California Water Service Group
Q1 2008 Earnings Call Transcript

Published: 7 May 2008

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the California Water Service’s First Quarter 2008 Earnings Results Conference. (Operator Instructions) I would now turn the call over to your host, Martin Kropelnicki, Chief Financial Officer.

[Martin Kropelnicki:]

Thanks, Christopher, and good morning everybody. Welcome to the First Quarter 2008 Earnings Conference Call for California Water Service Group. With me today are Pete Nelson, President and CEO. I’d like to remind everyone that a replay of today’s conference call will be available starting from about 2 PM today and that’s available through June 30th, and that number is [phone] ID# 1226399. Before reviewing the results for the quarter, I’d like to take a brief moment to talk about forward-looking statements. In particular, during the course of this conference call, the company may make certain forward-looking statements. Because these statements deal with future events, they are subject to various risks and uncertainties and actual results could differ materially from the company’s current expectations. As of this, the company strongly advises all parent shareholders as well as all interested parties to carefully read and understand the company’s disclosure on risks and uncertainties and other important disclosure information found in our Form 10-K, 10-Q and other reports filed from time to time with the Securities Exchange Commission. I’d like to take a brief moment to talk about the financial results for the quarter. During the quarter, revenue was $72.9 million, up $1.3 million or 1.9% from the same period last year. Contributed increase in revenue was rate increases of $4.2 million. Sales/New Customers added $400,000 and we experience a decrease in sales to existing customers of $3.2 million. Operating expenses were up approximately $1.8 million. Included in that number was a decrease of $500,000 from water production costs to the declining sales. In general, other operations were at $1.8 million. Two primary contributors to that

[Pete Nelson:]

Thanks very much Marty and welcome everybody this morning. The first quarter, as you know from previous phone calls, has always has low numbers and especially in those years when we have a lot of rainfall, which we did this year in January and February in California. So, the action this conference call in this quarter, is really on the rate front. And I’ll talk about my rate update which will be in three pieces actually

[Martin Kropelnicki:]

Thanks, Pete. One thing before I get to the balance sheet

[Operator:]

[Operator Instructions] Our first question or comment comes from the line of Michael [Gresence] with Robert W. Baird.

[Michael [Gresence]:]

Good morning, gentlemen. First question

[Martin Kropelniki:]

We haven’t, Michael, and I’ll tell you why. We are in the design phase of the RAM and the modified cost balancing account and it’s a fairly elaborate process that we have to go through. We have to design it. We have to share that information with the Commission to get their sign off. So we’re approximately halfway through the design and obviously we have to have a conclusion made up of that design before we can model anything. So, we have a tremendous amount of work and a very large cross-functional team working on this project. And I’ll look forward to sharing details of design with everybody in July after we get them all approved.

[Peter Nelson:]

Michael, I’ll make one more comment. This is Pete. I know it’s confusing to prorate the change mid-year on everybody. July 1st is a tough time to kind of do your analysis but we’re moving towards a January 1st rate year. So our next general rate case filing for the whole company will be filed in July ’09 for rates effective January 1, 2011. I think from that point on it makes it a little easier to do your analyses because we’ll be in a calendar year for rate making in California.

[Michael [Gresence]:]

All right. In terms of capital expenditures, where do you stand on terms of the annual forecast and some of the major projects that are going on? If you could update.

[Martin Kropelniki:]

Sure. Our forecast this year is in between $80 and $100 million. I realize there’s a pretty broad gap there but part of the problem is when you’re putting a new plant into the ground, the permitting process to sign out costs and etc. takes a little bit of time. So, if our goal is $100 million and we’ll be $28 million in the first quarter, I think we started off the year strong and we will continue to put that pressure on. I’d like to see us get $100 million into the ground this year but frankly I don’t control the sign off. That’s where function of state and local government. But between my proxies, who’s our VP of Engineering and myself, we keep a very close eye on that and we’d have a lot of pressure to get those projects on the ground. We do have what’s approved in rates as approximately $100 billion of cap ex for the year.

[Michael [Gresence]:]

Okay, thank you.

[Operator:]

Our next question or comment comes from the line of Rishal Petraval with Stanford Group.

[Rishal [Petraval]:]

Hello guys, good morning. You know the pension rated cost, I would assume that one time?

[Peter Nelson:]

No, actually it’s not and that’s a good question. Let’s talk about that for a minute. We have two components of our pension plan. We have a qualified plan which is in a separate trust and you do not have market-to-market adjustments for the rest of the sponsored qualified plan. And then we have a supplemental executive plan which is a non-qualified plan. The part where we have to market-to-market adjustments is typically on the [serve]. In addition to that, the company sponsors a non-qualified deferred compensation plan. And as everyone knows, the market’s been under a lot of pressure in Q1. We do have to make market-to-market adjustments on corporate whole and life insurance policies that the trust is on by the company and those change daily as market values change. So those are not one-time events. They happen. We’ve had these for some time. When the market’s up, it runs the other way. When the market’s down, it goes the other way.

[Rishal [Petraval]:]

Okay, so depending the market conditions that maybe next quarter or either quarter it’ll go down.

[Martin Kropelniki:]

That’s right, and that’s why we have that down on Other Income and Expense, so people can clearly see what the utility operations are versus the market-to-market adjustments associated with the pension and the deferred comp plans.

[Rishal [Petraval]:]

And sorry if I missed it but did you mention that out of the $1.8 million increased in the [straight] general expenses? How much exactly was from [federal] increase and [employment] programs?

[Peter Nelson:]

No, we’ll have more information on the 10-Q when we file that next week to break that out. We just talk generally about the $1.8 million and those are the two primary drivers. I do not have the split here in front of me.

[Rishal [Petraval]:]

Okay. In terms of quantity of water sold during the quarter, can you give me the number for this quarter versus first quarter last year and also your normalized number?

[Martin Kropelniki:]

Sure. Usage was down approximately 3.9 million acre feet, or 5% from the 74 million-acre feet, that we had the previous year. I don’t have a normalized number. We don’t think of it that way. We do track production and we look at production on a monthly and quarterly basis.

[Rishal [Petraval]:]

Another question is how much of your operating expenses except general taxes would you say sticks towards [variable]?

[Martin Kropelniki:]

You know, that’s a good question. Economically speaking, it depends how you look at it. We are a high-fixed cost producer. Most utilities are. And depending on how you define labor. In the short-term, i.e. less than twelve months labor becomes a fixed cost. All over a twelve-month period can become a variable cost, but yet the bulk of our costs are too full, a three-fold. It’s property, plant and equipment. It’s the cost of operating that property, plant and equipment as people. So I haven’t sketched out what the break would be but it would depend basically on the time period that we’re talking about.

[Rishal [Petraval]:]

But let’s say that you break down the operating expenses, I can assume the water production cost to be variable but what about maintenance and administrative and general costs? Would you say those are fixed or those are variable component patterns as well?

[Martin Kropelniki:]

Well, I think, again, what period are you talking about? If you’re talking about in the short-term, labor costs are going to be fixed. In the long-term, labor costs would be variable. We can control when we hire and when attrition is people retire. But in the short-term, labor becomes a fixed component.

[Rishal [Petraval]:]

Okay, thanks guys.

[Operator:]

Our next question or comment is from the line of Tim Winter with Smith Moore.

[Tim Winter:]

Good morning, guys. I was wondering if you could go into a little bit more detail about the implementation of these items, the water action plan items, that go into effect July 1st. Is this going to cover all districts? I believe Phase Two is going to be the ROE applied to these rate adjustments. And maybe we could talk about how it’s going to impact the income statement going forward. I guess if I just look at the first quarter and you were $3.2 million short due to conservation or whether tax affected that, it’d look like it would be about a $0.10 impact in the first quarter. But if you could just apply how that’s going to affect things going forward and whether this cost to capital filings in the future going to cause adjustments to the rate adjustments in July.

[Martin Kropelniki:]

Sure. Well, let’s talk about our current process and then contrast that to where we’re going. I think that’s the simplest way to understand the change that we’re about to go through. First and foremost, Pete and I, we both agree that this is probably one of the largest single fundamental shift Cal Water’s ever gone through in its long rich history. We’re going from a simple revenue environment where you have rate cases and you have tear ups and tear is time consumption gives you revenue. To where we are going to have basically a marginal, or modified, cost balancing account and a RAM for every district that we operate. And so the water production cost will flow through the modified cost balancing account when there, I believe, is a 2.5% threshold. When a cost goes up or down 2.5%, we’ll either have to [serve] credit up or [serve] credit back and that’ll have an effect on the revenue stream. The revenue stream will be based on the adopted sales and how we stand on the adopted sales. So it is a big shift. It’s much more complex. The revenue accounting that cost, the accounting the front side of the business, become a lot more important and timely to how we operate and recognize things in the financial statements. So in terms of the impact on the financial statements, again, once we have the model signed off, and so hopefully in Q2 I’ll be able to describe this in detail to everybody. But until we have the exact mechanisms pinned down and agreed to with Commission, it’s kind of hard to say what the exact impact’s going to be. But I think generally speaking, you see the direction. The shift smoothes out the seasonality. This allows the company to promote conservation and to promote conservation in a big way. And basically allow us to, I’d say, normalize our sales cycle a little bit more.

[Tim Winter:]

Will the implementation go across all districts?

[Martin Kropelniki:]

Yes.

[Tim Winter:]

Okay, and then as far as the allowed ROEs applied to the adjustments, will that be based on the 10.2% of the most recent case or how will that be decided?

[Martin Kropelniki:]

As of right now it would be based on the 10.2%. As you know, there have been some discussion that if you implement a RAM and the modified cost balancing account, you’re taking away some of the revs. You were at the water AWC meeting in San Diego and some people from the Commission think that therefore you should take a haircut on your ROE. I’m not prepared to talk about our cost to capital filing. As of today it’s being filed, but I can certainly talk about it tomorrow. And the company’s position is that the 10.2% is a modest ROE. When you compare it to the analysis that’s concluded in our cost to capital filing, we believe that number should be higher not lower.

[Tim Winter:]

Okay and just one last question for clarification. Peter mentioned that in 05/09 you’re going to file consolidating cases. So all 24 districts in Cal Water will file a one-time for a 3-year cycle with the rate impact being in effect, January 1, 2011. Is that correct?

[Peter Nelson:]

That’s exactly correct, Tim.

[Tim Winter:]

And then you’ll still get the annual staff adjustments to make sure you can earn the allowed ROE up until year three?

[Peter Nelson:]

Yes, that would be attritional adjustments in the two enter ending years. We’d still be on a 3-year rate case cycle, that the whole company would be filing every three years.

[Tim Winter:]

That’ll make things a lot easier. Looking forward to that. Thanks, guys.

[Operator:]

Our next question or comment comes from the line of Heike Doerr with Janney Montgomery Scott.

[Heike Doerr:]

Thank you. Good morning, gentlemen. I’d like to talk a little bit more about the cost to capital proceeding that Tim was referencing. I believe that this is the first time that you’re working in such a concentrated effort of corroboration with the other two companies. Can you talk a little bit about how this works and how the three companies have worked together this forth in front of the Commission?

[Martin Kropelniki:]

Yes, I think corroboration somewhat of a nebulous word. Obviously, we do talk to our brother and sister companies within the state of California but each company’s filing their own cost to capital.

[Heike Doerr:]

So you each have a separate docket number?

[Martin Kropelniki:]

Correct. So we’re all filing today and that makes sense. If you think about it, we’re separately publicly traded companies. We have separate balance sheets; we have separate income statements; separate regions that we operate in; separate drivers of our business. Well, collectively, in terms of regulatory finance, we talk about the weather. We talk about the generalities that drive our business. But the fact is, we do operate in a very large state and we do have separate drivers. So we have had discussions and we have talked through some base strategies with our peer companies, but it is our own cost to capital filing and we do our own work on it.

[Heike Doerr:]

So does that mean that you haven’t all asked for the same authorized return?

[Martin Kropelniki:]

I can tell you as CFO at Cal Water, I do not know what our peers are going to ask for.

[Heike Doerr:]

That is a fair answer.

[Martin Kropelniki:]

And I do not know what their worksheets are going to show and support of that answer. I do know, for us, as you know Heike because you published the information on the data, there are some things going on in California because the data for water companies has gone up approximately 40 basis points higher than the average utility data. So, I don’t know if they’re going to use that argument but I’ll tell you that we certainly are.

[Heike Doerr:]

Okay and touching on the RAM recently. I know it was approved for residential. Can we get an update on how you’re doing on getting CNI folded into that?

[Martin Kropelniki:]

Yes, the RAM that’s approved is actually for all. So it’s the whole enchilada, so to speak.

[Heike Doerr:]

Great. I didn’t know that has improved. That’s great to hear. And lastly, we get lots of questions about how the economy impacts water consumption and the typical opinion has been it doesn’t really impact on the residential side, but you do see it on the commercial and the industrial side. We’ve heard anecdotal evidence from some of your peers that operate in other states that they are seeing some impact pure recession-related decreases. Can you comment on that? I don’t know if that’s something you break out in your Q.

[Martin Kropelniki:]

We don’t but I can certainly talk about it a little bit. In looking at Q1, one thing where we have to use a chart of accounts that the PFC publishes so we have to subscribe to what they publish. So in every state it’s going to be a little different that chart of accounts. So to some extent you may be comparing an apple to an orange. And so for anyone who’s going to do this, you need to get into the chart of accounts to understand the components. In looking at our chart of accounts and looking at just residential this year and last year, our residential demand or sales grew approximately two-tenths of 1%. Demand for businesses and who use our water services grew by 2.7% and industrial customers were up 17.1%. Really, I think from a water standpoint, what [people] at the executives at Cal Water talk about is when did you turn on your sprinkler system? Last year, we were turning on sprinkler systems on in February because it was so dry. This year, I think most of us turn on our sprinkler systems on in the end of March. And so, we don’t quite look at it that way. We do track it based on residential, business and industrial but in this case we did see more increase in the business and industrial versus the residential.

[Heike Doerr:]

Okay, that’s helpful.

[Martin Kropelniki:]

That to be expected given, called the Sprinkler Syndrome.

[Heike Doerr:]

Okay, and Marty, you gave us some weather statistics for the first quarter. Are the weather statistics out yet for April? I know that the month just closed yesterday but do you have any indications of how the second quarter has started?

[Martin Kropelniki:]

They’re not out yet. The information I gave you yesterday, most of it referenced back to as of April 1st, but I can certainly talk about it. We do know January was a very wet month and February started to dry out. We had a little bit of rain in February. Then March, for the most part, was fairly dry but the average temperatures have been approximately 2 degrees cooler. So I expect that the start of Q2 will be relatively good just given where we are.

[Heike Doerr:]

Great and one last question. I know in the fourth quarter conference call, you had mentioned all of these Hawaii acquisitions. Can we just talk quickly on, are those approvals happening in the timeline that you have been expecting?

[Martin Kropelniki:]

Yes, again, it’s a process we have to go through on the regulatory side. The Waikoloa and the Pukalani, those applications were filed. They’re moving to a PFC. So far they look to be on track. I would expect them to close sometime this summer.

[Heike Doerr:]

And the unregulated business acquisition that was supposed to close in March, did that occur?

[Martin Kropelniki:]

We have not closed on that yet. I anticipate that closing sometime in the next week to 10 days.

[Heike Doerr:]

Great. Thanks. That’s been helpful, gentlemen.

[Operator:]

Our next question or comment is from the line of Jonathan Reeder with Wachovia.

[Jonathan Reeder:]

Good morning, gentlemen. I’ve a few questions on the ROE. So right now, you guys are authorized a 10.2%. Will a new ROE be set in the 2007 GRC or is the 10.2% going to be adopted in that? Do you know?

[Martin Kropelniki:]

The 10.2% is the basis for the ’07 general rate case so that decision will not change the authorized ROE at 10.2%.

[Jonathan Reeder:]

So you’re authorized ROE will stay there. And then, those cost of capital applications, you said it would be effective January 1, 2009. Is that correct?

[Peter Nelson:]

That’s correct.

[Jonathan Reeder:]

Would that then reset the rates based on that new ROE at that point?

[Peter Nelson:]

If the ROE does change, yes, that’ll change the rates.

[Jonathan Reeder:]

Okay and what is going on with the team reference, the Phase II aspect of the conservation proceeding with the ROE. That’s a different track from these cost to capital applications?

[Peter Nelson:]

Yes, different tracks. The testimony the data is in and then we’re waiting at the Co’s decision on that.

[Martin Kropelniki:]

No time schedule yet. In fact, there’s no target date. There’s no schedule from the Commission on when that might occur.

[Jonathan Reeder:]

Whenever those decision comes it, is it going to actually give what the ROE is or is that addressing whether or not there should be adjustments to the ROE?

[Peter Nelson:]

We don’t know yet. We’re still waiting for word from the Commission.

[Martin Kropelniki:]

And I think part of it, Jon, as we talked about, the change we’re about to go through is significant. Setting all hands on kind of on deck with the RAM and the modified cost balancing account and getting through that first. So I don’t anticipate a whole lot of activity in that area until we kind of get this next wave.

[Jonathan Reeder:]

Okay, and as far as the 2007 GRC, your filing was based on a 10.2% ROE. Correct?

[Martin Kropelniki:]

That’s correct.

[Jonathan Reeder:]

I don’t know if you can give any indications as to how that’s progressing. It’s a fairly large dollar amount you guys are requesting. If it’s based on the 10.2%, how much of that do you think we can reasonably expect to be approved or is it just too early to speculate? I mean, this settlement, is that out of the question at this point?

[Peter Nelson:]

It’s too soon to speculate and it would be crazy to speculate. I’ve never been correct on speculating on a Commission decision. All I can say at this point is it’s unscheduled and the data and the testimony is in and we’re just waiting for the ALJ to produce those decisions.

[Jonathan Reeder:]

Okay, so you’re passed the chance for a settlement or anything like that?

[Peter Nelson:]

Well, as the case goes on, several things are settled with the staff and some things are not. And then the ALJ writes the proposed decision and we’ll deal with that when it comes out.

[Jonathan Reeder:]

Okay, and if I heard you correctly, there will be no 2008 GRC. The next one is just a consolidated filing?

[Peter Nelson:]

You’re right.

[Jonathan Reeder:]

I guess there’s still attrition or staff increases associated with the 2007 GRC that will occur up until the consolidated filing is effective.

[Peter Nelson:]

Yes, that’s right. For all 24 districts, they have a general rate case every three years and then the [interceding] years two and three, attrition increases. And that’s built into each general rate case.

[Jonathan Reeder:]

Okay, and then as far as the three aspects being implemented from the Phase I conservation with the effective July 1st date, is there any concern with the designs not being finalized yet, that those won’t be ready and it wouldn’t be in effect on July 1st?

[Peter Nelson:]

You can answer that one.

[Martin Kropelniki:]

Thanks, Pete. I think generally speaking, Jon, almost all your questions, things with the general rate case has progressed as planned. The PBOP, if you’ve read our 10-Q’s and 10-K’s, that we got a favorable resolution to that, 100% resolution of that to our favor. I think generally speaking, things are going well with California Water Action Plan and how we’re implementing them. Could things get delayed? Absolutely. Is this a complex thing we’re trying to do? Yes it is. But so far with our meetings that we’ve had at the Commission has gone well. They’ve liked what we’ve come up with. They all mention how we’re closing reporting etc. And I think for us, until we hear otherwise, we’re going to drive that July 1st date.

[Jonathan Reeder:]

Okay, that’s good. And then just last clarification. You were talking about the market-to-market losses. Could you give that number again and what it was on after-tax EPS basis?

[Mark Kropelniki:]

It was approximately $750,000 before tax. To break that down in EPS basis, I would say about $0.025.

[Jonathan Reeder:]

I mean as far as an on-going basis, it’ll reoccur but it’s completely out of your guy’s control. Therefore, we’re going to normalize earnings. I mean, we should probably take it out. Right, Marty?

[Martin Kropelniki:]

Yes, I think that’s right and that’s why we have it down in the Other Income & Expense line. It’s one of those things people tend not to look at when it’s adding earnings. So when the market runs the other way, it gets more attention. But it’s always down on Other Income & Expense line. And in fact, we always talk about it if there’s swings in our Q’s. So we try to make that transparent so people can see that. And certainly, if you have questions about it, you can certainly call me and I’ll walk you through the accounting for it. In case you want to be an actuary, I’ll be happy to walk you through the actual calculations.

[Jonathan Reeder:]

I’ll let that up to you guys but appreciate the responses today.

[Operator:]

Our next question or comment comes from the line of Andrew Shirley with Ivory Capital.

[Andrew Shirley:]

My question was asked and answered.

[Operator:]

There are no further questions in queue at this time.

[Martin Kropelniki:]

Great! Well in closing, as Pete and I talked about today, we have much going on between the ’07 general rate case, the conservation, the RAM, the modified cost balancing account. Q1 certainly was a soft quarter and I think everyone knows why. We certainly have much different weather this year than Q1 of last year. We continue to believe that the company has made significant progress in implementing the California Water Action Plan. I think we are pleased to date. We continue to believe that we have positioned the company the right way for a bright future with the Water Action Plan and certainly we look forward to being able to share the details of the RAM and the modified cost balancing account and how it’s all going to work, hopefully, next quarter. So we want to thank everybody for their support this quarter and if you have any questions, feel free to give us a call. Thank you.

[Operator:]

Ladies and gentlemen, this does conclude the conference for today. We again thank you for your participation. You may all disconnect at this time. Good day.