California Water Service Group (CWT) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your first-quarter 2011 earnings results conference. At this time all participants will be in a listen-only mode; but later we will conduct a question-and-answer session, which instructions will be given at that time. (Operator Instructions) As a reminder, today's conference is being recorded.

Now I would like to introduce your host for today, Marty Kropelnicki.

Hey, Jon, thank you. Good morning, everybody, and welcome to the first-quarter 2011 conference call for California Water Service Group. With me today is Peter Nelson, President and CEO.

As Jon mentioned, a replay of today's discussions will be available from May 5 through July 4 at 1-888-266-2081, ID number 1519942.

Before jumping into the quarterly results I would like to take a moment to briefly remind everyone that during the course of this 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 in our Form 10-K, Form 10-Q, and other reports filed from time to time with the Securities and Exchange Commission.

All right, now let's jump into the quarterly results. We released our press release last night at close of market. For the first quarter, revenue was $98.1 million, up 9% or $7.9 million over the first quarter of 2010. Included in revenue was a net WRAM MCBA adjustment of $6.1 million.

There's two components of that. First the WRAM adjustment. The WRAM adjustment was a positive $9.3 million, meaning actual consumption below adopted; so the Company books a receivable of $9.3 million. And that was offset by a reduction in the MCBA of $3.2 million, meaning actual production costs were below adopted; and that $3.2 million is booked as an offset going the other way.

For the quarter, in terms of ccf, adopted ccf was 24.2 million; actual ccf used was about 20.4 million. So you can see how the WRAM works there. That is about a 16% lower number, which has been consistent with what we have seen over the last couple quarters.

Going down to operating expenses for the quarter, for the first quarter of 2011 operating expenses increased $5.7 million or a 7% to $88.2 million. Of this amount, water production costs increased $1.5 million or 5%, primarily due to higher wholesale prices and increase in the pump taxes.

The following three components are covered by the MCBA, so I want to give the breakouts on purchased water, purchased power, and pump taxes. But do keep in mind that they are covered by the modified cost balancing account.

For the quarter, purchased water was up 7% or $1.7 million to $25.5 million. Purchased power was down about 6% or $318,000 to $4.9 million. And pump taxes increased 11% or $156,000 to $1.6 million.

One of the things that is interesting to know, and you will notice this in our 10-Q which we expect to file later on this morning, is we are seeing a slight shift in our water portfolio in that the reliance on surface water is up about 2% and the reliance on purchased water is down. So as we have seen purchased water price increases continue, that gives us the economic incentive to seek out other sources such as surface water and more well water.

Going down the line on A&G, A&G increased $3.1 million or 18% to $20.5 million. This is primarily driven by increased wages effective January 1, as well as the corresponding benefit costs that go along with that.

Other operations increased $1.1 million or 8% to $14.6 million, primarily driven by conservation and increased costs of water treatment and water quality, again going back to that 2% increase that we saw in surface water.

Maintenance expense for the quarter increased 5% or $200,000 to $5.2 million. Depreciation increased $1.8 million to $12.6 million due to the increased CapEx and new depreciation rates that went into effect January 1 from the '09 General Rate Case.

Now keep in mind, when you look at depreciation you got all the California districts effective January 1. If you go back and look at historical changes, remember you are only picking up eight of those districts that are going through the General Rate Case cycle in that given year.

Other income taxes has a credit of $1.2 million. I want to take a moment to briefly describe that.

The $1.2 million is a result of a favorable non-reoccurring one-time adjustment of $1.6 million as a result of an accounting change in depreciation used in the state of California. The Company uses double declining balance on new assets; and then when they get to about midyear life you switch them to straight-line. If you stay on double declining balance you'd never fully depreciate the asset.

So during last year we did a lot of tax work. We put in a new tax system, PowerTax, and we filed with the state of California -- the Franchise Tax Board -- to change to straight-line on a number of assets.

That was approved during the first quarter, and as a result there is a retroactive catch-up on that depreciation. That results in that one-time tax credit of $1.6 million or $0.08 a share that we booked in the quarter.

Going down to other income and expense, net of income taxes, that increased about $600,000, primarily due to in Q1 of 2010 we were involved in chasing an M&A target. The expenses assisted with that, as we described in our first-quarter Q last year, was about $1 million. So we didn't have that expense this year; so, it looks like other income and expense is up $600,000.

Net interest expense increased $2.1 million to $7.8 million primarily due to our long-term debt offering that was in November. We issued $100 million of first mortgage loans bonds at a double A-minus rating and a 5.5% coupon. Part of the proceeds of that went to pay down the line; and the remaining amount will be used to fund the capital program for 2011.

Going down to net income, net income for the quarter was $2.7 million or $0.13 per share compared to $2 million or $0.10 a share in the same period of last year. Having said that I will turn it over to Pete, then I will come back and talk about the balance sheet. Pete?

Okay, Marty, thanks very much. Good morning, everyone. I am going to comment on three areas this morning. First, our financials for the first quarter, which came in as we expected; I will also talk about our dividend increase; and then an expected stock split coming in later this year.

Second I will talk about rate making now that California Public Utilities Commission is fully staffed with five commissioners. I will talk about how that is shaking out, and I will also talk about our latest filing, which is cost of capital that we filed this week.

Last I will talk about the state of California in general, Governor Brown, and how he is working through the budget situation here.

So first, the first quarter. Absent the one-time adjustments, we think it came in very close to our expectations. Anyone who is following us or has been for a while knows that we are very high fixed costs company. The way the rate decisions -- primarily the 2009 General Rate Case -- are implemented really makes the first-quarter results insignificant to us.

The reason for this is there are three phenomenons at work here. Marty mentioned these, but I am going to go through them.

First is the fixed-cost increase January 1. These are things like depreciation, labor costs, conservation, pension, all of those ramped up the first of the year.

Second is how those fixed costs are recovered is important. Most of the fixed costs -- in fact, 65% now; it was 50% before this year. But 65% of those fixed costs are now recovered in the quantity charges, which are tiered rates or increasing block rates. So you will see the recovery of fixed costs following usage patterns, and that is important.

And third phenomenon is just the way the rate case allocates the margin month by month. It squeezes the margin into the second, third, and fourth quarters. So that is the reason why you are going to see -- have seen first quarter being kind of ho-hum, and then the margin being collected in the second, third, and fourth quarter.

Having said that, our Board did however make some key decisions this quarter. First, they raised the dividend $0.04 a share. For us, that's a lot. Effective January 1. In the past few years we have raised it $0.01 per year, so the $0.04 is a big change.

Second, we essentially decided to split the stock 2-for-1. That decision is really on the proxy this year for a vote May 24. I know this is a mathematics situation, but really we don't do this stock split too often. This is done pretty infrequently.

So what you are seeing for the first quarter is our success over the last few years in reducing the payout ratio really, and getting where we are financially, makes us confident that this is the time to make the decision to change the dividend rate and split the stock. So you put that all together, and we feel very confident about how we are going into 2011 and '12 and '13.

Second topic is rate making. I mentioned the commission is now at full complement of five commissioners. Since our last call Governor Brown appointed the fifth commissioner, Mark Ferron of Marin County.

You have probably read about his background but it is in banking and finance; and most recently he has been a volunteer at the Silicon Valley Social Ventures, which is a nonprofit organization. But before he retired ant took that position he worked full time, career obviously, at Deutsche Bank, Salomon Brothers, Bank of America, and almost all that time was spent in London. Before he was appointed to the commission he was very helpful to the governor, working one-on-one on the state budget.

So now we have got the three new Brown appointees. Mike Florio, whose background is in consumer groups and electric regulation. Cathy Sandoval, law professor from the University of Santa Clara, background in telecommunications. And now Mark Ferron, background in banking and finance. And they are all waiting senate confirmation; no date certain on that.

I think you will see that all three are very different, you see from their resumes. The one thing they all have in common is they have no experience in water. And that is not good or bad, it just is.

You may recall Commissioner Bohn who was our water commissioner also walked into his appointment with no experience in water.

We have met and talked to each of the three. They are all very quick studies obviously and very interested in learning about water. But so far as one being named the water commissioner, in the John Bohn model, that remains to be seen and that will probably get sorted out in the next few months.

The second issue is cost of capital. We and all of the other large water companies in California filed our application for cost of capital on Monday. We all filed them together; but they are all processed really independently, at the same time, if that makes any sense.

We are asking for no change in our cap structure. It's 53% equity, 47% debt. We are asking for 11.25% adopted return on equity.

Anyone who has ever followed a cost of capital proceeding knows that this is sausage making at its finest. Those who thought it was an easy math situation or a linear financial calculation, they're cured of that notion pretty quickly.

So there is no way to speculate on where the cost of capital is going to go, how it is going to turn out. The schedule calls for a decision by the end of the year; and that will be in place for the years 2012, '13, and 14. So stay tuned on cost of capital; it is always an interesting proceeding.

Last issue is Governor Brown. I get asked about him almost every day. He is four months into his term. I and many others are very impressed with his focus on the budget, balancing the budget.

I still think if anybody can pull this off, he is the one person that can. And he is confident that he will pull this off too, and that he will pull it off soon.

As an example, I and many of my counterparts in the Silicon Valley met with him a couple weeks ago. The group that we -- as we met with him, it is called the Silicon Valley Leadership Group, which is a collection of CEOs in the Valley here. Pretty influential group in the region, if not the state.

We are on record as endorsing his budget and supporting his budget proposal. Anyway, we met with him a couple weeks ago and we asked him at the end of the meeting -- what can we do to help you get this budget through? It's an obvious offer to lobby for him.

He responded in so many words -- nothing. It is my job to get the agreement with the legislature and balance the budget, and I will get that done in May of this year.

So it's kind of refreshing to hear a different kind of politician, which is pretty refreshing. So that is my three points. I will go back to Marty now to wrap the financials and then we can take questions.

Yes, just one follow-up, Pete, on your point about how the rate relief works. I actually pulled some of the numbers to share with the folks on the call today.

If you look at the new rates that we got within the quarter, we got about $7.1 million of rate relief. But of that $7.1 million, $4.6 million had to do with purchased water offsets and purchased power. So there is no, quote unquote, margin associated with that $4.6 million.

So when you back that out, that gives us about $2.5 million of new margin, quote unquote, new margin. When you compare that to your costs, your employee costs, wages and pension and benefits that went up $3.1 million; add in depreciation that went up $1.8 million; and then put in your increase in conservation, you get $5.4 million of call it more fixed costs, effective January 1, offset by $2.5 million of real margin rate relief.

The other interesting thing to note is if you look at -- some of you have seen in our IR presentations, we have been showing what the adopted gross margin curve is for the year. For 2011 the target is $306.4 million; for the first-quarter 2011 we achieved about $61 million of that. So that means there is about $245 million of gross margin that will be obtained during the last three quarters of the year.

Having said that let's go to the balance sheet and talk about a couple things on the balance sheet. We started 2011 with two new balancing accounts.

We have the pension balancing account, which is a full two-way balancing account. Which is good because that takes away the volatility associated with swings due to changes in pension assets and pension estimates. So we are very happy to get that put in place.

We also got a conservation account that is set up. The conservation account is a little different in that we have a three-year target, and we are spending approximately $30 million over the next three years on conservation. If we don't use that we have to give it back.

So you contrast that to the pension balancing account, which will allow the pension assets to swing up and down. Now one important distinction between those two accounts -- the conservation balancing accounts follows the slope of the revenue curve.

So in Q1 it is a lower amount. As we have greater amounts of rate relief, we will spend more on conservation.

The pension balance account, pension costs are a straight 1/12th every month. So again getting back to one of the seasonality things that we see within the Company is the fact that we have to book 1/12th every month on the pension and we are not getting a full rate relief essentially for those pension costs. We will get that later on in the year.

Looking at net utility plant, we passed up $1.3 billion for the quarter; that is up 6.6% from the same period last year. Company funded CapEx was $23 million for the first quarter. Just to remind everyone, our target this year is do between $120 million and $140 million in CapEx.

Our work in progress balances were up about 4% from $103.7 million to $107 million year-over-year. So we continue building out our multiple projects.

Cash flow from operations was $25 million, up $2 million from Q1 of last year. So overall feel really good about where we are in the balance sheet and income statement. Obviously Q1 is typically our tightest quarter of the year, so it's nice to have that done and behind us.

And as I mentioned we will be filing the Q later on this morning. And some more information about the items that we talked about today will be found in the Form 10-Q. With that, John, we can open up for Q&A, please.

(Operator Instructions) Jonathan Reeder, Wells Fargo.

Hey, I guess I am the lucky one. Good morning, Marty and Pete. Just wanted to ask you if there is any reason we should suspect that the senate will not confirm those three appointees. It sounds like it is a balanced group of individuals, handpicked by the governor, that I think has a reasonable amount of power in the state. Is there any reason that we shouldn't expect those three to be confirmed?

Jonathan, I expect them to be confirmed. The state senate is Democratically controlled, and these are all three I would say reasonable appointees. So I don't see a problem getting them through the state senate.

When that happens, I don't know. So you have got to wait on that. But they have to be appointed by -- not appointed, they have to be confirmed by the end of this year, but they need to be re-appointed by the governor.

Okay, so it might be something they take up after they settle the budget?

I would think so. Yes, sometime this summer.

Okay, and then I guess with the cost of capital filing, are you hopeful that it gets done by year-end? I know all four companies laid out a proposed schedule with December resolution.

Is that realistic? Or with three new commissioners is it going to take a little more time, do you think?

Hard to speculate. We do want it by the end of the year, no question. We want it to stay on schedule.

But with the three commissioners this is going to be a learning experience for those three. However, the staff that is in place has been through this many, many times. So I don't yet see a reason for it to be off schedule; but where the numbers end up, anybody's guess.

Remind me, this is an issue where you can work with the staff, who historically you have been able to work with pretty well, and potentially come up with a settlement? Or is this something that has to be fully litigated?

Well, yes, we are hopeful for a settlement, a number we can all agree on. But it might be different for each of the companies. Could well be different for all the companies, in fact.

I don't know. So we will see how this goes. I think we will have much more information in the next quarter; so stay tuned on this.

Okay. Thanks. That's all I have right now.

Heike Doerr, Robert W. Baird.

Thank you. I know it is a small piece of the business, but I wonder if you could comment on Hawaii and the timeline for your rate filings there.

Sure. Heike, good morning. Yes, Hawaii we plan on filing -- there's actually seven rate cases there, seven rate-making areas. We plan to file all those this year.

We've already filed one, which is the Ka'anapali system; and we are asking for $1.5 million there in new rates. It takes about 12 months to process a Hawaii rate case.

Ka'anapali is one of our two systems on Maui; the second is Pukalani. Our other five systems are on the Big Island.

So you are right; the numbers are not going to move the needle that much. But we expect to have all the Hawaii rate cases filed early this year and in process.

Are you planning on working toward the consolidation at least on the Big Island?

Consolidation of rate-making?

Yes.

You bet. For water and for wastewater.

Do they have a forward-looking cost year, or is it historical?

It's historical.

I know on the electric side there has been a lot of changes on the favorable side in the Hawaiian regulatory climate, as they use the utility to help them work toward conservation. Do you see an opportunity for you there as well to partner with them?

To partner with the electric company?

No, to partner with the commission. Similar to how you have in California, to help with consumption patterns and wisely using your resources.

I think so. The new chair of the commission is very positive on that and willing to work obviously with electric companies, and I expect also to work with the water companies.

In fact I met her last year at an NAWC regional conference back there. She seemed very reasonable and easy to work with.

Yes, I think the other thing in Hawaii too is that they're subject to some pretty big swings in electrical costs which affect our pumping. So in Hawaii, if anyone has ever been there, it is just expensive to go there. Everything costs more money.

So when we put in wells, believe it or not, some wells we have to go down 1,000 feet, 1,200, 1,400 feet versus 300 or 400 feet in California. So costs are just more.

So I think the more we can do for conservation, the better. I think we have obviously set a good precedent in the state of California.

In fact, I was chuckling a little bit when I was preparing for this call, because I went back and looked at our conservation budget three years ago, and it was a couple hundred thousand dollars. I look at almost having a $10 million conservation budget this year, and everything that we are trying to do for all our customers. So we take conservation very seriously.

Great, thanks.

(Operator Instructions) It appears that there are no further questions.

Great, thanks. Well, just again thank everyone for dialing today on the call. If you have any further questions, feel free to give us a call as mentioned in the 10-Q we plan to file here -- hopefully as soon as I get off this call it will hit the printer and hit the SEC.

And thanks, everyone, for support. It is glad to have Q1 behind us and we look forward to talking at the end of Q2. Thanks, everyone. Thanks, Jonathan.

Okay, ladies and gentlemen. This does conclude your conference. You may now disconnect and have a great day.