for the same period last year.

Thanks. That's helpful. And can we talk a little bit about the process for these advice letters? How arduous is the filing process and how long will it take for you to get a decision? I'm wondering how we should think about that revenue and if perhaps that additional $7 million or $9 million is really a 2012 revenue contributor and not necessarily 2011.

Good question, Heike. I would say of the $7 million, there's a whole bunch of projects there. We have to do the project, build the project, close it out, and then go to the commission for rates. And I think your estimate's probably right, 2012 is a better starting time for those projects. These are things like build a new transmission line or a new well with a -- you're not quite sure how long it's going to take you. So I will spread that out over the three-year period.

And is this a bit of a divergence from how the Commission has handled projects like this in the past, right? They've normally just said if you expect it will be done on this date and you can start recouping -- or earning on that regardless of if the project had been completed?

Actually, it's not a change.

It isn't.

The last two general rate cases included projects like these. And there's always -- I'm going to just -- a number sits in my brain of 20 to 30 projects that are in advice letter status all the time, that as we complete them we file for recovery and the rates are changing.

So it's -- it has been the practice for, I'd say the last two general rate cases. Small numbers, but it still is part of our capital program and we're used to the process.

And on average, how long does it take from after you've filed the advice letter to getting a decision from the Commission? Is it a quick turnover?

It is. About 30 days --

Okay.

-- from application of the advice letter until rates change.

Okay. Thanks. That's helpful.

Thanks, Heike.

Thank you.

(Operator Instructions) We'll pause for just a moment. Our next question comes from Jonathan Reeder of Wells Fargo. Your line is open, sir.

Hey. Good morning, gentlemen.

Hi, Jonathan.

Just wanted to I guess kind of clarify one thing. Heike already touched on it. So the insurance sounds like the mark to market impact was kind of a plus $0.04 which kind of negates the two -- negative $0.02 charges. Is that kind of right, thinking about it that way?

Well, I think you've got to look at what line it rolls up in. It's down below the line in other income and expense, so it's not contaminating or bleeding into utility operations. So you are correct that it's below the line and it added about $0.02 of earnings, which is basically down a little bit from the contributions made in the third quarter of last year.

Okay. But if I'm just looking on the overall quarterly impact of kind of one-time charges, I guess the positive and negatives overall kind of net out where $0.98 is a pretty good ongoing kind of Q3 number?

Yes. I mean, you have all the elements. We did $0.98 a share. We had the pension adjustment. We had the settlement from the GRC. And then you have the mark to market adjustment with the corporate-owned life insurance products, yes.

Okay. That's all I needed. Thank you.

All right. Thanks, Jonathan.

Thank you. I'm showing no further questions in the queue at this time.

Great. Thanks, Tammy. Well, just in closing, as Pete said, it seems like it's been a long 18 months. It's nice to kind of see it coming to an end. We're real happy with the results of the general rate case. We're also very happy with the company's ability to manage its A&G expense as we went through this 18-month period, which was an extended process. But we're happy to get it wrapped up.

And we look forward to talking to everyone in February for our year-end earnings call. So thank you for your support and we'll talk to everyone later. Thanks. Bye-bye.

Ladies and gentlemen, this does conclude the conference. You may all disconnect at this time. Everyone have a great day.