Earnings Call Transcript - CWT Q3 2021

Dave Healey, Vice President, Corporate Controller

Good day and thank you for standing by. Welcome to the California Water Service Group Q3 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today, Dave Healey, Vice President, Corporate Controller. Please go ahead. Thank you, Laurie. Welcome everyone to the 2021 third quarter results call for California Water Service Group. With me today are Martin Kropelnicki, our President and CEO, Thomas Smegal, our Vice President, Chief Financial Officer; and Paul Townsley, our Vice President of Corporate Development and Chief Regulatory Officer. Replay dial-in information for this call can be found in our third quarter results release, which was issued earlier today. The replay will be available until December 29, 2021. As a reminder, before we begin, the company has 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. You can also access the webcast of this earnings call presentation at the same website. Before looking at the third quarter 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 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-K, Form 10-Q, press releases and other reports filed from time to time with the Securities and Exchange Commission. I'm going to pass it over to Tom to begin.

Thomas Smegal, CFO

Thanks, Dave, and good morning, everyone. So we at Cal Water are trying a little bit of new technology here today. We have the traditional conference call, which I know some of you are on, but in addition to that, we are webcasting this at our website. And with that, you get an opportunity to see the slides along with us talking. Hopefully, you'll find that helpful. You can also hear a replay of that later on. One other unusual aspect of this quarter is that because of what happened last year with our rate case; we're presenting our results in a slightly different order. So I'm mainly going to be talking about the year-to-date earnings and financial results, as you will see in the press release that we sent this morning, as well as our slide deck, emphasizing the year-to-date over the quarter because the third quarter results of 2020 were a little unusual. So leading off with Slide 5, which is our financial results year-to-date. Here we see that our net income rose $16.3 million, and that's about $0.25 per share on a per share basis. I will highlight also here, and we'll talk a little bit later that our capital investments are slightly down for the year-to-date from $221.3 million in 2020 to $207.7 million here in 2021. Looking very quickly to Slide 6, which shows the third quarter financial results. Remember that in the third quarter of 2020, we posted earnings that reflected the effect of the 2018 California General Rate Case proposed decision. We incorporated in that quarter results, regulatory assets for interim rates and for regulatory mechanisms that would have been reflected in Q1 and Q2 of 2020 had the decision been rendered timely. The results for 2021 third quarter are down, and it mainly reflects, in fact almost exclusively reflects the fact that we're not recording that extra Q1, Q2 that we had in 2020. That will be clearer on the bar chart, which I'll get to in just a couple of slides. Flipping now to Slide 7, the year-to-date financial highlights. As I mentioned, we had increased net income. The big drivers of this are rate increases. So it's the annual step increase in California and various offset filings that added $16.3 million to our revenue. Our operating expense for the year-to-date period increased only $7.8 million. This reflects reduced bad debt expense at the company and that bad debt was reduced because of our expectations that our customers are going to be more able to pay their past due balances due to several different state aid programs. We'll talk in some detail about that a little bit later in the call. We did see lower sales and higher decoupling balance here in the third quarter, and that is due to our drought conservation in California that we're promoting. As I mentioned, the capital spending is slightly lower than 2020, but it's on track to meet our target range of $270 million to $300 million for the year. Finally, impacting the year-to-date period, as we talked a bit about on the second quarter call, our unbilled revenue accrual is adding $8.7 million above what it added in 2020 and so that's an adder for the year-to-date results. Flipping to Slide 8, for the earnings. The EPS bridge, again addressing the year-to-date, first, you can see the impact of rate relief offset by operating expenses, depreciation, and local tax changes. The unbilled revenue is a big portion of that over on the right-hand side, that's the $0.14 element on the year-to-date. If you flip to Slide 9, this is the EPS bridge for the company just for the quarter from 2020 to 2021. There you can see the large amount, $0.80 that was booked in 2020 Q3, which had been related to Q1 and Q2 regulatory assets. From the other bars, you can also get an idea of what is driving our change for the quarter. You will see a reduced operating expense in the middle of that chart. Again, that is due to our lower estimate of uncollectibles as a result of the customer relief mechanisms. I wanted to take a moment on Slide 10 to talk about earnings and how to think about earnings for the rest of the year. We've talked about a number of these items on prior calls, and I just wanted to reiterate each of them so that there's a good understanding of where we are and where we're going. The first item over on the left-hand side of this slide is the unbilled revenue accrual. The revenue accrual is currently adding $20.1 million to revenue and that compares to last year where it was adding $11.4 million at this time. The unbilled revenue is the result of a calculation that we do based upon how many of our customers have not yet received a bill at the end of the quarter and how many days that bill represents and what the average expected payment under that bill is. We find that on a year-to-year basis, it generally comes back down at the end of the year because we're dealing with cooler weather and smaller bills. We expect that not to have a big impact on earnings on an annual basis. So when you see $20.1 million being added this year, that means most likely, you are going to see that number come down significantly by year-end. Please keep that in mind. The second item that I'll address on the right-hand side of the slide is the authorized rate base, we've mentioned this before. A good way to calculate our core earnings or base earnings is to take the authorized rate base multiplied by the capital structure, the equity portion of the capital structure, and the authorized return on the equity portion of that rate base. That gives you a general guide to annual earnings. In addition to the unbilled revenue, other items which may impact earnings outside the authorized return on rate base include recognition of equity AFUDC. This year we have $2.3 million recognized to date. Just to remind you, last year at this time, that number was more like $4 million; it's come down a bit from last year to this year, but nevertheless, it is additive to that core earnings power. The second item is the gain or loss on any non-qualified retirement assets. This year, we have so far a gain of $2.1 million in 2021. The value of these assets is, of course, market-driven, and the year-end values will be based on the market conditions at year-end. Lastly, the bad debt reserve has been reduced from $5.2 million at the end of 2020 to $2.8 million at the moment, reflecting changes in our estimates of cash recovery related to those state aid programs. For the year 2021, we actually have a negative uncollectible rate right now. We started the year with $5.2 uncollectible; we're currently at $2.8 uncollectible. That's certainly better than what would be expected in rates for 2021. With all that said, I'm going to turn it over to Paul Townsley to give us a regulatory update.

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

Thank you very much, Tom. Turning to Slide 11, Cal Water has two proceedings before the California Public Utilities Commission right now. The first is our cost of capital case, which we filed along with three other Class A utilities on May 1st of this year. Our schedule has been established in that case, in which we expect intervener testimony on the cost of capital will be filed later this year and a commission decision on the case probably in the second quarter of next year. We expect that a memorandum account will be established so that any changes in the cost of capital will be made retroactive to January 1st of 2022. The second matter is our triennial general rate case in front of the California Public Utilities Commission. We filed our application on July 1st and are currently going through discovery with the California Public Advocates Office. We expect that their testimony, along with testimony of any other interveners, will be presented in late January or early February of next year, with a commission decision either in late in the fourth quarter of 2022 or early in 2023. Again, we expect a memorandum account will be established so that any rate changes that are made will be retroactive back to January 1st of 2023. Lastly, we also have a rate case underway in Washington in front of the Washington Utilities and Transportation Commission. That rate case includes both our legacy Washington water systems, as well as our newly acquired Rainier View Water system. We expect the decision from that commission probably early next year. And with that, I will turn it over to Marty.

Martin Kropelnicki, President and CEO

Thanks, Paul. Good morning, everyone. A couple of operational updates I want to share. Starting off on Page 12, talking about the 2021 California Drought. As you may have seen on October 19th, Governor Gavin Newsom in the State of California expanded the drought declaration to be statewide. Prior to this declaration, it was 50 of the 58 counties. So the majority of the state was under a drought mandate. Now, as of October 19th, the entire state is under that drought mandate. Cal Water has moved to Stage 2 drought restrictions in six of our districts, which is really a continuation of voluntary reduction targets, enhanced advertising, and more mailers and information going out to customers promoting conservation programs. The company is prepared, if we have to implement water budgets in 2022, if the drought continues; the team is well prepared. Additionally, we continue to focus on our water supply resiliency in all our districts, tracking it on a district-by-district level. Every couple of weeks, we are reviewing that with our officer team. As you may have seen, five days after the Governor declared the drought declaration statewide, we had what was known as a monster storm, or atmospheric river, where the jet stream pivoted towards California and took moisture accumulating in the Pacific and targeted it directly at California. On that Sunday, in particular, Northern California received significant rainfall in a very short period. Rainfall totals ranged from a low of 3 inches in 24 hours to a high of over 20 inches. Eighty percent of our facilities in Northern California experienced power outages. We had a number of main breaks in Northern California due to the ground saturation. I’m very happy to report that our systems overall worked very well with this heavy type of rain, and very few of our customers, if any of them, experienced any water outages. We had one system that had a fairly large main break, and we had to provide bottled water, but they're back online now. I can tell you, living in the North Bay, the town I live in typically receives about 9.8 inches of rain in a given year, and during that storm, we received almost 9.2 inches in about a 14-hour period. It was significant. While this was a big storm, it is still a drop in the bucket in terms of the drought. We need to monitor the situation as we proceed into the fall and winter to assess drought conditions for 2022, updating everyone at our year-end conference call at the end of February. Moving on to Page 13, I want to give everyone an update on where we are with our pandemic response efforts in conjunction with COVID-19. All our company employees have returned to the office, and we remain vigilant by screening employees every day, temperature checks, and various testing programs. So far, things have gone quite well. New Mexico, Washington, and Hawaii have all allowed us to restart billing collection efforts with some restrictions. The California moratorium is expected to continue through 2021 for collection efforts. As Tom mentioned, the change in estimates for the allowance for doubtful accounts and collections has come down due to the allocation of $1 billion for the Arrearage Management Program from the state of California. Cal Water has applied for $16.9 million on behalf of our customers who have fallen behind on their water bills during the pandemic. We expect to see payment from that as early as February or potentially sooner. In total, our bills outstanding over 90 days have increased by approximately $16.6 million, and we are anxiously awaiting that money coming from the state, which has been reserved and allocated. The applications have been submitted, they have been approved, and we are waiting for allocations, hence the change in estimate. The incremental costs associated with COVID-19, as of the end of Q3, was a cumulative amount of $1.4 million for the pandemic to date. We anticipate filing for recovery of these costs in 2022. In Q3 alone, the incremental costs incurred were about $200,000, primarily related to increased purchases of PPE and incremental testing. Liquidity remains strong with the company, and at the end of the quarter, we had $140.4 million in cash and additional borrowing capacity of about $420 million on our line of credit, subject to various borrowing conditions. Overall, liquidity remains very strong. As we talked about in previous quarters, business development remains strong for the company. Paul, I think you want to provide a quick update on our business development efforts.

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

I do. Thank you very much, Marty. Turning to Slide 14, as far as acquisitions go, California Water has been busy. We have four announced acquisitions right now going through public utility commission approvals in New Mexico and Hawaii with over 8,000 equivalent dwelling units included in those acquisitions. You can see, we have The Preserve at Millerton, which is here in California's Central Valley; Animas Valley Water, which is a water system in Northern New Mexico with 2,000 dwellings; the Keahou Resort wastewater system on the big island of Hawaii with 1,500 units; and the HOH Utilities, again a wastewater system on the big island of Hawaii with 1,800 units. We have other acquisitions that we are working on and hope to make announcements. Our partnership with BVRT in Texas continues to grow. As of this month, we have over 5,500 connections and commitments in place.

Thomas Smegal, CFO

Thanks, Paul. I will briefly go over Slides 15 and 16. You’ve seen these slides many times before. We just want to keep everyone on track. On Slide 15, the only update here is the recording of year-to-date capital. I realize at the beginning of the call, I mentioned we would talk a bit more about capital, and I don't think we did that. So very, very briefly, I think there are two bigger explanations for why the capital is slightly slower this year than last year. The first relates to the supply chain issues that you've been hearing about; materials that we use in construction have had significant delays, particularly in the early part of the year with PVC pipe and the Texas winter storm later in the year with other materials, mainly due to general logistics issues facing the country. I think we've worked well with our suppliers and construction companies to mitigate a lot of those, but some delays persist. The other factor is that we are in the middle of the prosecution of the 2021 general rate case. Paul, I don’t know if you have the number in your head, but I think there's been about 200 data requests from the commission staff. A lot of those requests concern capital projects and are addressed by the same engineers who would be working on designing and implementing these capital projects, causing delays. Slide 16 shows no change here. These are just our estimates based upon the rate case filing, and as Paul mentioned, we do not currently have any additional information on where that might go. Marty, I'm going to turn it over to you on Slide 17 for a wrap-up.

Martin Kropelnicki, President and CEO

Great. Thank you, Tom. As we reflect back on Q3 of 2021, results are in line with our expectations. As Tom said, it's a little bumpier comparing year-over-year and quarter-over-quarter. So we encourage you to take time to look at the information in the slides that Tom's laid out. Overall, we are happy with our results for the quarter. As Paul mentioned, we have two open CPUC filings, which is the biggest part of our business for the Group. We've completed all our site visits with the PUC here in the state of California, and as Paul and Tom mentioned, we're in the middle of responding to a lot of data requests. We are also preparing for our public participation hearings, which we expect to start sometime in the first quarter of 2022. As Paul mentioned, the team is busy working on regulatory approvals and integration of multiple acquisitions across our platforms. The business development team remains busy, which we're excited about; we don't see that slowing down anytime soon. We will continue our efforts in seeking expansion opportunities for California Water Service Group. Our next quarterly call will be at the end of February, and we will have a much better sense of winter conditions. Obviously, this is the first storm we just recently went through here on the West Coast. We will wrap up the year and go through year-end earnings, where we'll provide better insights into the snowpack and drought conditions in the state and give better guidance on what the drought might look like in 2022, once we have more data from our winter season. So with that, Laurie, we're going to open it up for Q&A.

Dave Healey, Vice President, Corporate Controller

Operator.

Martin Kropelnicki, President and CEO

And Laurie, if I might add, just because we're dealing with this new technology, if you are on the webcast rather than on the telephone, up in the upper right-hand corner of the screen, there is an opportunity to press a button to ask a question. If you don't see that button, you may need to refresh your tab on your browser, but if you refresh, you see that button. You can type in a question, and we can address that question as well. So go ahead, Laurie.

Ben Kallo, Analyst

What's going on, guys? So Tom, Slides 15 and 16, I know those are projections there. How do you guys get comfortable with doing that, because I know there are big step-ups going on there? But how do you get comfortable with all the regulatory stuff that isn't outstanding? And then just maybe you guys have been doing a lot of good work in California. How do people recognize that at the PUC, or how does that work? That's all. Thanks, guys.

Thomas Smegal, CFO

Thanks, Ben. Let me take the first part of it, and maybe I'll rope Paul in as well. Marty can back lean up on this. The projections on the yellow bars on Slides 15 and 16 represent what we've filed with the commission. We're in the process of working through those requests. We’ve done pretty well in the past on requests that we’ve made to the commission. Paul could address that particularly. There's kind of two things here. One is getting the commission to approve those capital investments, and the other is execution on those capital investments. What we've shown over the last six to seven years is our capital execution has ramped up dramatically. If you look back to 2014, 2013, we were putting in CapEx of just over $100 million; we've done a lot with re-engineering our process on the operation, contracting, and engineering sides, allowing us last year to invest almost $300 million. Moving from that number to $360 million, $365 million in a couple of years seems quite doable.

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

The only thing I would add, Tom, is that our ability to justify our capital projects at the commission has significantly improved over the past decade. The projects we are seeking approval for are bread and butter types of utility projects that should be non-controversial. These include main replacement programs, treatment for chemicals, IT system upgrades, and similar initiatives. While I don't expect the commission to approve everything we've asked for in the rate case, I believe we will be very successful in obtaining the vast majority.

Martin Kropelnicki, President and CEO

And Ben, I would just add, and you know this, we've spent a lot of time internally improving ourselves, focusing on our forecast, planning, rate case preparation, community, and governmental affairs. We always tell people we sit on a three-legged bar stool: One leg is customers and affordability, the second leg is regulators who need to assess reasonableness, and the third leg is stockholders. We need to consider rate-based growth, dividend growth, and book value growth. Over the last decade, we’ve managed to keep that balance, meeting the capital program needs while ensuring rates remain affordable and continuing to grow dividends and the company's rate base and book value. As we move into 2022, we have exciting initiatives where we're re-examining how we look at capital. If you remember, we previously re-engineered some of our capital planning processes and are doing the same moving forward into 2022. We are recruiting fresh new talent into engineering to help us look at things differently and focusing on our capital delivery process. This continuous improvement while remaining focused on those three legs of the stool has been key to our success. I would argue that the 2020 rate case is probably the best prepared we've done and should aid us in settlement discussions with the commission to achieve a favorable final number.

Jonathan Reeder, Analyst

Hey, good morning, gentlemen. I’m just curious what happened to the intervener testimony, and the cost of capital? I thought it had been due much earlier in the month; I haven’t seen it posted?

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

Paul, I can start. We had expected the testimony to be submitted after a pre-hearing conference with the administrative law judge, which included a verbal agreement on the schedule. That verbal agreement had the intervener testimony due earlier in October, but we suspect, since the schedule wasn't formally published, the advocates chose to delay their testimony until that schedule is published. So we are in a bit of a holding pattern. I assume they are prepared with their testimony ready to go, but it seems they are waiting for the actual schedule to be adopted.

Jonathan Reeder, Analyst

Okay, no clarity as to when that might happen?

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

Unfortunately not. We are waiting for the judge. We've made inquiries, but the commission has lots of matters to handle right now, and judges are very busy. We are all simply waiting to see that schedule come out.

Jonathan Reeder, Analyst

Okay, so from our perspective, we shouldn’t assume anything about settlement discussions potentially preempting the necessity of intervener testimony?

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

No, you should not presume that. We would not start settling until we see their testimony and know where all the parties stand.

Thomas Smegal, CFO

And Paul, as shown in the slides, we expect the cost of capital to be concluded by sometime in the second quarter. So it is definitely delayed compared to the last cycle.

Jonathan Reeder, Analyst

Right, okay. Any updated thoughts on who Governor Newsom might appoint to lead the CPUC with President Batjer's imminent retirement?

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

Nothing official yet, obviously rumors are starting to surface a little bit, but those are all unofficial. We are anxiously waiting to see. We have shared our opinions and suggestions with the Governor's office. We know they are actively working on this.

Jonathan Reeder, Analyst

Okay, maybe slightly differently: some names being tossed around – I know you guys have been advocating that someone with good policy experience, perhaps on the water side directly, gets appointed to the commission; is that still a possibility?

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

Jonathan, you always ask excellent questions. I can't speculate on any of the rumors, but in my last discussion with the Governor, he seemed to focus on the necessity for someone with good utility regulation experience, along with a reasonable policy background.

Angie Storozynski, Analyst

Thank you. I have a couple of numbers questions. For the bad debt provision falling year-over-year, I appreciate the disclosure, but what is roughly reflected in the rates? I'm interested in the delta between where you are tracking now versus what's reflected in the rates.

Thomas Smegal, CFO

In the California rate case, we have $1.9 million of bad debt reflected in rates. I regret I didn't pull the figures for the other states. So it's probably on the order of about $2 million on an annual basis that would be covered.

Angie Storozynski, Analyst

And then unregulated earnings year-to-date?

Thomas Smegal, CFO

You will see the 10-Q later today. I don’t anticipate any big movements in unregulated earnings for the year when compared to the prior year; I think it’s about the same.

Martin Kropelnicki, President and CEO

Yes. There has been no change.

Angie Storozynski, Analyst

Last year, it was about $1.4 million for the year. Okay, go ahead.

Thomas Smegal, CFO

Yes. Angie, sorry, just to clarify one thing, the way we now book our pension costs: keep in mind that the regulated pension costs account for the non-service portion of that pension cost being below the line for accounting purposes. This could lead to apparent large differences in reported amounts due to the pension cost element covered in a balancing account in California. Even that non-operating part of it is covered in that balancing account. So, we might see it create some confusion, but that does not represent a change in the company's profitability.

Angie Storozynski, Analyst

Understood, thank you. Lastly, regarding the repair tax benefits, in 2020, it added nearly $3 million. How big of a benefit have you recorded year-to-date?

Thomas Smegal, CFO

For year-to-date, the benefit is $92 million gross. That will be the gross deduction and it's included in our rates on the regulatory side. The actual repairs benefit this year will be slightly lower than the value in our rates.

Angie Storozynski, Analyst

Okay. So I'm trying to solve for all additions to basically net income derived from the rate base. So that is not a driver this year.

Thomas Smegal, CFO

That's correct. It will not be additive this year, unlike last year.

Angie Storozynski, Analyst

Awesome. Lastly, without accounting for changes in the ROE or the cost of debt for 2022, should I assume that given that it's the last year of the current rate cycle, there will be some detriment versus the allowed ROE? This is considering that costs are catching up and we are just before a revenue reset.

Thomas Smegal, CFO

Looking back at history, that has been the pattern: higher ROEs are in the first year of the California GRC. There are certainly a lot of other factors now at play, obviously with the company's growth in other states and various other items. I don’t know if that pattern will necessarily play out this time, but historically, that trend has been observable.

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

Yes, I'd add that if we were in a COVID-free environment, we would usually tell people that during the third year of the rate case not to expect much, as the regulatory lag often hits during the third year regarding some corporate expense items, etc. However, it's likely clouded due to the COVID situation, with our travel budgets essentially zeros and not sending people to conferences and trainings. It's a bit tougher to see those impacts, but typically, third year of the rate case shows more challenges.

Angie Storozynski, Analyst

Lastly, regarding the disclosure on the consolidated rate base, how much of the 1.82 is outside of California?

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

That number, if compared to what we've requested in the California rate base, is between $100 million and $150 million from other states.

Angie Storozynski, Analyst

Between $100 million and $150 million. It was $110 million last year, so that means it's probably closer to that $150 million this time?

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

We have had investments in Texas, for example, and have been purchasing systems in Hawaii earlier in the year. Those systems are contributing to the rate base as well.

Angie Storozynski, Analyst

Okay. I understand we're still waiting for the interveners' filings. However, we're starting to hear some rumors about what their position might be. I think we had all hoped that the cost of capital proceedings would mainly address the true-up of the cost of debt. That doesn’t seem to be the case now; there is some sentiment that allowed ROEs for the water utilities in California are too high. I don't know if you can provide clarity on this, given that we're waiting for official positions to be filed?

Paul Townsley, Vice President of Corporate Development and Chief Regulatory Officer

We have not seen the testimony, and like others, have heard rumors about possible positions. But we have to wait until actual positions are put in writing by the interveners, after which we can make our decisions based on that.

Martin Kropelnicki, President and CEO

Great. Thanks, Laurie. That concludes the third quarter call. Thank you for staying with us and asking excellent questions. We will be available today if anyone has follow-ups. Feel free to reach out to Tom or any of us to get further information. Happy holidays to everyone, and our next conference will be at the end of February for our year-end call. In the meantime, everyone be safe. Thank you for your continued interest in California Water Service Group, and we look forward to speaking with everyone again soon. Thanks, Laurie. Thanks, everyone. Have a good day.

Dave Healey, Vice President, Corporate Controller

Thank you, and this concludes today's conference call. Thank you for participating. You may now disconnect.