California Water Service Group (CWT) 2012 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the California Water Service Group fourth-quarter and year-end 2012 earnings results conference. Today's call is being recorded.

I would now like to turn the meeting over to Mr. Thomas F. Smegal, VP, Chief Financial Officer, and Treasurer. Please go ahead, sir.

Thank you, Diana.

Welcome to the fourth-quarter and year-end 2012 earnings call for California Water Service Group. With me today is Peter Nelson, Chairman and CEO; and Martin Kropelnicki, President and Chief Operating Officer. A replay of today's proceedings will be available beginning today, February 28, 2013, through April 29, 2013 at area code 888-203-1112, replay pass code 8496669.

Before looking at this quarter's results, we would like to take a few minutes to cover certain forward-looking statements. 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 risk and uncertainties, and actual results could differ materially from the Company's current expectations. Because of this, the Company strongly advises all current shareholders, as well as interested parties, to carefully read and understand the Company's disclosures on risk and uncertainties found in our Form 10-K, 10-Q, and other reports filed from time to time with the Securities and Exchange Commission.

Now let's look at this quarter's forward-looking statements. And as a reminder -- we will be filing our 10-K later today, and all the matters that are discussed today are described in detail therein. So, I am going to first go over our income statement. Quarterly results -- on revenue side, we recorded $121.5 million for the quarter. That's up 18%, or $18.5 million from 2011. Our sales to new customers added $300,000. Rate increases added $2.4 million. Production offsets added $3.2 million. Usage and other factors added $12.6 million. And remember that 2011 reflected a deferral of $12.9 million of WRAM revenue; that accounts for the major difference here.

Our production costs for the fourth quarter were $44.6 million. That's up 2.6%, or $1.1 million; and that is primarily driven by purchased water, up 4.8%, or $1.7 million, to $36.1 million. Purchased power was down 5.9%, or $0.4 million, to $6.4 million. On the A&G expenses, they were $24.8 million for the quarter, up 7.6%, or $1.7 million. That reflects higher labor and benefits expenses, healthcare, retiree healthcare, worker's compensation and pension expense. The pension expense is covered by a balancing account in California. In other operations, they were $17.9 million for the quarter, up 162.5%, or $11.1 million. And again here, in the comparison, 2011 reflected a deferral of costs associated with the deferred WRAM revenue. And the deferred costs in revenue were recognized throughout 2012, but primarily in the second quarter of 2012. That accounts for the major difference in this category.

On the maintenance side, our maintenance was $4.4 million for the quarter, a decrease of 20.9%, or $1.2 million. And that is reflecting decreased costs for main and service repairs. Our depreciation was $13.3 million for the quarter, an increase of 4.6%, or $0.6 million. Income taxes were $0.6 million for the quarter, a decrease of 11%, or $0.1 million. And that reflects, primarily, the new corporate tax regulation on repairs and maintenance that was discussed first in the third quarter.

Our net other income was $1.1 million of income net of expenses, and that had been a loss of $1.8 million in the fourth quarter of last year. The increase here is primarily due to an unrealized gain of benefit plan insurance investments. Our net income for the quarter was $5.0 million, up 168%, or $3.1 million, from the fourth quarter '11 value of $1.9 million. And earnings per share were $0.12 on a fully diluted basis, up 167.4% from $0.04 in the fourth quarter 2011.

For year-end, our results -- our net income was $48.8 million, up 29.5%, or $11.1 million, from 2011. Our diluted earnings per share $1.17, increase of 29.1%, or $0.27 over the prior year. As we first described in the third quarter, $0.15 of the earnings reflects a reduction in tax due to applying new repairs and maintenance tax regulations to plant from 2011 and prior years that was previously capitalized. We estimate that the repairs deduction for the year 2012 added $0.04 to net income, and we do anticipate a continuing benefit from the tax law changes in this area. I will also add, for the year our sales were 92% of the CPUC's adopted sales, compared to 86% in 2011.

I now will turn it over to Pete Nelson for a regulatory update.

Thank you, Tom, and good morning, everybody.

I have got three quick subjects this morning. One is, I will talk about rates, give you a rates update, and I will cover our major general rate case in California. And then I will talk about two Hawaii rate cases that we expect to come to a conclusion this year. Secondly, I will talk about two people have taken over key positions since our last call. One is, we have a new California Public Utility Commission commissioner; and second, at Cal Water, we have a new rates officer starting on Monday.

So first, a general rate case update. Our current general rate case in California, recall our 2012 general rate case, is about to enter a very hectic period starting tomorrow, and I think it's be helpful for me to walk through the next steps in this rate case so you can see what is going to happen between now and the end of the year. Tomorrow, Friday, is the day we receive the -- what we call it the staff report. This is what the Commission's Department of Ratepayer Advocates thinks we should be receiving in rate relief, as opposed to our filing, which is originally asking for $93 million in 2014, and then $17 million in each of 2015 and 2016. We'll get the staff report on Friday. And they will tell us on capital, project by project; and expense, category by category; what they think we should receive in the way of rate relief.

Then that kicks off a 60-day period for us to file rebuttal testimony, that is March and April. And then after that, we have 30 days in settlement discussions, which takes us from May 1 to June 1. The items that are not settled in that one month will go to evidentiary hearings the first two weeks of June, two weeks for that. This is what it looks like at trial with witnesses and briefs, examination, cross-examination, and all that. And then when that is concluded, the administrative law judge takes all that material and composes his proposed decision. Once he issues that, there is a 30-day comment period. And then once that is finished, if all stays on schedule, the Commission should have something on their agenda for a decision on this case before the year end.

So, in summary, we're starting our final lap of this rate case. It has gone on since July of 2012. If anything would delay this decision, and those things happen, our usual practice is to ask for interim rates and a memorandum account to keep track of the revenue we would have received going back to January 1, and then ultimately recover that revenue in rates from customers. At this point, I am sympathetic to the people on the call, because it's going to be difficult to financially forecast our 2014 results. Tough year to model for you folks. But we won't be able to help you much there, because there is so much uncertainty the next few months on this rate case.

Next, I will talk about Hawaii. We have two rate cases there that are active. One is our Pukalani rate case, wastewater case. It's a relatively small case. We have settled that case, and we're waiting for a decision to approve a phase-in of the rates there -- $200,000, pardon me, in each of the first three years, starting this year, 2013. The other rate case is our Waikoloa case, which is a total of $6.3 million we're requesting. We filed that in August of last year. It is now in process, and we expect a decision this year.

Going back to the two people I want to talk about, one is a new commissioner at the Commission. Governor Brown appointed Carla Peterman in late December to the Commission for a six-year term. She replaces Commissioner Simon. She comes to us from a commissioner role at the California Energy Commission. We have met with her. She has shown some interest in water, but I would really expect her, given her background, to be more focused on electricity in California.

The other person I would like to talk about is Paul Townsley, who is our new Vice President, Regulatory Matters and Corporate Relations, replacing Tom Smegal in that role. Paul is no stranger to the water business, especially in the Western states. He started his career at Citizens Utilities. When American Waterworks acquired Citizens a few years ago, he was running Citizens' Water and Wastewater Business nationwide. Then, at American, he worked through several positions, and ended up running their regulated and non-regulated businesses in the Western region, which is the Western states, including Hawaii.

And when EPCOR recently purchased American's New Mexico and Arizona subsidiaries, Paul was the Divisional Vice President for Operations and Engineering for EPCOR's New Mexico and Arizona operations. I'd say everyone in investor-owned water business knows and respects Paul highly. For those of you who have not met Paul, you will, and I know you will enjoy getting to know him and work with him. We just feel fortunate to bring Paul on board.

The timing is good for us, obviously, and he will run our rate-making, communications, and government and community relations functions here at Cal Water. Reports to work on Monday. Looking forward to that.

So with that, we'll go back to Tom to talk about changes in the balance sheet.

Thanks, Pete.

I will just make a couple of notes about the balance sheet. Our net utility plant is $1.457 billion for 2012. That's up 5.5% from the year 2011 value. Our capital expense in 2012 was $127.7 million, versus $118.5 million for 2011. We ended the year with $38.7 million in cash, and we do have borrowings on our lines of credit -- revolving line of credit facilities of $89.5 million at the end of the year.

I do want to highlight a pretty important factor for us, that the net WRAM balance -- this is the decoupling mechanism in California -- at the end of 2012, the WRAM receivable was $46.1 million. That's down from $49.6 million at the end of 2011, a decrease of $3.5 million, or 7%. The decrease is driven in part, by higher water sales in 2012, but really because of higher collections due to the adoption by the CPUC of a new decision in April of 2012, which allowed accelerated collection of those WRAM balances. So, we're really starting to see the effect of the Commission's decision on that WRAM balance, driving it down, again, 7% in 2012. We're looking forward to continuing to resolve that issue.

And now I will turn it over to Marty for some comments about 2013.

Thanks, Tom.

I want to take a couple moments just to recap 2012 and talk about 2013. As Pete mentioned, there's a lot of moving parts. As many of you may recall, 2012 started off a little rough for the Company. In particular, we had a delayed cost-to-capital decision, as well as a delayed WRAM decision. And with the delays in that WRAM decision, essentially it was constricting our cash flow.

Early on in the year -- in fact, about 45 days after our earnings call -- those two issues were resolved. And, as Tom mentioned, it's nice to see the WRAM receivable dropping. As a result, our FFO ratio-to-debt has gone up, and is back up above 17%, which is good. That's giving us more money that we can invest in capital.

In addition to getting the two regulatory issues resolved, as Pete mentioned, it's the second time in the Company's history we've filed an all-California rate case. It's the largest rate case we have ever filed for the California Corporation. And we are in the process of working that rate case to a conclusion. In addition, the Company made progress in several fronts during the year. Company-funded CapEx, as Tom mentioned, $127.7 million; approximately $119 million was Company investment. That is investment that will ultimately end up in rate base, and will grow future earnings. Our targets for 2013 is between $120 million and $130 million of Company-funded CapEx.

In addition, as many of you may be aware, in California, we get step increases, our inflationary offsets. However, those step increases are subject to an earnings test. In 2012, we have done the best we have done on our earnings test, with 19 of our districts passing the earnings test. And as a result, the Company is receiving $9.6 million of new rates, effective January 1, 2013. That was the focal point for the Company, to get more of our districts passed in the earnings test, and we feel really good about the progress we have made over the last 12 months.

In addition, during 2012, in January of 2012, the Company increased its annual dividend to stockholders 2.4%, which was followed up by a 2% dividend increase that was announced last month on January 30. The dividend increase that was announced on January 30, 2013 represents the 46th consecutive annual dividend increase that we have been able to give our stockholders. So, overall, 2012, which started off a little rough, ended up with some good operational and financial results.

Having said that, 2013, the Company will face a number of challenges, and the operational headwinds will be the strongest, given the fact it's the third year of the rate case cycle in California, which is by far our biggest utility that we operate. And, frankly, the inflationary step increases are not enough to keep up with the actual inflationary increases we're seeing on several lines. In particular, health and welfare costs are growing at a much faster rate than what we are getting rate relief for. Labor costs are up, although the Company has an excellent working relationship with our unions, and the union and Management work together to minimize labor increases in 2013, labor costs are still up.

And we have increases in taxes associated with the phase-out of certain deductions, as Tom mentioned. We had the maintenance repairs deduction, which on one hand, is great; it gave us more income. It's given us more cash flow. But on the other side, it phases out other deductions, so you will see taxes move up, and you will see the corporate tax rate move around a little bit. These things, coupled with the cost-to-capital adjustment mechanism for 2013, the Company will lose $3.9 million or $0.06 per share associated with the cost-to-capital adjustment mechanism that took place on January 1, 2013.

So, for 2013, what is our plan? As I said, there are a lot of moving parts. It's important to read the K to understand all the moving parts. But our plan is really quite simple. One, continue to tightly manage the operating budget. During 2012, we implemented new tools and techniques to better manage our budget. As we said in the press release, costs associated with interest expense, outside services, maintenance were tightly managed and we were able to offset some of the headwinds that we faced.

We want to keenly focus on completing the rate case on time. That request is for $92 million in new revenue and $480 million new capital. Again, it's the largest rate case in the Company's history; trying to drive that to a logical conclusion. And three, stay focused on finding operational efficiencies and advice letter projects that can help enhance revenue.

Of course, these three things are in addition to doing what we do best, which is serving our customers. By staying focused on these three items, the Company will take every step to help minimize the headwinds and position ourselves for 2014, when the new rates will hopefully take effect on January 1.

With that, Tom, I will turn it back to you.

Thanks, Marty.

I did want to mention one more thing about the cost-to-capital adjustment mechanism, and that is to remember that it's a two-way mechanism. So each year in October, we evaluate whether the Moody's AA utility bond index has moved past the collar, which is a 100-basis point collar from the October, 2012 value. And if it has, we will make another adjustment, either up or down, depending on what has happened in the ROE.

So it's important to know that's a two-way mechanism, and it goes on into the future.

I think that wraps up our presentation for today. Diana, I think we're ready to take questions.

(Operator Instructions) Jonathan Reeder, Wells Fargo.

I got one question, and I apologize if I missed it in the prepared remarks. What was the overall year-to-date insurance gain? I think it was $0.05 through Q3.

Yes, Jonathan. Just a second while we look that up. So the (technical difficulty) markets gain for '12 was $2.5 million, so a $1.9 million loss in 2011.

And Jonathan, this is Marty. One thing to point out on that, the Company does have a pretty sizeable asset there, between $22 million and $25 million. During 2012, one of the steps we took was to try to de-risk that portfolio, and bring the data associated with those assets way down. So, overall through the year, we were happy with the lower volatility of the portfolio and the way performed for the year.

Okay. But, so this year, it was actually about a $2 million loss, though, is what you're saying?

No. A $2 million gain in '12.

$2.5 million gain in '12, versus a $1.9 million loss in '11.

Okay, okay. That, and then the catch-up of the repairs tax deduction of $0.15. Those would be the only two non-recurring items that you would single out? Is that accurate?

Going back to the retirement assets, we don't budget from our operating perspective, any gain or loss associated with those assets. But the fact is, they do follow the market. And again, we do have between $22 million and $25 million in those assets. So, in a normal market, it's probably fair to expect you will have some rate of return on those assets. That's why I plan to de-risk the portfolio and minimize the volatility from our earnings standpoint was really important.

And, Jonathan, just on the other issue, of course, is that the WRAM deferral that we had in 2011, that we re-booked to revenue in 2012. So that is not going to recur, snap back into the income statement.

That was about $0.04.

That was about $0.04.

Okay, that was a $0.04 benefit?

Yes.

And then, the other point of clarification, Marty, you mentioned the $3.9 million or $0.06 impact from the cost of capital. Is that net income or is that revenue?

That would be the EPS effect.

Okay.

So, the $0.06 is the actual effect that we anticipate on a per share. So, earnings per share will go down $0.06 per share, just by the cost of capital adjustment mechanism. And I want to emphasize Tom's point. We have actually gotten a couple calls from people who have studied the mechanism now and have come back and -- well this.

Yes, it's kind of bummer. It's gone down over two years, but it also is a hedge against inflation, because it's a two-way collar. So it's a two-way balancing account. If interest rates start to rise drastically, we're not waiting -- we have a 12-month window that we're exposed for, or less. And we have the opportunity to reapply to bring that rate back up.

Right. We're still pretty early in that process for the current year. I haven't looked at it personally, but do you know where it stands? Are we tracking down a little bit, but obviously, well within the 100-basis point band?

Yes. I haven't looked at the utility index. I have been following the 10-year bond, and the 10-year bond is hovering up around 2% right now, so it has moved up. I want to say it's about 30 to 35 basis points from its low of about $1.6 million, $1.7 million. Clearly, the 10-year has moved up a little bit. Most utilities, when they issue a bond, price off the 10-year treasury, with the credit spread on top of it. I think we are going to see it try to move up the other way. Someone on CNBC once said -- Don't bet against the Fed, or don't fight the Fed -- and I think this mechanism follows that methodology. Two years ago, we thought interest rates could never go lower, but they did. I just don't see them going any lower now. (laughter)

I hear you there. Thanks for the time today.

Yes. Hopefully, Mr. Bernanke is not listening to this call. (laughter)

(Operator Instructions) I show that we have no further questions. I would like to turn the call over to Mr. Smegal for any closing remarks.

Thank you, Diana. Thank you all for your continued interest in California Water Service Group. 2012 was a good year for the Company, and we look forward to talking to you again as we move through 2013. Thanks very much.

This does conclude today's conference. We thank you for your participation. You may now disconnect.