California Water Service Group's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.27.14 | About: California Water (CWT)

California Water Service Group (NYSE:CWT)

Q4 2013 Earnings Conference Call

February 27, 2014 11:00 AM ET

Executives

Thomas Smegal – VP, CFO and Treasurer

Paul Townsley – VP, Regulatory Matters and Corporate Relations

Martin Kropelnicki – President and CEO

Analysts

Spencer Joyce – Hilliard Lyons

Heike Doerr – Robert W. Baird

Operator

Well good morning ladies and gentlemen. And welcome to the California Water Service Group Fourth Quarter and Year End 2013 Earnings Results Conference Call. Today’s conference is being recorded.

And I will now turn the meeting over to Mr. Thomas Smegal, Vice President, Chief Financial Officer and Treasurer. Please go ahead, sir.

Thomas Smegal

Thanks Kelbie. 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 Corporate Relations.

As a reminder a replay of today’s proceedings will be available beginning today February 27, 2014, through April 28, 2014, at 188-820-311-12 or 171-945-708-20 the replay pass code is 1339013. 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, there are subject to various risks and uncertainties, and actual results could differ materially from the company’s current expectations.

Because of this, the company strongly advices 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’m going to 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. Quarter 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 with $7 million including a $0.5 million of unbilled revenue approval.

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

Moving on to 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 they are 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 earnings per share for the quarter were $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. Primary drivers here of course are increased wholesale water prices. And increases in the quantity water produced. We saw wholesalers increased 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 the purchased water changed from 47.4% to 49.2% and this was primarily due to increased usage and localize pumping and streams last year. And again these costs are all booked to the MCBA. Our A&G expenses we booked $98.1 million for the year, that’s up 4.4% or $4.1 million and the primary the drivers here in 2013 we saw an increased and expense medical costs of about 20% or about $3.8 million and that’s primarily due to high claims activity from our participants. And while salaries and other benefits cost increased, we managed other administrative expenses to remain relatively flat except for the medical cost item.

And 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 been 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’s 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 mains, services and hydrants. And primarily what’s going on here is more the maintenance activity this year qualified for accounting treatment as the 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 and 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 $600,000 reduction in mark-to-market adjustments for our non-qualified retirement programs, during 2013 compared to 2012. For income taxes as a result of the enterprise zone credits recognized in the quarter and the revised repairs deduction and other tax groups in the fourth quarter our tax rate was 30% for the year.

We expect the tax rate between 39% and 41% for 2014 as discussed in the third quarter. So finally our net income for the year $47.3 million its down 3.2% or $1.5 million the major factors there are the difference in tax benefits this year to last year, our headwind, from the reduced return on equity granted by the California Commission. And the regulatory lag from being in third year of the California rate case cycle.

Our earnings per share for the year are $2 on fully diluted basis down 12.7% from a $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, the stock offering the 5.75 million shares that was completed in March of 2013.

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

Paul Townsley

Thank you Tom. As management previously reported on October 30th of last year we filed a rate case settlement with the California Public Utilities Commission. This settlement was signed by our California Water Service Company, the Office of Ratepayer Advocates and by 10 other parties. On January 6th of this year the rate case evidentiary record was closed with 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 the final decision has been delayed past the January 1st, 2014 date for newer 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 14th once the 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 a one-year delay in the filing of our 2014 cost of capital filing, which was to be filed by March 31st 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 forgo 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 respected water companies will file our cost of capital applications in March 2015. You may have heard the California, 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 to – for a renewable energy to Governor Brown.

And he’s also been a member of the Board of Directors of the Sacramento Municipal Utility District 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’ve 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 for the consumer advocate in our Pukalani wastewater system. The commission decision authorizes us an annual increase – annual revenue increase of $586,000 for this Pukalani wastewater district based in over three years and new rates are now in effect.

We have also reached rate case settlements with the consumer advocate on two other systems that we own in Hawaii, the Waikoloa water systems and the Waikoloa sewer system. These settlements were filed with the commission late last year. And we are awaiting this action. And we are currently in settlement discussions with the consumer advocate on our Waikoloa utilities system. And we’re gearing up for our next rate case filing for our Coquille water and wastewater system.

Overall I believe the California Water Service is doing well in executing on our rate case strategy in California and in Hawaii. And that’s the end of my report.

Thomas Smegal

Thanks Paul. So now I’m going to summarize major balance sheet items for the year-end. Our net utility plant at 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 and $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 of the California GRC activity over the course of 2013.

We are estimating that same range of $110 to $130 million for company funded CapEx in 2014. Our cash at the end of year we had $27.4 million. And our total borrowings on our line of credits, was $46.8 million up $16.8 million for the group and $30 million for the company.

One of the regulatory asset side the RAM, MCBA combined balance at the end of year is $44.5 million is 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 in 2012. However higher purchased water cost have increased the MCBA balance in 2013. So the increase in the balances is due to a lag and purchased water offset rate increases. And so significant changes we’ve 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 to next year or two as those rates go, go through the system.

And now I’m going to turn it over to Martin for some general comments.

Martin Kropelnicki

Thanks Tom. Good morning everyone. There’s for 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, giving 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 earnings for the quarter were $0.12 and $1.2 for the full year. The results achieved by California Water Service Group were better than expected driven by three primary areas. One we had a $0.13 pickup and 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 a tighter budget and operational control that was $0.03.

And then three we had to $0.02 pick up on the revenue accrual which is outside of around at year-end driven by the dry weather in California so there’s more accrued revenue as we ended 2013. It’s worth noting that the $0.03 budget actual variance from operations is after we absorb the $3.8 million of healthcare cost that Tom mentioned. Backing up 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 control 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 is as many of know is the third year to 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 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 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 California, Q1 is going to be extremely difficult quarter for the company. As many of you may recall Q1 is always a difficult and challenging for the company with the majority of our revenue coming in the summer – excuse me late spring and summer months. Well the rate case decision will be retroactive to January 1st, 2014. The delay decision will hurt our financial results during the first quarter.

During the first quarter of 2013 which was the third year rate case cycle we $0.03 a share. And we expect a larger loss this quarter as the rate approval from the CPUC to execute our new rate structure and tariffs.

As we stay in this holding pattern, kind of conclude the generate case in California. The company will remain very focused on our budget and operational controls of executing our 2014 capital program.

Moving on, talking about the drought as many of you have 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 calls on this, and there are a few key points I’d like to reinforce here today while we have everyone’s attention. First and foremost planning for such things in the drought is a core competency of the company. And we are constantly updating our plans.

Second the 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 what we felt was critical.

In addition to the decoupling mechanism as Tom mentioned we have to balancing accounts, one’s called the RAM water rate adjustment mechanism. And this – which covers the decoupling of revenue and second is the balancing account called the MCBA Modified Cost Balancing Account which covered all of our production costs. These two balancing accounts work together to record changes in revenue as well as changes in production cost and get booked monthly.

We started down the conservation patent 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 have on standby, we have put that drought team employed, deployed our draught team and they are busy working with the various agencies to coordinate any draught-related issues that may arise including our media campaigns, our outreach and education. And 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 good position to help both the state and our customers manage through this crisis.

Lastly I want to talk about our new Board member. Yesterday, the Board of Directors of California Water Service Group elected Terry Bayer to the Board of Directors effective March 1st. Terry is Chief Operating Officer of Molina Healthcare Inc., which is a multibillion-dollar healthcare service provider that trades on the New York Stock Exchange under ticker MOH. Terry has excellent background, operational management, including multi-jurisdictional healthcare, healthcare regulations in compliance with customer service. Terry adds an unique perspective to our Board and I now speak for all Board members at California Water Service Group and welcome to our Board of Directors.

And with that [indiscernible] there ends my prepared comments and we will open it up for question please.

Question-and-Answer Session

Operator

[Operator Instructions]. And we’ll go to Spencer Joyce with Hilliard Lyons.

Spencer Joyce – Hilliard Lyons

Good morning guys.

Paul Townsley

Spencer how are you?

Spencer Joyce – Hilliard Lyons

Doing well. Thanks for taking my call, just wanted to ask a quick question here about the delay in getting the rate case rates into effect. You all mentioned that delay would weigh a little bit on the first quarter but is it safer to assume that we’ll see all of that made up by the end of 2014 or could there potentially be some still over into ‘15?

Paul Townsley

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 timeframe that he has. Typically judge has been given about 2.5, 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 into itself and so there could be other reasons for delay or speeding up with that process. But there’s really an uncertainty, if for some reason that were delayed until very late in the year. There might be – the revenue might trickle into 2015 instead of 2014.

Martin Kropelnicki

Okay 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 ‘14 but just not something we can say with certainty.

Paul Townsley

And that’s the best way to say it I think.

Martin Kropelnicki

Yeah I think our expectation is, again the settlement process was supposed to be a total of six weeks it was 25 which was a massive, massive user resources within, within the company but we got the settlement done and we got it signed. And we’re running about 100 days behind essentially. So as Paul said we had to take in early January where the briefs had be filed. So you push out a little bit that would put us sometime in Q2. And Q2 assuming they stay on track and on schedule, which won’t be too bad but it does mean that we’ll have a significant effect in Q1 as we wait for the commission to wrap up the rate case.

Spencer Joyce – Hilliard Lyons

Okay thanks a lot for the color there. Just one more broader question. I know from, well on a regular basis we talk about or at least ask you all about the potential for an acquisition outside of California, maybe materially moving into another state. And can you talk a little bit of about how the landscape there may have changed to what the current plans are. And that could include sort of expansion there in Hawaii or just say anything else you may be able to give us on the region?

Thomas Smegal

Sure the company’s philosophy hasn’t changed. And we don’t comment on any type of M&A activities but inside the company we do have a business development team that is full time. And we’re always out there actively looking. In Hawaii right now I think we’re staying put, we’re 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’re working to get those rates established, to recoup the costs and getting all those plants 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 etcetera. Hence Hawaii was a nice bid for us. I think the other thing that the company has done very well that I think is, become a core competitive frankly is conservation. And as Paul and I’ve moved over and met with people in Hawaii, the commissioners elected official, except the conservation comes up alive.

And we feel we have a very good blueprint in California for conservation. And we think that depending on what happens with the water supplies in the state that becomes a key core competency that make us very attractive. Other systems in other states, so we’re always out there looking obviously our balance sheet’s strong, our credit 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.

Spencer Joyce – Hilliard Lyons

Okay. Thanks a lot guys. That’s all I had.

Thomas Smegal

Spencer have a good day.

Operator

Our next question will come from Heike Doerr with Baird.

Heike Doerr – Robert W. Baird

Good morning. Congrats on a solid earnings report.

Thomas Smegal

Hey Heike.

Heike Doerr – Robert W. Baird

Quick question can you give us a refresher on the way the ROE metrics gets rebound to the Moody’s bond. And that how often that happens and how or if there’s any way that we can be tracking future changes.

Thomas Smegal

So Heike, what’s called the water cost to capital mechanism is a mechanism which is for the two years after the adjudication of a new cost to capital. So we have an adopted cost of capital in 2012. And then the Moody’s AA index what happened is that band of 100 basis points and if it swings up or down a 100 basis points. Then there’s a half adjustment of the ROE. So 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 9.99% to 9.43%. And so 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 in for 2014 we did not trigger for 2014. And so it’s not going to happen again until after the time 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.

Heike Doerr – Robert W. Baird

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

Thomas Smegal

That is correct.

Heike Doerr – Robert W. Baird

Got it. Okay, thanks. That’s helpful.

Thomas Smegal

Thank you.

Operator

And gentlemen, we have no further questions.

Martin Kropelnicki

Okay well as a last point everyone thank you all for being on the call. We will be filing the form 10-K later today. So obviously more and more detail in there. And thank you all for your continued interest in California Water Service Group. We look forward to talking with you again with our first quarter results in April. Thanks.

Operator

Thank you and again ladies and gentlemen that does conclude our conference for today. We thank you all for your participation.

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