Earnings Call Transcript - CWT Q2 2021

Operator, Operator

Good morning, and welcome to California Water Service Group Q2 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, David Healey, Vice President and Corporate Controller. You may begin.

David Healey, Vice President and Corporate Controller

Thank you, Carol. Welcome everyone to the 2021 second quarter results call for California Water Service Group. With me today are Marty Kropelnicki, our President and Chief Executive Officer; Tom Smegal, our Vice President, Chief Financial Officer; and Paul Townsley, our Vice President of Corporate Development and Chief Regulatory Officer.

Tom Smegal, CFO

Thanks, Dave and good morning everyone. Thanks for being with us for our second quarter earnings call. Today I'm going to talk a little bit about our financials and then turn it over to Marty and Paul to talk about some of the other aspects that are going on for the quarter. I'm going to start and I'll walk through the slide deck. So as usual, I'll refer to the page numbers so you can follow along and try to be as descriptive as possible if you don't have the slides with you. For the quarter, the company's net income rose to $38.2 million, compared to $5.3 million in the second quarter of 2020. On an earnings per share basis, that is $0.75 per diluted common share in 2021, compared to $0.11 for the quarter in 2020. That was on slide 5. If you flip to slide 6, we can talk briefly about the year-to-date results. Here, we have a net income of $35.2 million on a year-to-date basis that compares to a net loss in 2020 of $15 million. And on a per share basis, we have earnings of $0.69 per share in 2021 which compares to a loss of $0.31 in 2020. And for the year-to-date, the capital investments I will highlight $138.5 million of capital investments compared to $133.5 million of CapEx in 2020. Flipping to the next slide, slide 7. The story here in the second quarter is very similar to what we talked about at the end of the first quarter. The financials are primarily better because we have the result of the 2018 California Water Service Company general rate case which did a number of things for us. First of all, if you'll recall last year in the first and second quarters, we did not book the interim rates or the regulatory mechanisms that the company eventually got approved by the commission, because of the uncertainty at that time. So we did book those in the third quarter of 2020. When you're comparing our results here in 2021 to those results from 2020, keep in mind that you were missing a big chunk of what ended up being the earnings in 2020.

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

Thank you, Tom. Turning to slide 11. I'm pleased to report that California Water Service Company filed its General Rate Case with the Public Utilities Commission on time July 1. This rate case, the largest in our history, is requesting approval of just over $1 billion in capital expenditures during the three-year rate case cycle. We worked very hard on addressing customer affordability when preparing this case and have been able to keep increases under $5 per month for the median residential customer in all of our service areas. This will be our first rate case in which the full WRAM/MCBA is not part of the filings. We've taken a deeper dive into sales forecasting and rate design to enable us to balance customer affordability, revenue stability, and conservation. This has led to a 6% lower sales forecast than in our last adopted, but also an innovative rate design that provides significant discounts for the first six units of water used each month and increases the amount of revenue collected in our fixed monthly service charge.

Marty Kropelnicki, CEO

Thanks, Paul. Good morning, everyone. Two areas I want to provide operational updates on. Starting off on page 12, talking about the recently declared droughts. I say droughts is plural given the approach the state has set forth early on in the second quarter. By doing so, they were evaluating drought conditions on a county-by-county basis. As we wrapped up the second quarter, the drought kind of quickly spread, and we have 51 of the 58 counties in the state of California now under a declared drought emergency. Accordingly, as part of our planning process and rate case process with the Public Utilities Commission, we filed what's called Rule 14.1, which is our water supply master plans in June. Within that water supply master plan is something called Schedule 14.1, our water supply contingency plans that cover the various stages of drought. I'm very happy to share that on July 14, the Commission approved our Rule 14.1 plans as well as our Schedule 14.1 water supply contingency plans. We are officially in a Stage 1 drought in all the districts that we operate in. We are currently monitoring water supply conditions in every location within the state of California that we have. We have asked our customers for a voluntary 15% reduction over the summer months. We're utilizing the same model that we developed during the last drought, doing what we call the customer-first approach to provide our customers with as many options as we can to help them hit their reduction targets. We're utilizing that same model, which includes a drought steering committee that we have within the company that I meet with every other week as we go into the summer months.

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

Great. Thank you, Marty. If you will turn to slide 14. California Water Service Group has been busy in the business development area. In May, we announced our establishment of Texas Water Service and our entry into the fast-growing region of Texas, known as the Austin-San Antonio corridor. As part of our entry into Texas, we also announced our majority ownership of the BVRT Water Resource Company, which owns four wastewater utilities in this Austin-San Antonio corridor. Also, in May, we closed on our acquisition of the Kapalua Water and Kapalua Wastewater Company, adding 1,000 new Maui customers to our Hawaii Water Service Company. Last month, in June, we announced the execution of a definitive agreement to acquire a wastewater utility on the island of Kauai in Hawaii, bringing 1,800 Equivalent Dwelling Units to our Hawaii Water Service Company, and we will file the application with the Hawaii Public Utilities Commission shortly for its approval of this purchase. A week ago in July, we filed an application with the New Mexico Public Regulatory Commission for approval to acquire the Morningstar Water Company in Northern New Mexico, bringing its 2,000 customers to our New Mexico Water Service Company. Next week, we anticipate that the California Public Utilities Commission at its August 5 open meeting will approve our newest California utility known as The Preserve at Millerton, a new development utility, which will bring about 2,800 customer connections to California Water Service Company. If you turn to slide 15, you can see on this map the four utilities that we have, and they are poised to capitalize on the tremendous growth in this region. Remember that Austin and San Antonio are among the five fastest-growing cities in the US. We have approximately 2,500 customers and customer commitments today among these four utilities, and we anticipate that their combined service areas could build out to over 60,000 customers. Meanwhile, Texas Water Service is seeking out other opportunities in Texas. If you turn to slide 16, that's my final slide. It’s really a recap of some of our recent business development activity. We have a full pipeline of growth opportunities, and we are excited by the potential to further grow the company through acquisitions and other deals. With that, I will turn it back to Tom.

Tom Smegal, CFO

Thanks, Paul. I'm looking now at slide 17, and as promised in the first quarter, we've updated slide 17 and 18 to reflect the proposal made in the California General Rate Case. The last three bars on each of these charts represent the effect of the proposal. I want to remind everyone that this is a proposal made to the Commission and will be evaluated by the CPUC with a determination expected in late 2022 with an effective date in 2023. These numbers can obviously change as we go through the regulatory process. The projected CapEx for 2022 through 2024 is estimated to be in the range of $355 million to $365 million a year, which corresponds to the $1 billion proposal that Paul's group submitted to the CPUC, plus the CapEx that we are spending in our other states. The estimated rate base for 2021 is about $1.82 billion, with an anticipated increase to $2.2 billion, $2.5 billion, and $2.75 billion combined if the proposal is adopted as proposed. There is certainly a lot for us to do in the regulatory process, but good news ahead from a company growth standpoint in all respects. Thank you, Paul, for outlining both aspects of your work.

Marty Kropelnicki, CEO

The heavy lift, so to speak, right?

Tom Smegal, CFO

Yeah. Paul's got two big revenue-generating items.

Marty Kropelnicki, CEO

Alright. I'm going to wrap up here. Just in summary, Q2 results were in line with our expectations. I apologize for the complexity in sifting through the financials as Tom did a really good job pointing out in our graphs and our earnings reconciliations. That was driven by the late GRC we had, which there was not much we could do about. Just to remind everyone that those comparables quarter-over-quarter and year-over-year must factor in that delayed General Rate Case. We're clearly seeing the effects of the drought in the second quarter with the unbilled revenue, which is our revenue accrual. We typically see increases in consumption as we move into the warmer summer months, and you'll see that accrual go up. Conversely, there will be a downturn during the winter months when consumption decreases as the rains start on the West Coast. Therefore, we clearly observed an uptick in the unbilled revenue due to the drought and the associated weather conditions. Tactically, there are really four things going on that we're focused on as we move into the fourth quarter. Firstly, the cost of capital, which is paramount as we seek to finalize that this year. Secondly, as Paul mentioned, the discovery phases of our 2021 General Rate Case for the state of California, is a Herculean event. There are numerous data requests that circulate back and forth—hundreds of them. We will remain vigilant and focused on closing those two regulatory proceedings. We look forward to collaborating with Commissioner Houck to achieve a timely and successful resolution. Additionally, two major challenges on the West Coast, particularly in California, are the drought and the wildfire season. Currently, there are nine wildfires burning in the State of California, with two of them being significant. These major wildfires are occurring in national forest areas and pose no threat to the service areas we operate in. However, it's notable that smoke from the West Coast can drift all the way to the East Coast as it travels through the atmosphere. Kudos to our Operations team for their proactive approach in getting ready for fire season this year. This indicates that August, September, and October, given the dry conditions, could be volatile. However, I would note that the team completed their wildfire readiness plan ahead of schedule. All the employees have undergone the necessary training, and we're ready to address the hotter, drier summer months while ensuring that our customers receive clean and fresh drinking water. Finally, strategically, we remain committed to focusing on climate change resilience for the long term, addressing its effects on our customers and our operations, and exploring how we can help mitigate those ramifications. You will hear us discuss climate change and risk management in our Q&K filings and investor presentations. If you haven't already reviewed our ESG report, I highly encourage you to do so. This will be a key focus for the company for the foreseeable future. So with that, Carol, we will conclude our prepared comments and open the floor for Q&A.

Operator, Operator

You have a question from the line of Ben Kallo with Baird.

Ben Kallo, Analyst

Hey guys, good morning.

Tom Smegal, CFO

Good morning, Ben.

Ben Kallo, Analyst

A couple of questions. First, regarding the unbilled revenue, could you explain if you believe it will carry over or if it definitely will not carry over? That's the question.

Marty Kropelnicki, CEO

So Ben we've discussed this multiple times, and it can be somewhat confusing. The key thing to remember is that the unbilled revenue accrual is outside of our WRAM mechanism. Consequently, what we're measuring is the number of customer days that have not yet been billed multiplied by the expected bill for those customers. What we normally observe is that the bill increases in the third quarter, which would typically lead to a higher unbilled revenue accrual at that time. This year, however, the bill rose more due to increased rates and greater customer usage, which reflects in the second quarter and is somewhat unusual. If there's a standard third quarter where the bill remains high, you would normally see an earnings bump representing that added accrual, but that likely will not occur to the same extent this year. Essentially, the unbilled revenue we are recording this quarter is essentially borrowing from the earnings we would typically see in the third quarter. Then, when we reach the fourth quarter, due to colder weather and the typical rains in our service areas, we observe a significant decline in the usual unbilled revenue. That's why we traditionally do not earn as much in the third quarter, as we're reversing out that big summer unbilled revenue due to lower bills during the winter months. Does that help, Ben?

Ben Kallo, Analyst

That's great. Regarding the GRC, could you remind us about the $860 million you submitted in 2008 and what transpired after that? Also, while I understand you can't discuss what will be permitted, could you provide some insights on the $1 billion and what it includes? Marty, you mentioned climate change; is there any climate change-related content involved? Is that what California is looking for? Please elaborate on the details within the rate case.

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

Hi, this is Paul Townsley. Regarding the rate case, it is very similar to our last rate case in terms of the types of projects included. A significant component involves the replacement of aging mains across our service territories, alongside well replacements, new treatment facilities, and other fundamental capital investments. I anticipate that the Commission's review will focus on whether these particular investments are apt for today or if they should be deferred. Nonetheless, I do not expect considerable contention over the types of projects we've included in this case. I'm optimistic that we will achieve a favorable outcome from the Commission regarding the approval of these capital projects, mirroring our success in the last case.

Marty Kropelnicki, CEO

Yes. I would add that our management team's focus has been on better-integrated planning for the rate case and the company. We performed commendably in the last rate case regarding our initial request versus what we received. The process we followed previously has improved for this round. My intuition is that normally during the week we file our rate case, Paul and his team work nearly 24/7. However, this year, their progress in planning for capital and rate case items indicates significant improvement. Typically, the week before the filing, I would bring in dinners, ask if I should hire a masseuse, and provide snacks and caffeine. But this year, the team displayed remarkable control heading into the last weeks. This indicates the improvements we have made in our planning process. The key takeaway is that the more we plan ahead for capital and rate case items, the better our outcomes. We're inherently optimistic going into this rate case, albeit acknowledging the ongoing pandemic. It's crucial to remind everyone that these adjustments will impact rates only several years from now, not immediately. We're acutely aware of affordability issues. I appreciated the team's approach to rate design, as we transition away from decoupling starting in 2023. We believe we've devised a way to support underserved and low-income communities while enhancing our fixed cost recovery. I'm eager to see how this rate plan performs, as the team did a fantastic job working alongside an economic modeling firm to model it accurately. It's going to be intriguing to see how it proceeds through the Commission.

Ben Kallo, Analyst

Got it. And then, the last one is just with the cost of capital coming up, can you just remind us or maybe provide an overview of what we should be watching for in terms of benchmarks? And then, I think you mentioned timing is a couple of months away?

Marty Kropelnicki, CEO

So Ben, we've made our filing. The commission's internal processes have slowed down a bit. Normally, we would swiftly have a pre-hearing conference, during which the regulatory and advocate staff would report back swiftly. However, we have not had that conference yet. Therefore, it is challenging to determine the exact schedule. We're expecting a staff report around September-October. The usual procedure includes potential settlement discussions and hearings on the various positions, leading up to the Commission's decision. We do not have any clear expectations for what the regulator advocate's feedback will be; they typically propose lower numbers.

Ben Kallo, Analyst

Is there anything recently decided in the market that could provide us with an indicator?

Marty Kropelnicki, CEO

Nothing in California that I'm aware of.

Ben Kallo, Analyst

Okay.

Marty Kropelnicki, CEO

So, no apparent benchmarks.

Ben Kallo, Analyst

Yes. Okay. Thank you. Thanks, guys.

Marty Kropelnicki, CEO

Thanks, Ben.

Operator, Operator

Ladies and gentlemen, there seems to be no further questions at this time. So I'll turn the call back over to management for any closing remarks.

Marty Kropelnicki, CEO

Okay, Carol. Thank you very much. I know it's earnings week, and there's a lot going on. We appreciate everyone's support. Obviously, we got a lot of irons in the fire as we go into the second half of the year. Any material changes that come out of the company will be communicated accordingly. If nothing occurs between now and then, we'll talk to everyone for our third-quarter earnings call. If something material arises, you can expect a filing sooner. With that, thanks for being with us today, and we'll talk soon. Be safe. Thank you.

Operator, Operator

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