California Water Service's (CWT) CEO Martin Kropelnicki on Q1 2016 Results - Earnings Call Transcript

| About: California Water (CWT)

California Water Service Group (NYSE:CWT)

Q1 2016 Results Earnings Conference Call

April 08, 2016, 11:00 am ET

Executives

Dave Healey - Vice President, Corporate Controller

Martin Kropelnicki - President, Chief Executive Officer, Director

Thomas Smegal - Chief Financial Officer, Vice President, Treasurer

Analysts

Jonathan Reeder - Wells Fargo

Operator

Good morning, ladies and gentlemen. Welcome to the California Water Service Group first quarter earnings results teleconference. Today's conference is being recorded.

I would now like to turn the meeting over to Dave Healey. Please go ahead, sir.

Dave Healey

Thank you, Wes. Welcome everyone to the first quarter earnings results call for California Water Service Group. With me today is Martin Kropelnicki, our President and CEO and Thomas Smegal, our Vice President, Chief Financial Officer and Treasurer. A replay of today's proceedings will be available beginning today, February 28, 2016 through April 28, 2016 at 1-888-203-1112 or at 1-719-457-0820 with a replay pass code of 9747630.

As a reminder, before we begin the company has developed a slide deck to accompany the earnings call this quarter. The slide deck was furnished with an 8-K this morning and is also available at the company's website at www.calwatergroup.com/docs/earningsslidesmarch2016.pdf

Before looking at this quarter's results, we would like to take a few moments to cover forward-looking statements. During the course of this 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. 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-Q and other reports filed from time to time with the Securities and Exchange Commission.

Now let's look at the first quarter 2016 results. I am going to pass it over Tom to begin.

Thomas Smegal

Thanks Dave. And just as an overview of what we are going to discuss today, we will go over our financial results, some of the highlights and changes there, talk about the drought in California and talk about our rate cases, give you an update on our CapEx program and balance in our WRAM decoupling mechanism, bridge the earnings and Marty will have some closing comments as well.

So turning to financial results. Our operating revenue for the quarter was essentially flat compared to the operating revenue in the first quarter of 2015. A couple of competing things there related to water production costs. Sales are down, but the price for our purchase water is up. Those offset each other. Operating expenses or purchase water costs are down because of the volumes and that's offset as we will discuss it in a moment by maintenance costs and drought related activity costs.

Other highlights on slide five of our deck are that our interest cost is up. That is due to new long-term debt, both in October and in March, October of 2015 and March of 2016. So our net income is down $2.4 million and our EPS is down about $0.05 from the year ago period.

So flipping to slide six of our deck on the financial highlights. We had incremental drought expenses of $2 million in the quarter. That is a little higher than our run rate for the previous six months, this last six months of last year and has to do with communications that we made to our customers about with the new drought tariffs and changes to the drought regime in 2016. So that is a bit higher than it's been.

Once again the drought costs are subject of an approved memorandum account of California Public Utilities Commission. That means that we record those costs and we are going to ask for recovery of those costs that has to go through a reasonableness review and we will expect a future increase in our revenue to cover that. But those are being passed through to expense right now.

Our maintenance expenses were $1.6 million higher during the quarter and that has to do with again the drought. We believe this is a very similar run rate on maintenance expenses that we have had for the last two quarters. We believe a lot of that has to do with fixing leaks when they occur despite the magnitude of the leak. In a normal time, we would have prioritized leaks and addressed the much smaller leaks in due the time when we had a spare moment, Now, we are trying to fix every leak every day and that is driving up our cost for maintenance. And as I mentioned before, the interest expense due to the long term debt did increase our expense by $800,000.

Two big highlights for us for the quarter. Our company and developer funded capital investments were $55.6 million. That is really on target for our $180 million to $210 million CapEx spend for the year. So we are very excited about that. That's probably the highest amount of CapEx in the first quarter in the company's history.

The second really good news item is that our customer receivable for the WRAM decoupling mechanism declined to $33.6 million. That was in part due to $11 million of drought surcharges and the effect of new rates that were put in 2016 that lowered the expected sales and therefore bring us closer to recorded and adopted sales. And finally as we noted that we did complete our financing, our long term debt financing with $50 million and that was in March, previously announced.

Now I am going to turn it over to Marty for some updates on the drought.

Martin Kropelnicki

Thanks Tom. Good morning everyone. I want to give you a quick update on the drought situation in the State of California, our performance and where we are in terms of our savings with our customers versus the emergency declared by the Governor last year in the State of California.

First and foremost, we ended the quarter. So the savings for March, we were at 27.9%. So we are continuing well above the state 25% mandate. A couple of interesting stats to a share with everyone. If you look at the estimated savings for the state from June 1, 2015 through the end of February, the state saved 1.19 million acre feet of water through the conservation efforts that were declared in emergency declaration. During that period, Cal Water customers saved 74,000 acre feet, which is about 6.2% of the total savings for the State of California. So I think when you look at how robust our drought program has been and how well our customers have done in terms of hitting their targets, we have been very pleased with our contributions to the savings that they have put with State of California.

As we put in the deck, Northern California, we are coming into the spring month now. Northern California had above normal rainfall and snowfall levels than Southern California. It was different. They were lower than normal. So just to share some numbers with everyone that I think are going to be very important, the snowpack reading that took place on April 1, which is a very important in the State of California, statewide the snowpack levels were at 85% of normal. But when you dissect North versus South, you will start to see how the picture changes a little bit. In Northern California, we were above 95% of normal, but when you go down to the snowpack range in Southern California, they are only 71% of normal. So again, most the snow and rain happened in northern parts of the state.

Likewise, when you look at reservoir levels throughout the state, when you look at Northern California, most of our reservoirs are at 100% of capacity and 100% of their historical averages for this time of year. When you move to Central California, most of the reservoirs are between 40% and 80% of their historical averages, but only at about 40% to 50% of their total capacity. And then when you move to the reservoirs in Southern California, they are between 40% and 80% of normal in terms of the historical averages, but well above 50% of capacity. So despite the strong rain and snowpack in the North, you can still see why the drought has been extended through October 31 of this year.

Having said that, clearly we have more water this year and as we have in the deck, the State Water Project bumped up their allocation to 60%. It's the highest it's been in five years. So that's good news. That allows us to move more water from Northern California to Southern California. Likewise with the Federal Water Project, we have seen an increase in allocations as well. In 2015, the allocation for urban areas was 25% on the federal project, that's been bumped up to 55%. And on the agriculture front, the allocation from the federal project was zero in 2015 and that's been bumped up to 5% for 2016. So again, well, conditions have improved. They vary dramatically depending on where you are through the state. Northern California is in fairly good shape. But clearly Southern California is below average.

What will happen next? The State Water Resources Control Board, we are expecting them to issue updated draft regulations any time during the next 10 days. They have a meeting scheduled to approve any changes on May 18. And then those changes will go into effect on 6/1. So in terms of where we are, I fully expect and this my personal opinion, that you will see some easing of the drought restrictions but clearly we are not going to see them go away. And again, you can just look at that the numbers I gave you, if you run them down, Northern California versus Southern California, we are still not where we need to be and frankly we are far from it, even with the strong rains in the North. So watch those new rates to come out shortly and we will be communicating on the second quarter earnings call what the changes are to the drought policies for the State of California and the impact on Cal Water.

Likewise, one of the things we put on slide seven is that we have implemented in our drought program, I call it a dead band, the drought people call it a courtesy tier, given the fact that 80% of our customers are coming in at or below their conservation targets. Basically a band around the tear-off before they get a surcharge. So if they go one unit over their authorized amount, they are not hit with a penalty. So it gives customers a little bit more breathing room. We expect that will reduce the number of calls to the drought call center and ease some of the backlog that we have seen on applications for exceptions to their water allocation budget process.

Tom, back to you for an update on the regulatory mechanisms.

Thomas Smegal

Yes. Just a reminder to everyone of the regulatory mechanisms in California that help us through the drought. Obviously, we has been decoupled since 2008 with WRAM and MCBA mechanisms and again what that does is it keep our revenue normalized even if the sales are declining. And then the drought costs, as I mentioned before, the $0.02 EPS impact in the quarter or the $2 million, we do expect to request approval for last year's expenses in the second quarter. If you will remember, the expenses there were about $4.4 million for 2015. We are preparing that filing for the Commission and expect to file that within the next 90 days and that will go to the review process. The expenses for 2016 will be on our review schedule later on.

Our customer surcharges, as I mentioned, it really positively impacted our WRAM balances. $11.4 million of drought surcharges recorded in the quarter and the WRAM balance again declining $6.9 million in the quarter and year-to-date. And the other thing that I have been mentioning on these calls is that we did have a mechanism called the sales reconciliation mechanism which allowed us to change or rates for customers in 2016 with a lower expectation of sales, so that when those sales do come in lower due to the drought, the potential WRAM balance is much smaller and so that improves for cash collections.

And Marty, I am going to turn it back to you for a rate case update.

Martin Kropelnicki

Great. On slide nine, that's the recap. I think you maybe have seen this before of what our rate case was for July 1 last year that we filed, July 1, 2015 that was filed with the California Public Utilities Commission. I am not going to go through the numbers here rather than on the last bullet point, we are about nine months through the 18 month process.

And if you turn to the next page, on page 10, we will give you more of an update. So we did receive the Advocates' report or the ORA report. Today, close of business today, we will be filing our rebuttal testimony. To give an idea of how many people have been working on this, we have got about 115 people throughout our company working on rebuttal and support for rebuttal testimony. So we have about 2,000 pages of testimony that will get filed at close of business today.

Likewise, during the first quarter we have started our public participation hearing meetings. We will our sixth public participation hearing meetings tonight and those are progressing as scheduled. And we have our interveners lined up. In total, there are 17 intervening parties in the rate case. Most of what our cities and counties and we are going to the process of starting to meet with them. So in terms of next steps for the rate case, as we file the rebuttal testimony and then we will start settlement negotiations on or around approximately May 9.

So things are right on track as of right now, but now is where the rubber meets the road, which is a settlement discussions or if we decide to litigate. And so we will have a much better sense of where we are with the Q2 call at the end of July and we will provide a detailed update then.

If you go to page 11, as Tom said, this is the best first quarter in terms of CapEx spend. We spent 27% of our budget. If you remember our range was between $180 million and $210 million. I think it's noteworthy that it is the highest number we have recorded in the first quarter in terms of capital investment. It's also noteworthy that we accomplished this with so many people working on the general rate case rebuttal testimony and a lot of support has to come from engineering on the capital program for that rebuttal testimony. So overall very happy with the start of the year in terms of our capital program and the results and the productivity we are getting out of our engineering departments which you may recall, we reorganized in the fourth quarter of last year. So overall off to a very good start on our CapEx and look forward to seeing how that number progresses throughout the year,

Tom?

Thomas Smegal

Sure. The next slide is a graphical representation of our WRAM and MCBA net balances. These are receivable balances from customers over the last five-and-a-half years. And what you will see here and what's notable is that we have really made an impact with the drought surcharges on that WRAM balance. We have as low a balance as we have had since the very beginning of 2011 and that was really in a period back then when things were rising and things were off-kilter. We are getting back to a spot where we expect this to continue to decline. So really happy about that receivable balance.

On the next page, just an earnings bridge from 2015 to 2016 for the first quarter and you will see there that the big impacts are obviously, as we talked about, the drought expenses and the increased maintenance expense. And all other items that impacted us about $0.01 and that includes the interest and other cost changes on us.

And so that is it for the deck. I do want to pass to Marty for some closing comments.

Martin Kropelnicki

Great. Thanks Tom. Well, it's nice to have Q1 behind us. For those of you who have been with us for a while, Q1 is always our leanest quarter of the year and that is especially true, the third year of the rate case cycle which is where we are in right now. It's the year we have the least amount of rate relief and we start to see regulatory lag in certain costs. While we have a number of balancing accounts that cover major costs, things like labor, chemicals and filters, some of the operating lines are affected by a lack of charges that creep in during the third year. So nice to have the third year behind us.

In terms of what the company is focused on during the second quarter obviously, as I mentioned earlier, the rebuttal testimony is key. We expect to file that today, close of business today and then start settlement discussions approximately a week, week-and-a-half later.

The second thing and Tom mentioned this earlier as well, is filing for the recovery of drought cost from 2015. So the 2015 costs will be filed on a stand-alone basis and then 2016 cost will be recorded to the memorandum account for this year and then what happens with the drought. And so we will know a lot more about the drought. I fully expect some type of restrictions to continue throughout the year, but what that will be, we don't know as of now and we expect to find that out in the next two weeks. And like I said, we will be communicating that once we know what those restrictions are.

So overall kind of the quarter was what we thought it would be. If you back out the drought expenses, we were tracking right to where our internal budgets were. And then we will be focused on the drought and any change to be made in our capital spending for 2016 in the rate case.

So Tom.

Thomas Smegal

Thanks. Wes, we are ready to take any questions that people have.

Question-and-Answer Session

Operator

[Operator Instructions]. We will go first to Jonathan Reeder at Wells Fargo.

Jonathan Reeder

Hi. Good morning, Marty and Tom. Thanks again for slide deck. That's helpful to follow along. First question, so including the drought costs, earnings were essentially flat in Q1. Were there any other items that you would single out as nonrecurring?

Thomas Smegal

I don't think so. You can always pick your expenses apart and say, well that legal bill or that consultant bill is in this quarter and not in that quarter or anything like that. I don't see that there is anything significant in any of those variations. Just normal stuff.

Jonathan Reeder

So were there any items in Q1 that were not in line with your expectations or plan for 2016? Or did the quarter, for the most part, go the way you were anticipating?

Thomas Smegal

I think it did go the way we were anticipating. We do have an internal budget obviously and we are tracking pretty close to that. I think just the drought costs are the big item there and the maintenance costs that are probably related to the drought as well.

Martin Kropelnicki

And one thing I would highlight on the drought costs, we did have a step-up in advertising in terms of related to the drought. And that's because as we go into the winter months, it's a lot harder to hit your conservation targets. In the spring and summer months, people have their lawns, you start watering, outdoor watering and that's where we get a lot of the savings from during the summer months and fall months. But as you go into winter, people turn off their water. So we stepped up our advertising campaigns in the districts that weren't hitting their targets.

Thomas Smegal

And Jonathan and everybody, I think the other thing to note is, with the uncertainty related to how much drought restriction we are going to have this year, there is a potential that the drought costs will start to come down a little bit over the second quarter, third and fourth quarter of the year. The $2 million, I wouldn't characterize as a run rate every quarter for the company going forward. We have seen a slight decline in the number of calls to our drought call center. And so we are going to manage the staffing on the call center. We are going to be managing the staffing related to the outreach customer or direct outreach. And so if you see the state coming in with a major reduction in the drought requirements, we will also probably see a reduction in our costs on a go forward basis.

Jonathan Reeder

Okay. Do you think, is the state, would they distinguish between the North and the South in terms of restrictions? Or is it just going to be a blanket thing?

Thomas Smegal

We participated in a couple of calls talking about different ideas. One idea was that you basically put it at a groundwater adjudication level or at a regional level and allow each region to make the appropriate changes based on their water supply situation. But as you know, the groundwater adjudication bill which was signed a year-and-a-half ago, that's not fully implemented yet. So we are not sure that's probably going to work. So we are not sure of what they are going to do. But I think when you look at the numbers, if you look at the snowpack and reservoir levels, you get the clear sense of Northern California is great shape, Southern California is still really in a danger zone. And while we have water to move from the North to the South, on average the snowpack was not at average. It was still below average. And so this was supposed to be a big El Niño year. So I think there is a number of factors they have to work through and we just don't have clarity we will get the orders from them here, like I said, expected within the next two weeks. Then we will know what to do once we see that. But I still think you will have drought restrictions statewide at some level.

Jonathan Reeder

Sure. And then did you specify when you are going to file for the 2015 drought cost recovery?

Thomas Smegal

They are working on that now. We think we will have it filed some time here during the second quarter and it has been a busy, busy, busy time for the rates team. There is core team of about 15 employees who work on the staff, the rate case is actually for the four states. So between the GRC and preparing to file for recovery of the drought costs, everyone has been really busy, but performing very well. Very happy with how everyone is performing. They were on schedule. So you will see it filed here in the second quarter, I believe.

Jonathan Reeder

And then potential to pickup would be by Q3? It's pretty quick turnaround?

Martin Kropelnicki

Yes. It's an advice letter process. So presuming that the Commission determines things are reasonable, I think it could move within 90 days of filing. That would be a best guess. But with the Commission, you can never tell.

Jonathan Reeder

Sure.

Martin Kropelnicki

It could get held up.

Jonathan Reeder

Okay. Any impact from unbilled revenues in Q1, like we have seen in the past few quarters?

Thomas Smegal

There was a slight positive this quarter when you get out the Q and look at that, it's not a negative for the quarter this time. But remember that the big negative that we had in 2015 was the second quarter. And so we will be watching carefully to see how we are different in the second quarter from the second quarter of 2015.

Jonathan Reeder

Okay. And then any discussion for extending the water GRC to cover for you [indiscernible]? I know that some of that's been kicked around a little on the electric side?

Martin Kropelnicki

I know that there has been a lot of interest in the water rate case plan among the different parties, the water companies and ORA have talked about this periodically over the years. But there is no formal effort to change it at this point of water side. And if we were going to change it, we will probably see some other things. I think some of the companies and ORA are sick of having the cost to capital as a separate item. And so if you change the schedule, you might also change that, embed that back into the rate case. So those changes, I don't anticipate but we will follow the energy industry and see what changes there.

Jonathan Reeder

Okay. And then last question and I will hop off. Can you quickly sum ORA's testimony in terms of the CapEx budget and the revenue increases and just how that compares to your request? I know you are filing a rebuttal.

Thomas Smegal

Yes. The easiest sum is, no. NO. Obviously in our rate case, we made a case for a major expansion of our CapEx and we think it's with very good justification. We went into great amount of detail as far as we have talked to this community about the need for additional main replacements and how we have been following behind our main replacement program. The attitude of the Ratepayer Advocates seems to have been in opposition to that expansion. As I think Marty, did you mention the number of pages of rebuttal testimony? I think it was about 1,000 pages.

Martin Kropelnicki

2,000 pages.

Thomas Smegal

2,000 pages of rebuttal testimony. So we are going in fighting. It's not unusual as a former regulatory person all the way down from the regulatory VP to a regulatory analyst, the worst day of my year has always the day I get the ORA or DRA report and then we just move on from there. Because remember that they are not the Commission. They are an advocate and they are taking a position and often it's a very short term position as far as the immediate impact and looking at the long term effects on the system. So we have a lot of confidence that our arguments are good and that we will be able to reach a settlement or if we don't get to settlement, that we are going to able to go through and litigate and have a favorable outcome.

Jonathan Reeder

I was going to say, based on those comments, if was a different kind of mindset between the short-term and long-term nature of the two sides. It seems like reaching a settlement could be a little more challenging this time around.

Thomas Smegal

I don't mean to be too pessimistic about the settlement possibilities. I know that we have a very good relationship with the staff of ORA in terms of a working understanding of passing data back and forth. There is no intent on either side to hide information or couch arguments in terms of really expressed terms. So I think that we are expecting to have settlement. And I believe that ORA is expecting to have settlement. And that's always encouraging. If we were to know, for instance, that they have no intention of settling and wanted to litigate everything, then I would be feeling a little bit differently. But I know for a fact that we have been trying to negotiate which subjects get settled at which time. And so there is a high likelihood that we will have a productive settlement discussion. Whether that leads to a full settlement or not, I don't know.

Martin Kropelnicki

Yes. I think Jonathon, we have spent a lot of time preparing this rate case. And I think Tom and I have really been focused on getting the company to focus on the long-term planning around capital. So we have got a lot of people to work on the rate case. We put our best people on the rate case, including Tom is doing a big piece and I got a piece of it. We have three or four officers dedicated to working on it. So I think we are going in in a very good position and we just have to see where the process takes us. I think it's fair to say, this is probably the best job we have done on our justifications in terms of making sure that we are well rounded, well thought out, well backed up with data and third-party data to validate the company's positions. So their job is to say no and our job is to convince them why we need it and have good reasons and explanations for that. And that's the next step of the process here.

Jonathan Reeder

Okay. Thanks so much for the insight and good luck over the next few months. It sounds like it's going to be a pretty busy time.

Thomas Smegal

All right.

Martin Kropelnicki

Thanks Jonathon.

Operator

[Operator Instructions]. And we have no further phone questions at this time.

Martin Kropelnicki

Okay, Wes. Well, just to wrap up, I want to thank everybody for their continued interest in California Water Service Group. We look forward to giving you updates on all these subjects with our second quarter call. And have a good day, everybody.

A -Thomas Smegal

Thank you.

Operator

That concludes today's conference. Thank you for your participation. You may now disconnect.

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