California Water Service Group (CWT) 2013 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the California Water Service Group's fourth-quarter and year-end 2013 earnings results conference call. Today's conference is being recorded. I will now turn the meeting over to Mr. Thomas Smegal, Vice President, Chief Financial Officer and Treasurer.

Thanks, Kelsey. Welcome, everyone, to the fourth-quarter and year-end 2013 earnings call for California Water Service Group. With me today are Martin Kropelnicki, President and CEO, and Paul Townsley, Vice President of Regulatory Matters and Corporation Relations.

As a reminder, a replay of today's proceedings will be available beginning today, February 27, 2014, through April 28, 2014 at 1-888-203-1112 or 1-719-457-0820. The replay pass code is 133-9013.

Before looking at this quarter and year-end results, we would like to take a few moments to cover 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're 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 shareholders, as well as interested parties, to carefully read and understand the Company's disclosures on risks 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 get looking at this quarter's forward-looking statements. I am going do a quick review of some of the financial highlights from the fourth quarter and then spend a little bit more time on year-end results.

Quarterly results -- fourth-quarter revenue, we recorded $133.7 million, which was up 10% or $12.2 million. Rate increases added $3.8 million. The effect of our pension and conservation balancing accounts increased revenue by $1.4 million. Usage, combined with the effect of the RAM and MCBA mechanisms increased our revenue $7 million, including $0.5 million of unbilled revenue accrual.

Fourth-quarter production costs were $50.4 million. That's up 21.4% or $9.5 million. The primary drivers here are increased wholesale water prices and increases in the quantity of water produced. These costs are booked through our MCBA. In the fourth quarter we had no meaningful change in A&G expenses, maintenance or other income.

Moving onto other operations, that was $19.4 million for the quarter, up 8.5% or $1.5 million, primarily due to increased spending on conservation programs. Our depreciation for the quarter was $14.7 million, an increase of 10.6% or $1.4 million. And that's consistent with the prior quarters in 2013.

For income taxes in the quarter, as a reminder, under our regulation, federal taxes are normalized and state taxes follow a flow-through method. Changes to state income taxes can impact earnings in the periods that they're realized.

During the fourth quarter, the Company recorded a $1.1 million increase in net income due to a revised estimate of state repairs and maintenance tax deductions. So, our net income for the quarter was $5.7 million compared to $5 million in the same period last year. And the earnings per share for the quarter were $0.12. That was the same as it was in the fourth quarter last year.

Moving on to our full-year results, we recorded revenue of $584.1 million. That's up 4.3% or $24.1 million. Our consumption in 2013 was 91% of the adopted in California operations.

Our rate increases added $13.6 million. The effect of the pension and conservation balancing accounts increased revenue by $900,000. Usage, combined with the effect of the RAM and the MCBA, increased revenue by $10.4 million.

Our unbilled revenue accrual at the end of the year added $1.6 million over what it did in 2012, primarily due to higher customer usage at the end of the year. Our production costs were $226.1 million for the year. That's up 11.5% or $23.4 million. The primary drivers here, of course, are increased wholesale water prices and increases in the quantity of water produced. We saw wholesalers increase their prices from 3% to 12% in 2013, with a median increase of 8%.

Our pumping represented 46.3% of production in 2013 compared to 47.6 in 2012. And purchased water changed from 47.4% to 49.2%. This was primarily due to increased usage and localized pumping constraints last year. And, again, these costs are all booked to the MCBA.

On our A&G expenses we booked $98.1 million for the year. That's up 4.4%, or $4.1 million. The primary driver here, in 2013 we saw an increase in expensed medical costs of about 20% or about $3.8 million. That's primarily due to high claims activity from our participants. And while salaries and other benefits costs increased, we managed other administrative expenses to remain relatively flat except for the medical cost item.

Some good news, in 2014 due to investment performance and changes in interest rates, we expect our pension contributions to be around 20% lower than in 2013. Now, California has a balancing account for this item so we don't expect a significant impact on the P&L. However we consider this a good sign moving forward on our customer rates, particularly in California.

On other operations $69.7 million for the year. That's down 9.6% or $7.4 million from last year. And this is primarily due to the reversal of the $10.5 million deferred MCBA cost recorded in 2012. And also there is a $2.6 million offset of that due to increased conservation expenses.

On the maintenance side we recorded $17.4 million for the year, down 9.3% or $1.8 million. That's from a decrease in the cost of repairs of main, services and hydrants. And primarily what's going on here is more of the maintenance activity this year qualified for accounting treatment as a capital replacement.

On the depreciation side we recorded $58.3 million. That's an increase of 6.7% or $3.7 million. And that just reflects our 2012 ongoing capital additions program.

Our net other income was $2.1 million for the year, a decrease of 32.5% or $1 million. And this decrease was primarily due to a $600,000 reduction in mark-to-market adjustments for nonqualified retirement programs during 2013 as compared to 2012.

For income taxes, as a result of the enterprise zone credits recognized in the third quarter, and the revised repairs deduction and other tax true-ups in the fourth quarter, our tax rate was 30% for the year. We expect a tax rate between 39% and 41% in 2014, as discussed in the third quarter.

So, finally, our net income for the year was $47.3 million, down 3.2% or $1.5 million. The major factors there are the difference in the tax benefits this year to last year, our head wind from the reduced return on equity granted by the California Commission, and the regulatory lag from being in the third year of the California rate case cycle.

Our earnings per share for the year, $1.02 on fully diluted basis, down 12.7% from $1.17 in 2012. And the difference here between the change in net income and the change in EPS has to do with the dilutive effect of the stock offering, the 5.75 million shares that was completed in March of 2013.

So, with that, I am going to turn it over to Paul Townsley for a regulatory update.

Thank you, Tom. As management previously reported, on October 30 of last year we filed a rate case settlement with the California Public Utilities Commission. This settlement was signed by California Water Service Company, the Office of Ratepayer Advocates, and ten other parties.

On January 6 of this year, the rate case evidentiary record was closed with the filing of briefs by various parties to the case. And the hearing officer to the case now has the settlement agreement and all the other evidence before him and will be writing a proposed decision for commissioner action. Since a final decision has been delayed past the January 1, 2014, date for new rates to go into effect, California Water Service Company has approval to retroactively charge customers the new rates, once the Commission, approved by the Commission back to January 14 once a final rate decision is made.

I would also like to update you on the status of our cost of capital application with the California Public Utilities Commission. Last week we announced that the Commission approved our request for one-year delay in the filing of our 2014 cost of capital filing, which was to be filed by March 31 of this year. As part of the Commission's approval California Water Service Company and the three other affected Class A water companies agreed to forego filing a cost of capital adjustment mechanism this year.

As a result of the approval, California Water Service will continue to be authorized a 9.43% return on equity, as was most recently approved by the Commission. And we along with the other three affected water companies will file our cost of capital applications in March 2015.

You may have heard the California PUC has a new Commissioner, Mike Picker. Commissioner Picker replaces Commissioner Mark Ferron who resigned in January due to health issues. Mike Picker is known as a renewable energy expert, having most recently served as senior advisor for renewable energy to Governor Brown. He's also been a member of the board of directors of the Sacramento Municipal Utility District, and has been working in and around the capitol in Sacramento for many years. Since Commissioner Picker understands complex long-term issues, such as renewable energy, I believe that he will be a benefit to the water industry and our long-term approach to infrastructure and water supply issues.

In Hawaii, we have been busy working on our various rate cases affecting our operating districts in that state. In January the Hawaii Public Utilities Commission approved the settlement we reached with a consumer advocate in our Pukalani wastewater system. The Commission decision authorizes us an annual revenue increase of $586,000 for this Pukalani wastewater district, phased in over three years. And new rates are now in effect.

We have also reached rate case settlements with a consumer advocate on two other systems that we own in Hawaii, the Waikoloa Water System and Waikoloa Sewer System. These settlements were filed with the Commission late last year and we are awaiting its action.

And we are currently in settlement discussions with a consumer advocate on our Waikoloa Utilities System. And we are gearing up for our next rate case filing for our Kukio Water and Wastewater System.

Overall, I believe that California Water Service is doing well in executing on our rate case strategies in California and in Hawaii. That's the end of my report, Tom.

Thanks, Paul. Now I'm going to summarize major balance sheet items for the year end. Our net utility plan at the end of the year is $1.516 billion as compared to $1.457 billion in 2012.

We added $116 million in Company-funded CapEx. Our target for 2013 was $110 million to $130 million. We came out at the lower end of our range due to a lot of participation by our engineering and operations groups in the California GRC activity over the course of 2013. We are estimating that same range of $110 million to $130 million for Company-funded CapEx in 2014.

Our cash at the end of the year, we had $27.4 million. And our total borrowings on our line of credits was $46.8 million. That's $16.8 million for the group and $30 million for the Company.

On the regulatory asset side, the RAM MCBA combined balance at end of year is $44.5 million. That's down $1.2 million from the end of 2012. Collections are very strong on the surcharges, with $35.3 million collected in 2013 versus $25.3 million in 2012. However, higher purchase water costs have increased the MCBA balance in 2013. So, the increase in balance is due to a lag in purchase water offset rate increases.

So, significant change, as we have talked about on these calls from time to time. And the RAM is really only expected after we get the effective rates from our 2012 GRC process. And we look forward to that coming in the next year or two as those rates go through the system.

now I am going to turn it over to Marty for some general comments.

Thanks, Tom. Good morning, everyone.

There is four areas that I want to cover today. One, I'd like to give some color and commentary about my impression of the earnings for the quarter, including the capital program. Two, briefly talk about what we're expecting in Q1 as we wait for the conclusion of the rate case in California. Three, give you an update on the drought and what's happening here in California. And then, four, talk about a new Board member that was elected to the California Water Service Group Board yesterday.

First, talking about earnings, as Tom mentioned our earnings for the quarter were $0.12 and $1.02 for the full year. The results achieved by California Water Service Group are better than expected driven by three primary areas.

One you had a $0.13 pick up in earnings per share due to tax-related items. Two, you had positive variance from operations, which is really driven by the Company's execution of tighter budget and operational controls. That was $0.03. And then, three, we had a $0.02 pick up on the revenue accrual, which is outside of the RAM, at year end, driven by the dry weather in California. So, there was more accrued revenue as we ended 2013. It's worth noting that the $0.03 budget to actual variance from operations was after we absorbed the $3.8 million healthcare costs that Tom mentioned.

Backing out the tax credits, core earnings for the Company were $0.89 a share versus our internal target of $0.84 a share. The 6% better-than-expected core earnings was driven by tighter budget and operational controls, and enhanced reporting from the financial planning and analysis team, as well as the organization's ability to stay focused on budget management. Overall, the management team at California Water Service Group executed well during 2013 which, as many of you know, was the third year of the general rate case and we feel the most regulatory lag.

As Tom mentioned, our capital program was adversely affected in 2013 by the longer-than-expected settlement process in California, which ran for a total of 26 weeks, or half the year. As a result of this, critical resources that would normally be working on our capital programs were tied up in settlement negotiations during our peak construction times. As we move into 2014, the Company will be diligently focused on our new capital program and playing catch up with the projects that were delayed as a result of the resources required to settle the general rate case process.

In looking at 2014, and as we wait for the rate case process to settle out in California, Q1 is going to be an extremely difficult quarter for the Company. As many of you may recall, Q1 is always a difficult and challenging quarter for the Company, with the majority of revenue coming in late spring and summer months. While the rate case decision will be retroactive to January 1, 2014, the delayed decision will hurt our financial results during the first quarter.

During the first quarter of 2013, which was the third year of the rate case cycle, we lost $0.03 a share. And we expect a larger loss this quarter as we wait approval from the CPUC to execute our new rate structure and tariff. As we stay in this holding pattern trying to conclude the general rate case in California, the Company will remain very focused on our budget and operational controls, while executing our 2014 capital program.

Moving on, talking about the drought, as many of you probably heard, 2013 was the driest year on record in California. And in January, Governor Brown declared a drought emergency statewide. We have received a number of calls on this and there are a few key points I'd like reinforce here today while we have everyone's attention.

First and foremost, planning for such things as a drought is a core competency of the Company, and we are constantly updating our plans. Second, California Water Service Group was the first major company to decouple sales from revenue in the water space, which allowed us to aggressively go after conservation in California, which we felt was critical.

In addition to the decoupling mechanism, as Tom mentioned we have two balancing accounts. One is called the RAM -- Water Rate Adjustment Mechanism, which covers the decoupling of revenue. The second is a balancing account called the MCBA, or Modified Cost Balancing Account, which covers all of our production costs. These two balancing accounts work together to record changes in revenue as well as changes in production costs and get booked monthly.

We started down the conservation path in the summer of 2008. And since then our average customer's consumption has declined approximately 15%. While we also have a drought team that we always had on standby, we have put that drought team, and fully deployed our drought team, and they are busy working with the various agencies to coordinate any drought-related issues that may arise, including our media campaign, our outreach and education, and, of course, our continuation of our core conservation programs.

While the regulatory mechanisms freed us up to go after conservation, the ultimate results are in the numbers. And we feel that we're in a good position to help both the state and our customers manage through this crisis.

Lastly, I want to talk about a new Board member. Yesterday the Board of Directors of California Water Service Group elected Terry Bayer to the Board of Directors effective March 1. Terry is Chief Operating Officer at Molina Healthcare, Inc., which is a multi-billion-dollar healthcare service provider that trades on the New York Stock Exchange under ticker MOH.

Terry has an excellent background in operational management, including multi-jurisdictional healthcare, healthcare regulation and compliance, and customer service. Terry adds a unique perspective to our Board. And I know I speak for all Board members of California Water Service Group in welcoming her to our Board of Directors.

And with that, Kelsey, that ends my prepared comments. And we will open it up for questions please.

(Operator Instructions)

Spencer Joyce with Hilliard Lyons.

Good morning, guys. Thanks for taking the call.

I just wanted to ask a quick question here about the delay in getting the rate case rates into effect. You mentioned that that delay would lay a little bit on the first quarter. But is it safe to assume that we'll see all of that made up by the end of 2014? Or could there potentially be some spillover into 2015?

Let me take the first crack at that. Spencer, it really depends upon when the final decision comes out of the Commission. And the key here is that we think that we've given the judge everything he needs to write a decision within the time frame that he has.

Typically the judge has been given 2.5 months to write a decision. And so it's our expectation that that will be done in the first half of the year.

Now, obviously the Commission is an animal unto itself and so there could be other reasons for a delay or speeding up of that process. So, there is really an uncertainty. If for some reason it were delayed until very late in the year, the revenue might trickle into 2015 instead of 2014.

Okay. So at this point, if we were base casing it, we would say most likely we'll get things wrapped up and see the benefit in 2014, but just not something we can say with certainty.

That's the fairest way to say it, I think.

I think our expectation is, again, the settlement process was supposed to be a total of 6 weeks and it was 25, which was a massive use of resources within the Company. But we got the settlement done and we got it signed. And we are running about 100 days behind, essentially.

So, as Paul said, we had the date in early January where the briefs had to be filed. So, you push out a little bit, that would put us sometime in Q2, end of Q2, assuming they stay on track and on schedule. Which won't be too bad but it does mean that it will have a significant effect in Q1, as we wait for the Commission to wrap up the rate case.

Okay. Thanks a lot for the color there. Just one more broader question.

On a regular basis we talk about, or at least ask you about the potential for an acquisition outside of California, maybe materially moving into another state. Can you talk a little bit about how the landscape there may have changed or what the current plans are? That can include some expansion there in Hawaii, or just anything else you may be able to give us on the region.

Sure. The Company's philosophy hasn't changed and we don't comment on any type of M&A activity. But inside the Company we do have a business development team that is full time. And we are always out there actively looking.

In Hawaii right now, I think we are staying put. We are really focused on getting those rate cases done.

We rolled up a number of companies in 2008 and then brought those systems up to compliance. And now we are working to get those rates established to recoup the cost of getting all those plans up to compliance.

So, we're always out there looking. Obviously we like to be in states where the regulation's good. We try to focus on being a very good operator, the water quality, the environment, et cetera. Hence Hawaii was a nice fit for us.

I think the other thing that the Company has done very well that I think has become a core competency, frankly, is conservation. And, as Paul and I have moved over and met with people in Hawaii, the commissioners and elected officials, et cetera, conservation comes up a lot.

We feel we have a very good blueprint in California for conservation. And we think that, depending what happens with water supplies in the state, that becomes a key core competency that makes us very attractive to other systems in other states.

So, we're always out there looking. Obviously our balance sheet's strong. Our S&P credit scores are strong. And we'll continue to be out there looking. But it has to be an acquisition that would make sense for the Company and for the stockholders of California Water Service Group.

Okay, thanks a lot. That's all I had.

Heike Doerr with Baird.

Good morning. Congrats on a solid earnings report.

Quick question -- can you give us a refresher on the way the ROE metric gets rebalanced to the Moody's bond index, how often that happens, or if there is any way that we can be tracking future changes?

What's called the water cost of capital mechanism is a mechanism which is for the two years after the adjudication of a new cost to capital. So, we had an adopted cost of capital in 2012. And then the Moody's AA index, what happens is there is a dead band of 100 basis points. And if it swings up or down 100 basis points then there is a half adjustment of the ROE.

In the case of 2013, we had 112 basis points negative to the Moody's AA bond index, so we had a 56 basis point reduction to the ROE. And that's where we get from 999 to 943. That happens in the two years subsequent to a cost of capital decision.

So it would have happened in 2013. And it would have happened for 2014 -- we did not trigger for 2014.

So, it's not going to happen again until after the next time we file and get approval of rates of cost of equity and cost of debt rates, now filing in 2015 with rates expected to be in place in 2016.

So we wouldn't expected any change to your allowed ROE in the next 18 months?

That is correct.

Got it. Okay, thanks. That's helpful.

Gentlemen, we have no further questions.

Okay. As a last point, everyone, thank you all for being on the call. We will be filing the Form 10-K later today. There is obviously more detail in there.

Thank you for your continued interest in California Water Service Group. We look forward to talking to you again with our first-quarter results in April. Thanks.

Again, thank you, ladies and gentlemen. That does conclude our conference for today. We thank you all for your participation.