California Water Service Group (CWT) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the California Water Service Group Third Quarter Earnings Results Conference Call. As a reminder, today's call is being recorded. I would now like to turn the meeting over to Mr. Martin Kropelnicki, Vice President and CFO. Please go ahead, sir.

Thanks, Leah. Good morning, everybody and welcome to the Third Quarter 2011 Earnings Conference Call for California Water Service Group. With me today is Peter Nelson, President and Chief Executive Officer.

A couple administrative things before we start, a replay of today's proceeding will be available from October 27, 2011 through December 26, 2011. That dialer number is 1-(888) 203-1112 and the replay pass code is #4591937. Also, if anyone needs a press release, it's up on the company's Web site at www.calwater.com, and before looking at the quarter, I'd also like to take a few moments to read our Safe Harbor Provision on 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 uncertainty 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 disclosure on risks and uncertainties found in our form 10-K, form 10-Q, 8-K and other reports filed from time to time with the Securities and Exchange Commission. Having said that, let's start talking about the quarter.

Revenue for the quarter was up $22.9 million or 15.7% to $169.3 million. Four main drivers that are affecting revenue, first and foremost rates went up $21.5 million. New customers added approximately $1 million. That was partially offset by a decline in water consumption and other charges of about $12.8 million and finally we have the RAM MCBA, which added in back $13.2 million. That will reconcile back to your change in revenue of $22.9 million. Operating expenses for the quarter increased $18.7 million or 15.5% to $139.2 million. Consistent with past practices, I want to break out some of the water production costs and other major components within our operating expenses.

First, and keep in mind water production costs are covered by the modified cost balancing account and have a net zero impact to the EPS line. Water production costs for the quarter; purchased water increased $7.1 million or 18% to $47.6 million. This is primarily due to wholesale water increases, not increases in consumption or increases in demand. Purchased power increased $32,000 or .03% to $10.9 million and pump taxes decreased $200,000 or 6% to $3.1 million. Overall, Q3 2010 to Q3 2011 consumption declined approximately 4%, and year to date 2011 consumption's down about 2%.

Terms of A&G or admin and general increased $3.9 million or 21.7% to $21.6 million, couple drivers here, first and foremost increased labor and benefits, in particular pension and healthcare and higher legal and outside services. And looking at the pension healthcare, pension increased $750,000 or 12% and healthcare increased approximately $650,000 or 17%. Both of those increases were budgeted for and well within the budget that was set by Cal Water and both of those costs are embedded in current rate structures. Litigation, outside services, here this is where we start to see a little bit of variance from the company's budget. Litigation, outside services were up approximately $700,000 on the quarter, really driven by two primary reasons. One, we just had in the ordinary course of business from time to time we have litigation, excuse me, and the company is required to defend itself. Year to date we've spent about $1.4 million in this area. We've just had some increased litigation this year, none of which the company believes has any liability, but is defending itself. Secondly, we have had some increased security costs throughout our service territories. We've had a couple issues of attempted robberies and so we have spent about $300,000 more on some security for some of our offices in some of the more depressed areas of California. So in total, on a year-to-date basis, there's a couple pennies there that were things that were above what was budgeted for within our operating budgets.

Looking at other production costs, other production costs increased $2.6 million or 17.6% to $17.5 million. Two primary drivers here, first and foremost conversation. Conservation was up $700,000 or 117% to $1.3 million. That's consistent with our goals and expectations set with the water action plan and our corporate goals to help our customers conserve water. In addition, we had increased labor of subsidy with pumping in operations within the quarter, which is pretty typical during the third quarter as it is one of our busiest quarters. Maintenance expense for the quarter was down about $200,000 or 4.2% to $4.7 million and depreciation was up $1.8 million or 16.4% to $12.7 million. Primary reason for the increase in depreciation is really driven by the company's capital program as well as higher depreciation rates that went into effect on January 1, 2011 from our last general rate case for the State of California. Income taxes for the quarter were up about $3 million or 24% to $15.8 million. The increase is driven primarily by higher earnings from utility operations as well as a higher effective tax rate. Also during the quarter, property taxes increased $615,000 or 13.5% to $5.2 million primarily due to new plants that's been put in the ground over the last 12 months and the property tax that is associated with that.

Net operating income increased 16% or $4.2 million to $20 million for the quarter and for the nine months ended 9-30-2011, that operating income was up 19% or $10 million to $59.5 million. Going down into what we would say is below the line, other income and expense net. That decreased $2.8 million to a loss of $1.8 million for the quarter. Couple things happening here, as some of you may recall, the company holds certain long term assets in this non-qualified retirement plan. If you look at the VIX index, the volatility index, September 30th happens to be the second worst day of the last 12 months for market volatility and we're required to essentially mark to market and flow through the unrealized gains and loss to the income statement. So as a result, the loss within the quarter was $0.04 and if you look at the swing from Q3 from last year to Q3 this year, it's a negative $0.06. It's above that. Again, that's a non-realized loss. If you look at where the VIX is now, most of that's been regained. It's really a timing difference of where we shut the books and what's happening with the value on that particular day. In addition, in other income and expense net, we have about a $0.01 or about $650,000 increased costs associated with new business opportunities that the company has been pursuing.

Going down to interest expense, interest expense is up about $900,000 or 13.3% to $7.3 million. This is primarily driven by our long term debt offering during 2007, and embedded in that number there is a partial offset of about $500,000, of which a majority of it was associated with the savings from our amended and restated line of credit that we renegotiated over the summer with our syndicated line.

Net income for the quarter was $20.9 million or $0.50 per diluted share, and a couple things. We've come back up to 10,000 feet. Let's just kind of look what's happening within the quarter. Consumption has continued to decline. The RAM MCBA mechanisms are working, and earnings from operations continue to be strong. Couple things that we've highlighted in my points, again, legal outside services are up for the reasons discussed. We had a fairly large mark to market or change in asset value that we had to reflect on the books and then we had some business development costs that we had incurred over the quarter.

With that, I'd like to turn over to Pete and have Pete talk about what's happening at 20,000 feet.

Okay. Thanks, Martin. I'll stick on the throttling with the 20,000 feet here, but welcome everybody. Glad you could join us this morning. I do have four items to talk about today. Well, the first three are regulatory items. First, an update on our cost-to-capital proceeding. Second, I'll talk about the California Commission has named a Water Commission this month, which is a good move. And third, I'll look ahead to 2012 and 2013 as to what rate changes to expect for next year and the year after. And lastly, I'll talk about one non-regulated issue, and that's our lease of the City of Hawthorne's water system, which was just renewed. We're very pleased with that.

So going back to rate making, the first item is our most important and current proceeding, that's cost of capital. Most of you know that this is a proceeding that sets the adopted return on equity and capital structure for the company and we're currently at 10.2% adopted return on equity and 53% capital or equity as part of the capital structure. This proceeding, as most people know, there are four water companies are in the proceeding. So it's a four party proceeding and working with the commission staff. We have asked for, Cal Water has asked for an 11.25% ROE. Commission staff has recommended an 8.25%. So the hearings were scheduled to start October 17th and those of you who are paying attention realize that there are no hearings. In fact, they were cancelled. So many of you have rightly included that we are in settlement discussions with the four parties and commission staff, the rate advocates in particular. Of course, I can not comment on the discussions. Once those details are finalized and put to paper, we will file the settlement agreement, and then we'll issue an 8-K and a press release. When that's going to happen, I don't know. I'd say soon. We'll see, but you've got five parties working on this document and one settlement document. So given that, of course, nothing is final until the commission says it is. And so, the next steps here are first to finalize and file the settlement agreement. Next the ALJ, Administrative Law Judge [Benmenstorker] will issue his decision, and third there will be a decision by the commission on the case. I do expect a decision by end of the year, so any rate changes would be effective January 1st and not delayed.

Second issue is in California, the California Commission has named a water commissioner and you may recall that we have had named water commissioners in the past, Commissioner Bohn most recently. Before Commissioner Bohn, Commissioner [Ducchi] worked as the water commissioner. Both those appointments, I think, worked out very well for all parties, and I see this naming of a commissioner, in fact, this Commissioner Cathy Sandoval, as a good move for the industry and the commission in two ways. First is that I think it's good to have a water commissioner assigned. As the water industry is small compared to the electric and gas and telecom industries and if the water issues are spread out among the five commissioners, we can easily be diluted and no one really keeping track of or watching out for the water industry. So if you do have one commissioner and their staff that's at least feeling somewhat responsible for water industry cases and fully conversant in the water issues, I think that's a good thing and it's a place to go for us for water issues rather than try to go to all five commissioners.

The second reason I think this is a good move is I think Commissioner Sandoval is an excellent choice. She's got a very experienced staff in water. We've worked with them in the past. They know the issues. They know the background. They know all the issues very well, so a very experience staff. And she has been very willing to talk with us and engage with us on water issues. I'm still impressed, thinking back last year before she was appointed she was being considered, she called us up and said, "Can I come over and learn about water?" And she came over to our office, sat down with us and for two or three or four hours just talked through water issues to bring her a little bit up to speed to know what she was getting into on the commission. So I was very impressed with that. I've never seen that before from a perspective commissioner, so that was great. As far as her track record, this is her first year as a commissioner and she's -- I've noticed she's been very willing to apply facts and the law in a very pragmatic way in her decisions. We'll never agree with any commissioner on everything, but from my point of view, this is a good choice, sound choice to be the water commissioner for California.

The third regulatory issue is looking ahead to the rate cases that will be decided this year or next year in California or outside California. Actually, I've been asked about the non-California cases of late, so I'll talk about them quickly first. In fact, in the non-California states, all our customers will have been covered by some kind of rate case this year or next year, mostly small potatoes, but still important to those states. So first Washington, we have filed and asked for a $1.5 million rate increase. That's a pretty short process. I will expect a decision there before the end of the year. New Mexico, we were granted $300,000 in rate increases this year, 2011. And in Hawaii, we have seven separate rate cases, two of which are filed. We're requesting a $3.2 million in those and then we have five more cases that we'll be filing between now and the end of the year. The Hawaii cases take nine months to a year depending on their size, so I would expect these all to be decided in place sometime in 2012.

The other sources of new revenue for us next year in California are attrition and capital advice letters. Attrition also called step rate increases or sometimes inflation increases. These are the rate case increases that are between the test years. These are not easy to calculate, not easy to forecast because they depend on the inflation numbers at the time, depend on how each of our 24 rate making districts is earning, if they're earning their adopted rate of return or not. So it's a tough calculation. The maximum possible attrition increases in California is less than $10 million and I promise you it will be less than $10 million for next year. But we'll know better in a couple weeks, maybe sometime in November we'll make the filing and we expect a January 1st start date for those attritions.

The second source is capital advice letters, which you've asked us about in the past. The 2009 general rate case left about $8 million in revenue out there to be requested as capital projects were finished, completed and filed with the commission. The nature of these projects is that they tend to be later in the rate case years, 2012, 2013 and they tend to be more uncertain as to their cost and to the timing and so, it's pretty difficult to tell you when that $8 million of revenue will be requested, 2012, 2013, we'll see. So that's a little bit uncertain there, so I wouldn't probably change your forecasts on the capital advice letters. The last comment on rate making is we're spending a lot of our time and resources building up our 2012 general rate case filing. That will be filed officially July 1st. It's an 18 month process for rates that will be effective January, 2014.

I think that concludes the regulated piece. Now to the one non-regulated issue and in our press release you saw that we were awarded another lease for the city of Hawthorne water systems, about 6,000 customers. Our 15 year lease expired this year and we just finished a competitive process, have been awarded another 15 year lease. That for us is a good contract, good lease. It's a system that's adjacent to ours. We know the system. We know the customers very well. We've run that thing for 15 years, and so we're very happy to be chosen by the city as a leaseholder. This was a competitive process, not easy, but we feel good about being the winner there.

For those of you who are modeling this in your forecasts, I don't think I would change much. It's about a $7 million revenue issue and less than $1 million in contribution that will vary year to year. So I don't think I would make any new assumptions on the Hawthorne lease or results or returns to us.

That's it, and I'll turn this back to Marty for balance sheet and closing comments.

Great. Thanks, Pete. Yes, keeping on the same of what we're doing with the earnings test and getting the attrition rates filed, net utility plant for the quarter was up 5.7% to $1.356 billion. Work in progress declined $18.4 million to $115 million. Don't want anyone to panic about that. That was our mad dash to get as much capital into service by September 30th for the attrition rate filing, and now that we've closed the books and got the whip down, got the projects closed our rates department is now working on calculating that complex test and we'll get that filed.

Company funded CapEx is $83 million for the nine months ended September 30th and cash flow from operations for the same period, nine months ended September 30, 2011 was a positive $99 million. For the quarter, we ended the quarter with $47 million in cash and availability on our short term lines of credit, close to $400 million. So the company continues to have a very good balance sheet and plenty of liquidity for growing its business. As Pete said, we're spending a lot of time on the financial planning around the 2012 general rate case. If you remember pension, our pension expense is covered by a pension balancing account effective 01-01-2011, focused, I think, for 2012. Obviously, spent a lot of time modeling our healthcare costs, what's that going to look like, what are the impacts of the federal legislation on our healthcare expenses and we have a couple other projects we're doing across the enterprise looking at trying to model and squeeze out the efficiencies of our operation.

Leah, with that we will open up for Q&A please.

Thank you. Ladies and gentlemen, today's question and answer session will be conducted electronically. If you would like to ask a question, you may signal to do so by pressing the star key followed by the digit one. If you have joined on a speaker phone, you'll need to make sure that your mute function has been turned off to allow your signal to reach our equipment. Additionally, if you pressed star one prior to hearing this announcement, you'll need to make sure to press those digits again to ensure that your signal has been captured by our equipment. Again, that is star one for questions. And we'll move first to Michael Roomberg with Ladenburg Thalmann.

Hey, good morning guys.

Good morning, Michael.

Just first a question on the somewhat one-time items you have in A&G and other expenses. If you could kind of run through each of those and talk about how you see them evolving over the coming quarters? The litigation I think you mentioned was $1.4 million in the quarter, the security expenses were $300,000 and you had $650,000 in business opportunity expenses in the other category. So can you talk about how you see those expenses evolving in the coming quarters?

Sure, sure. First, let me just make sure I clarify legal costs. On a year-to-date basis it's about $0.02 of incremental costs associated with various litigations. And what's hard with legal costs is you don't know when they're going to hit and you have to expense those costs as they are incurred. So it's stuff, that while we say is in the ordinary course of business, we just don't know when it's going hit and sometimes you get a quick case that you have to defend. And what happened this year is we've had a couple major cases. We don't believe the company has any significant liability associated with those cases, but we do have costs to defend. And the ones I'm thinking about, they're going away. They're resolved. There was no liability found on behalf of the company, and of again, it's in ordinary course of business. So you do have this kind of $1.4 million sitting out there that is above and beyond what we budgeted for. I can't predict what's coming down the pipe next in terms of litigation, but I would strongly point out that that $1.4 million was above and beyond what was budgeted for in our operating budget this year, and was spent primarily on legal defense.

The other component of it is that we have had to beef up some security in some of our districts for our employee safety. And so there's a few hundred thousand dollars, about $300,000 associated with that in those numbers. So legal, the best thing I can do is call the variances out as they happen and make sure we explain them thoroughly on this call. I'd also call everyone's attention to how we describe things in our 10-Q and our 10-Q will be filed here probably in the next few days.

Pension, healthcare I'm not as worried about because the increases that we talked about a little bit earlier in my opening remarks, those were included in the budget. Pension's covered by a balancing account. We're not seeing a big benefit from that balancing account this year. We don't expect to see it because it's the first year out of a general rate case, but in year two and year three we expect that balancing account that will take care of a lot of the incremental expenses because they're certainly going faster than inflation. Healthcare so far has been in check. According to our actuaries, the national average is up about 9%, 10% this year. We're running about 7.5%, 8% this year, so we're running below the national average so we think that's good.

So really when you look at the quarter, the things that jump out, the things that are up in the line in operations, it's only just the legal costs and the costs of some increased security, so within our operations.

Sure. And the security, I mean, is it a one-time thing where you invested in new safes that are triple locked or is it something you could expect to continue to accrue a rough $250,000 in each quarter going forward?

That's a very good question, Michael. I mean, essentially in this case what happened is we had an armed robbery. It was picked up in the local papers, so this isn't any proprietary or confidential information. And we take employee safety very seriously. So we have the cost of the security that we put on site. We are in the process of spending capital dollars to reconfigure those offices to increase the security measures and we're also looking at that across our enterprise. Now, the reconfiguration of the office and improving the security, most of that's capital. But we do have -- we do operate in a couple districts that the economy has been pretty hard hit and we want to make sure our employees are safe. So I think as we spend the capital dollars to improve the security programs, you'll see those security dollars go away. And we'll use those on a case-by-case basis as needed where we have to collect physical security. That's not in the norm of our operations to have an armed security guard in our district offices. I think it's probably more a function of we've had a pretty bad economy.

No, fair enough, fair enough. I guess the next question will be with respect to unbilled revenue. I think in prior years through the first three quarters of the year, you tend to see about an $0.08 tailwind on average. It appears, I guess, by my calculations that you have about a $0.21 cent tailwind going into the fourth quarter of this year and correct me if that's wrong. But I'm just wondering if that is in fact the case, how does that set you up for what's typically somewhat of a reversal of that dynamic in the fourth quarter.

Sure, sure. Well, let me talk theoretical and then we'll talk practical, right. Theoretically, the changes in unbilled should net to zero right. Basically, it's the billed revenue accruals at the end of the period. The commission in the state of California uses billed revenues for rate making purposes. So they're on a cash basis. So this revenue accrual is not included in the RAM. So really it should just be a timing difference from point A to point B. The real question becomes at the end of the accounting period, at the end of the quarter, at the end of the year, what's going to be that billing lag, and that can swing a little bit as we saw in Q3 last year. We lost a couple pennies because that number swung way above its mean, its five year mean of where it was at 12-31. So we include that in our internal budgeting. We try to plan for it. I believe our ending AR at the end of Q3 was about -- our unbilled was about $21 million. I would expect that unbilled number to go down to about $16 million is my best guess, but it is a guess and it is contingent upon the last 30 days of consumption and what really the weather is in the last 30 days of the billing period.

No, that makes sense. One final question, if I may. The cost of capital here, and I think, I guess we were kind of excited when the hearings were cancelled and I guess the sense was that there would be settlement that would be pretty quick. Has anything that's happened in the last few days changed that thinking in terms of when the terms of the settlement would actually be announced.

Michael, no, it's going as swiftly as it can. I'm pleased with its progress and I think in this case at this time, it's a good thing to settle a proceeding like this rather than go to litigation, so no, nothing new. We're just kind of hammering out the details, putting it on paper. You got five parties who have to sign off on this. So it's going as well as I would expect it to.

Great. Thank you very much.

And Michael, just so you know, once we do have a signed settlement we will be filing that and filing an 8-K accordingly.

Okay. Thank you.

Our next question comes from Christopher Purtill with Janney Montgomery Scott.

Yes, thank you. Good morning, guys.

Hey, CJ. How you doing?

All right. First on the below the line adjustments, the mark-to-market adjustments, can you talk about any options that you think you may have in the accounting treatment of those changes for the life insurance policy, and I don't know if there's any routes that you can look to explore that would either minimize the impact or help smooth that impact out over time. It's certainly a difficult item to model for in the out years, so any color you have there would be really helpful.

Yes, CJ if you remember our discussion, because we went through this in detail and you had a lot of questions on this in June or July of 2009 when we were dealing with the full force of the down market due to the subprime crisis. Yes, the shopping back to 2009 as I was preparing my notes and looking at what was happening with what's going on here, first and foremost, I think just at 50,000 from a rate making perspective, the company recovers the current portion of any non-qualified retirement plan in rates, okay. And that's embedded in the rate structure and that's how we recover it. Most utilities have unfunded long term liability. They hang that long term liability up on the balance sheet and there's never a funding mechanism for that liability. They just -- it's a pay-as-you-go concept in California, and I think it is in most states. We have a long term asset that corresponds with that liability. That's not 100% funded, and I don't think it ever will be. I don't think it can be per IRS rules. Essentially, it's the [rabbi] trust. It's an insurance product. And then behind the insurance product is a number of investments, and those investments essentially change on a daily basis as the market changes and that is reflected in the change in cash surrender value associated with those policies.

The accounting literature, there's kind of two pieces. There's some literature that would say that real long term assets that you hold, you don't have to mark to market. If you think about real estate, for example, we're not always valuating our real estate and changing it, which frankly probably would be a good thing given the age of some of our properties that we hold. But there is specific accounting literature that talks about corporate owned life insurance policies and we're required to essentially reflect the changes in cash surrender value through other income and expense. So don't have an easy answer on it. I will tell you in 2009 I looked at the possibility were there hedging mechanisms we could use. I looked at the accounting treatment in detail. I'll honestly do that again now. I'm sure we'll get a lot of calls over the next couple days saying can you walk us through this stuff again, because it's a little foreign. No one else has it. But the bigger picture I would point out for the shareholders it is the right answer in that you have a funding mechanism for that long term liability and frankly, I don't want to say if Pete passes away or if Mike passes away or people in the plan pass away, that does provide part of the funding mechanism. So from a long term strategy, it makes sense, but we're unique in that we have set this thing up.

If I could shift away from me passing away here. CJ, let me give you a little of my opinion here. And if you listened while you were talking you would have hears us chuckling when you were asking the question.

Yes.

Any question, especially given the discussions here in the last week or so, to me, I'm a non-financial person, but to me it is frustrating to add this in and take this out every quarter to get down to the real base operating earnings. So yes, we're looking at options, how else can we do this to really communicate better with the financial community and the stockholders what the base earning are. It's frustrating here too.

Yes, CJ, one thing I would add on that too, is if you go back and look at our Qs and Ks, we've always disclosed what that net change is every quarter so people can follow it.

Right. Okay. All right, fair enough. And then I guess just on the admin expense, I don't want to beat a dead horse. We certainly have the labor up and benefits up across the board and you addressed the legal costs. I'm curious if there were any outside service costs maybe associated with lawyers and rate experts on the cost of capital case, so that as we move closer to a resolution maybe some of those outside services costs go or was it just kind of relatively minimal. I know Martin, you're really the rate expert, so.

I'm not the rate expert, but Tom Smegal is the rate expert. I was prepared to testify on our cost of debt on the risks that the company takes, things like that. We did have some, we did hire an outside economist who worked with us. It wasn't a real big number, and then we also have a very, very good in-house counsel that was leading that case for us. So historically, I would have said yes, we probably had $0.5 million to $600,000 embedded in that cost of capital process, but the way we structured the company with our in-house counsel, Tom's testifying, me testifying and then we have a little bit of piece from the outside third part, it's not a whole lot of money.

Okay. All right, great. And then just lastly, you talked about the settlement discussions. I'm curious if the settlement discussions kind of fail to come to any kind of resolution, do you think that -- what kind of risk do you see to the timing of that December, January deadline? Do you think we're totally safe in hitting that if the settlement discussions fail to materialize or do you think that because of the time that's been spent on the settlement we maybe push out a little bit?

I can't comment, obviously, but I feel very good about where it's going and I expect a decision by the end of the year.

Okay. All right, fair enough, thanks guys.

All right, thanks CJ. Hey congratulations on your new job.

Hey, thank you, appreciate it. Thank you very much.

Our next question comes from Garik Shmois with Longbow Research.

Thank you. Good morning.

Hi, Garik.

Hi. Just have a question on water consumption during the quarter. It seemed like it declined a little bit more than what we saw in the first half of the year. Can you break out if this was, in your opinion, weather driven, just given some of the rain that you had in California earlier in the quarter or if you're seeing anything more material occur there?

It's hard to break out weather versus conversation. The only thing I'd point to is we're spending a considerable larger amount on conversation with our customers than we've ever spent before. You couple that with the 20/20 goals of the state of California, the talks from the drought from California, the tail from the drought and I think you're seeing consumption just go down. But it's hard to pin any one particular element. And so one of the things we've tried to do on this call is we talk about the change in consumption and we try to -- if you think about the costs, the water production costs, purchase power, purchase water, pump taxes. On one sense, from a P&L perspective, those are almost irrelevant because we're made whole through the MCBA and the RAM, but on the other hand that's what tells the story what's happening with customer demand and that's why we try to give some update every quarter as to what those elements are, how the costs are moving. You're seeing very big increases in purchase water costs, and that's being offset by lower consumption.

Okay. No, that's fair. And just my last question is on the tax rate. Just wondered if you could provide a little bit more visibility on what we should expect. It trended up for the reason that you mentioned here in the third quarter as well as earlier in the year, but you have a pretty easy comp in the fourth quarter with respect to taxes. Shall we expect the tax rate to drop back down like you saw in 4Q of 2010 or would it be in your estimation somewhere in this low 40 range going forward?

I'm smirking because this is the one question I was dreading. And I'm going to have to go tax psycho on you guys to explain this, but I think it will make sense. First and foremost, to your question I would probably move closer to the higher statutory rate of 41.7%, and let me tell you why. Everyone knows bonus depreciation's out there. In 2010 we had about $19 million of bonus depreciation. In 2011, we have about $30 million of bonus depreciation. That bonus depreciation lowers our tax base, but that allow our Q pad deduction on our qualified facilities deduction, which is based on percent of revenue or percent of earnings, excuse me. So there's about a $2.2 million deduction, and we're losing deductions now because of bonus depreciation. So on one hand you're getting this tick up on cash flow and this tax credit back, but on the other hand you're losing deductions because of it. And so, given where we are for the next -- through the end of 2011, I would advise people to push up higher towards that statutory tax rate of 41.7%. Now, is it going to be 41.3%? Is it going to be 41.5%? Is it going to be 41.7%? I don't know until we actually do our estimate taxes for the quarter, but essentially what's happened is you're squeezing out deductions from the bonus deduction.

Okay. No, that's helpful. I appreciate you walking through us. That's all I had. Thanks a lot.

All right. Thank you.

Our next question comes from Jim Lykins with Hilliard Lyons.

Morning Pete, morning Marty.

Jim.

Morning, Jim.

First of all, with the $0.04 related to the mark to market, tell me if I'm thinking about this right, there's never going to be any kind of reversal for that, but or there's going to be some kind of ongoing quarterly fluctuation that we should be -- or looking at the volatility to get a rough gauge on how much that's going to move up or down each quarter.

Yes, well first of all let me -- two things; one, the decline in value in the quarter was a negative $0.04. If you look at the total swing from Q3 last year to Q3 this year, it was a negative $0.06. So that's an unrealized gain or loss. So you just have to flow that through the income statement. And yes, if you look at the VIX index today, it was -- well, let me back up. If you look at the VIX index kind of throughout the year up until August we were running about a 20, right. It was running about 20. And then all of a sudden in August you have the European banking crisis percolate up and your VIX index shoots up to 40. The last day of September it was at 39, and since then it has dropped considerably. And it's still above 20, but I want to say it's probably about 23, 24. You had some good news that came out from Europe over night on the Greek debt and a 50% haircut. I would expect the volatility index to drop back down to below 20, given that news, given that as long as it's a solid plan that's coming out of the EU for their debt resolution issues. And then, yes, you're going to see this stuff come back up and I'm sure in September we'll be booking the gain back up. Will it be the exact amount, probably not because every day is a little different. Each and every Wall Street day there's separate movements. If you ever read Malkiel's A Random Walk, one of my favorite books. But ultimately, it's an unrealized gain or loss and again, I'd point everyone's attention to the quarters, we always disclose what that is on a quarterly basis.

Okay, that's helpful. And also, I wonder if you guys can talk a little bit about how we should be thinking about adopted gross margin in 2012 and what the differences could be with the current year.

Sure. I can't talk about that yet because we're in the process off filing for the attrition rate. Obviously we have this cost of capital settlement discussion going on. Those are all things we have to fold into it, but as we get into January and we have our earnings call in February, we'll give some more color around that.

Okay. Thanks, Marty.

All right, Jim. Thank you.

And there are no further comments or questions at this time.

Great. Thanks, Leah. Well, thanks everyone for sticking with us. We had a lot to talk about this quarter, lot of stuff below the line, but overall, I think Pete and I are both happy with the operations from a utility business itself that continues to be strong. Hopefully, we get some market stability going here in the fourth quarter, and we look forward to wrapping up 2011 in a good way and we'll be talking to everybody in February. So thank you very much.

Thank you. Again, ladies and gentlemen that does conclude today's presentation.