Earnings Call Transcript - CWT Q2 2023

Operator, Operator

Thank you for your patience and welcome to the California Water Service Group Second Quarter 2023 Earnings Call. All lines have been muted to avoid background noise. After the speakers' remarks, we will have a question-and-answer session. I would now like to turn the call over to Marty Kropelnicki, Chairman, President, and Chief Executive Officer. Mr. Kropelnicki, please proceed.

Marty Kropelnicki, Chairman, President and CEO

Great. Thank you, Jack. Good morning, everyone. Thanks for joining us this morning. Apologies for the technical difficulties. We had some problems with our telecommunication line getting through. So, sincere apologies for that. With me today is Dave Healey, our Interim Vice President and Chief Financial Officer; and Greg Milleman, Vice President, Rates and Regulatory Affairs. Prior to getting into the results for the quarter, I'm going to turn it over to Dave Healey to go through our statement on forward-looking statements. And Dave, why don't you jump into the financial results for the quarter, please.

Dave Healey, Interim Vice President and CFO

Thank you, Marty. Replay dial-in information for this call can be found in our quarterly results release, which was issued earlier today. The replay will be available until September 25, 2023. 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 yesterday afternoon and is also available at the company's website at www.calwatergroup.com. Before looking at this quarter's results, we'd 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. Our presentation starts on Slide 4 with their values and priorities. And moving on to Slide 5, I'll discuss the second quarter results. So, during the second quarter of 2023, net income attributable to the group was $9.6 million and diluted earnings per share was $0.17 as compared to net income attributable to the group of $19.5 million and diluted earnings per share of $0.36 for the quarter ended June 30, 2022. As we discussed last quarter, second quarter results primarily reflect the temporary absence of 2023 California general rate increases and regulatory mechanisms included in our 2021 general rate case. As a result of the delayed California general rate case, there was a decrease in second quarter 2023 operating revenue as compared to the same period last year. Additionally, operating revenue decreased $13.8 million due to a 10.4% decrease in customer usage. General rate increases during the quarter were approximately $3.4 million, with most of it in California, along with the delay to our GRC; the commission authorized a 4% general rate increase for most of our California districts effective May 5, 2023, until the final 2023 GRC general rate case increases are authorized by the commission. This added approximately $3 million to operating revenue during the second quarter. Total operating expenses decreased slightly in the second quarter of 2023 as compared to the same period last year. Net interest expense increased $1.7 million, mostly due to an increase in interest rates and $23 million of additional borrowings on our short-term lines of credits. We invested $95.2 million in capital improvements during the second quarter of 2023, a 25.1% increase over the same period last year. This was a second quarter record for our company. In California, the governor extended the state's arrearage program to help customers struggling to pay monthly water bills. The program covers delinquent customer balances 60 days past due or written off during the period from mid-June 2021 to December 31, 2022. Our plan is to file our application for these funds with the State Water Resources Control Board at the end of September. One last item. We filed the California advice letter in July to increase annual operating revenues by $24.6 million to offset known increases in California water production costs. Our EPS bridge is on Page 10. And now I'll turn it over to Greg Milliman to discuss the temporary absence of the 2023 California General Rate Case, general rate increases, and regulatory mechanisms.

Greg Milleman, Vice President, Rates and Regulatory Affairs

Thank you, Dave. Looking at Page 7, consistent with the first quarter, we are using the same mechanisms available from the California Public Utility Commission to track the temporary impact of revenues whilst revenues from the delayed decision. The three primary mechanisms are shown on this slide. Moving to Page 8. We currently estimate that the temporary impact of the delayed decision on second quarter 2023 operating revenues to be between $19 million and $29 million based on current positions of parties in the 2021 GRC filings and consumption-driven regulatory mechanisms. While I'm on this topic, I would call your attention to Slide 13, which is the same information except for the year-to-date activities where the temporary delay in revenues is estimated to be $43 million to $63 million. With that, I'll turn it back to you, Dave, for Slide 9.

Dave Healey, Interim Vice President and CFO

Thank you, Greg. The second quarter earnings bridge is on Slide 10 and moving to Slide 11. For the six-month period ended June 30, 2023, net loss attributable to the group was $12.7 million or $0.23 loss per diluted common share compared to net income attributable to the group of $20.6 million or $0.38 earnings per diluted common share for the six-month period ended June 30, 2022. As Greg discussed, results for the six-month period ended June 30, 2023, reflect the temporary absence of the 2023 general rate case, the 2023 California general rate increases, and regulatory mechanisms included in our 2021 general rate case. Operating revenue was $325.1 million for the six-month period ended June 30, 2023, compared to $379.2 million for the same period in 2022. The $54.1 million or 14.3% decrease in revenue was due to a $21.8 million increase in revenue deferral, a $15.2 million decrease in RAM and MCBA revenue, and a $22.9 million decrease in customer usage, which was partially offset by general rate increases of $5 million. Total operating expenses for the six-month period ended June 30, 2023, were $326.7 million compared to $342.8 million in 2022, a decrease of $16 million or $4.7 million. Other operations expenses for the six-month period ended June 30, 2023, were $42.4 million compared to $55.3 million in 2022, a decrease of 23.2% or $12.8 million. The decrease was primarily attributable to the deferral of $17.8 million in costs related to the revenue deferral. Water production costs decreased $6.6 million or 5% to $125.9 million in 2023 compared to $132.4 million in 2022. The decrease in water production costs was primarily attributable to a 9.7% decrease in customer usage. These decreases were partially offset by increases in administrative and general expenses of $4.9 million, depreciation and amortization of $2.2 million, and property and other taxes of $1.5 million. During the first six months of 2023, the company invested $177.2 million in infrastructure improvements. This is also a record for the company. The company's ATM program increased cash by $112.7 million during the first six months of 2023. We are pleased with the results of our ATM program, and we will continue our at-the-market, or ATM program, through March of 2025. The year-to-date EPS bridge is on Slide 15. And now I'll turn it over to Greg Milliman for a regulatory update.

Greg Milleman, Vice President, Rates and Regulatory Affairs

Thank you, Dave. Regarding the cost of capital proceeding, the main point to note is that the perspective is from July 31, 2023, moving forward. Following the implementation of the water cost of capital mechanism, our return on equity will have increased from 9.2% to 9.57%, and our debt will be adjusted to reflect a lower borrowing cost of 4.23%. Additionally, if the bond index continues its current trend, we anticipate that the water cost of capital mechanism will be activated again either at the end of this month or the beginning of October, with an increase effective January 2024. On Slide 17, you'll find the California 2021 General Rate Case update. After the decision was extended on June 29 to December 31, 2023, the commission assigned a second judge to our case. This judge brings extensive experience with the commission and has already commenced work on our general rate case. With two Administrative Law Judges now involved, we are optimistic about receiving a proposed decision by the end of the year. Now, I will hand it over to Marty for the next update.

Marty Kropelnicki, Chairman, President and CEO

Thank you, Greg. I wanted to provide a quick update on the PFOS and PFOA situation. As mentioned in last quarter's presentation, the EPA has released draft regulations. Based on these, we estimate an incremental investment of about $200 million will be needed to treat around 75 wells across the five states where we operate. If these draft regulations are enacted as they are, we will need to comply by 2026, which gives us a tight timeframe. However, we have been preparing for this since 2018 in California, which has the strictest water quality standards. So we are ahead of schedule and will continue our efforts as we await the final regulations. Additionally, it's significant that our coalition, part of the National Association of Water Companies, has been pursuing accountability from polluters. There have been several proposed settlements in court that are set to be finalized, and we are actively involved in these legal efforts. Any recovery we obtain will help mitigate costs for our customers as we implement the necessary treatments to remove PFOA and PFOS from our drinking water. Moving on to business development, our team has had a productive quarter. Since our last update, we received approval from the California Public Utilities Commission to finalize our acquisition of the Skylonda Mutual in the Bay Area, which has 176 customers. This acquisition allows us to create an interconnect between multiple parts of the Bay Area, enhancing reliability and resiliency. We also completed the acquisition of the Stroh system in Washington, adding 900 connections to our Washington Water service. Furthermore, we gained approval to proceed with the HOH Utility in Hawaii, which will add about 2,200 wastewater connections. This expands our presence to our fourth island, allowing us to serve customers in Maui, the Big Island, Oahu, and now Hawaii. Overall, it was a busy quarter for our team, and our pipeline remains robust. While significant acquisitions are rare in the water sector, we are focused on smaller deals that complement our existing operations and facilitate economies of scale to benefit our customers. Regarding capital investment, as Dave mentioned, this quarter set a record with $95.2 million in new capital investments. We are recovering from a prolonged wet winter on the West Coast, and our team has done well to accelerate progress. Year-to-date, we have invested $177.29 million, which is a 22.5% increase, keeping us aligned with our 2023 targets. It’s worth noting that for 2022, 2023, and 2024, we anticipate over $1 billion in capital investment, which complicates our rate case significantly. While this poses challenges, it’s crucial that we maintain the momentum of our capital investments aimed at improving resiliency and sustainability. Turning to our regulated rate base, we will update these figures once we receive a proposed decision on our rate case. This snapshot illustrates potential earnings growth tied to our expanding rate base. Looking at the quarter, we remain in a holding pattern due to the delayed general rate case in California. While this is frustrating, the situation is intricate. We are pleased, however, with the recent cost of capital decision adopted in the second quarter and the addition of a second ALJ to our case, someone we are familiar with and who typically adheres to a strict schedule. Even with these delays, we are making substantial progress on our business plan, as evidenced by the record capital investments for this quarter and our continued expansion efforts in California, Hawaii, and Washington State. We also published our third annual ESG report detailing our commitments to reducing Scope 1 and Scope 2 emissions and our initiatives to combat climate change, enhancing sustainability and reliability for our customers. While we await further developments, we will continue executing our business plan and are hopeful to receive a rate case proposal before the year ends. Once we have the proposed decision, it will enable us to recognize several financial mechanisms that are currently unavailable for booking. Lastly, I want to recognize a new member of our Board of Directors, Charles Patton, who joined us. He brings 37 years of experience in the utility sector and a strong background in operations, external affairs, and rates. We're excited to have him on board after his first meeting yesterday. Jack, that concludes my update for now. Let’s open the floor for questions.

Operator, Operator

Certainly. Our first question comes from Angie Storozynski with Seaport.

Angie Storozynski, Analyst

Thank you. So, I mean, there are just so many moving pieces in your earnings power. So just a couple of things. One, you were hoping to actually have a final decision in the GRC this year or just a proposed one? And I assume that you need a final decision to book all of these revenue adjustments back to retroactively to January 1, 2023. Is that correct?

Marty Kropelnicki, Chairman, President and CEO

Angie, we are hoping to have a proposed decision by the end of the year with a proposed decision that should provide enough confidence for the accounting departments to go ahead and book the various items that have been deferred.

Angie Storozynski, Analyst

Okay. You provided us with all the revenue adjustments for the first half, including the gain on pension. Is there a general guideline we can use to get a rough idea of the earnings potential? For instance, can we estimate what the first half earnings might have been based on the adjustments you've shown us? Can I assume a certain percentage contribution to the total earnings of 2023?

Marty Kropelnicki, Chairman, President and CEO

Yes. Angie, that’s why we gave you the range of what we believe the high and the low. You’ll have to determine kind of what point in that range you think is the best one to look at. We thought the best thing we can do is show the two goal posts. Obviously, we’ll come out between those two goal posts. Historically, we’ve done, especially the last two rate cases, we’ve done very well in our rate cases. I think that the Cal Water team has really upped their game the last three cycles in terms of putting together a quality rate case and getting to a successful resolution with the Public Utilities Commission in California. The harder thing is we are officially decoupled from decoupling. So, under the old decoupling rules, we could show you what the consumption curve was that was in the rate case. Obviously, our pattern follows that consumption curve – now that we’re really demand-driven, it’s going to move around a little bit, and we haven’t had to really kind of look at it or think of the business that way in over 12 years. This year, what we’re going through, getting away from decoupling, the earnings will move around based on seasonality and the weather and consumption. Obviously, we had a very, very wet first quarter. We had a fairly wet second quarter, and consumption was down, but now we’re hitting this massive heat wave, which is happening all over the U.S., and I would expect consumption to jump up quite a bit in the third quarter. So, I know that’s not a super clear answer, but those are the variables that we deal with internally as we do the accounting and work on our rate cases.

Operator, Operator

Jonathan Reeder with Wells Fargo.

Jonathan Reeder, Analyst

I know it's very difficult given the moving pieces this year, just to maybe kind of expand on Angie's question there. Can you discuss, I guess, how customer usage is tracking against the usage levels that are included in the GRC's partial settlement agreement? Obviously, it's weather influenced to some degree in the first half, or not to some degree, it is weather influenced in the first half of the year, but maybe how you expect the full year to come in against those usage levels?

Marty Kropelnicki, Chairman, President and CEO

Jonathan, it is difficult to forecast future developments. Currently, we're at approximately 90% of the consumption level outlined in the rate case. Most mechanisms, except for the one concerning lost revenues due to drought, are based on actual consumption. The drought mechanism will account for lost revenue related to consumption declines from the drought for a certain duration, but it is uncertain how long this will be in effect, especially since the governor has lifted mandatory conservation measures while maintaining some executive orders for drought and conservation efforts in the state.

Jonathan Reeder, Analyst

Right. And when did those mandatory conservation measures get looked at? Was it in like early April?

Marty Kropelnicki, Chairman, President and CEO

It was in April.

Jonathan Reeder, Analyst

Okay. So, that 90% is against what's actually included in the GRC settlement, partial settlement?

Marty Kropelnicki, Chairman, President and CEO

Correct. That's right.

Jonathan Reeder, Analyst

Okay. Got you. So, I guess, with the loss of full decoupling and taking into account those usage trends as well as, I guess, the cost to supply the water that should be coming in much more favorable to you. Do you expect, I guess, by having the Monterey-Style RAM this year, is it going to be a headwind or a tailwind to kind of EPS? Is it still a headwind given the loss of decoupling? Or are these lower supply costs potentially going to help you to a decent amount that flows to the bottom line?

Dave Healey, Interim Vice President and CFO

Jonathan, I can take that question for you. So, I don't know what the consumption is going to be in the second half of the year. However, if it is still at 90%, there will be a small positive value in the Monterey-Style RAM mechanism.

Jonathan Reeder, Analyst

Okay. And that's netting, I guess, the revenue impact against the supply?

Dave Healey, Interim Vice President and CFO

Yes. It just tracks a single quantity rate to the actual quantity rates filled. There’s a certain level. Right now, we're at 90%; we're not at 100%. But it's not going to be a big value.

Jonathan Reeder, Analyst

Okay. All right. I appreciate the help there. Congrats on a good outcome in the cost of capital and good luck to getting the rate case at least proposed decision before year-end results.

Operator, Operator

Davis Sunderland with Baird, your line is open.

Davis Sunderland, Analyst

Good morning. This year, we won't delve too deeply into specifics, but if there isn't a proposed decision by the end of the year, how should we approach the changes to capital expenditures for next year without risking going past the end of 2023? I have one follow-up question.

Marty Kropelnicki, Chairman, President and CEO

Sure. That's a good question because, obviously, our capital program is included in the 2021 general rate case. The company takes a risk-based approach to prioritizing its capital. So, the capital spending we're doing now, we feel are necessary improvements that we have to make in order to maintain the system and to do things like wildfire management and other matters that we've had to step up our efforts for climate change adaptation. In the event, there is a capital project that is not approved of the rate case, it will get picked up in the next rate case, the 2024 rate case. Any financial exposure is really going to be associated with the depreciation in the interim period and how we pick it up in the next rate cycle.

Davis Sunderland, Analyst

Got it. That's helpful. I have another question regarding the PFOS legislation. You mentioned initiating litigation against some parties that may have been responsible for the pollution. Can you provide any details on the timeline or how we might quantify the benefits from that? Additionally, you noted some potential alternative funding sources that could help offset part of the $200 million in CapEx costs. Could you share more information about what those funds might be or when they could be applied?

Marty Kropelnicki, Chairman, President and CEO

Yes. We don’t know yet. If you follow the litigation closely, these are multibillion-dollar settlements. Obviously, there’s a group of claimants to that settlement, and we’re one of those claimants. We don’t know how it’s going to work out or how it’s going to be distributed. I will tell you, though, our General Counsel is very active and is the class representative in the lawsuit. We work closely with the counsel, the group’s plaintiff counsel to understand how those pieces will work. Once the settlements get more clarity and a judge approves them, we’ll then work with the representatives involved in the litigation on how those funds will be distributed, and a proposal is made to the judge, who must adopt it before they start distributing those funds. I anticipate, and this is just a personal opinion, that those settlements are going to total millions and millions of dollars. The main point about it, though, is that it’s not going to help from an investor standpoint because those funds will all go to offset the capital costs associated with the treatment. It really benefits the customer, and that’s where it should be. What’s left over that doesn’t cover the invested capital for PFOA and PFOS treatment will receive rate-based treatment. Obviously, we want to try to offset as much of that cost because it’s incremental to our capital program; that $1 billion I mentioned for the years 2022, 2023, and 2024. This $200 million will be on top of that. It creates the risk of rate shocks. We really want to minimize the effect on our customers. So, I think settlement funds could come in 2024 or 2025. Additionally, we’re looking at trying to get grant funds and other money from the state and federal levels, especially for underserved or poorer communities. It’s one thing to implement PFOS treatment in the Bay Area for Silicon Valley; the situation is very different when you go to some rural areas of California that have the same water quality standards but a much lower customer base, much lower number of connections, and overall a different economic environment compared to an affluent area like the Bay Area.

Operator, Operator

That was our final question. I'll now turn the call back over to Mr. Kropelnicki for closing remarks.

Marty Kropelnicki, Chairman, President and CEO

All right. Hey Jack, first of all, thank you for getting my name right. You're about 1 out of 100 who can get it right. Just for the record, it took me till about the age of 12 before I could spell or say my name right. So, thank you for having my name correctly. Everyone, thanks for joining us. Again, all eyes on the general rate case; that's a focal point. But while we're doing that, we're not taking our eyes off the business model, and we're going to execute our business plan to the fullest extent that we can. We'll look forward to talking to everyone at the end of Q3, and our earnings call will be on October 26. Thank you for being with us this morning. Apologies for the technical delays. We had some issues with technology and the lines working correctly. So, thanks for bearing with us, and we'll talk to everyone later. Thank you and have a good day.

Operator, Operator

This concludes today's conference. We thank you for your participation. You may now disconnect.