Earnings Call Transcript - CWT Q1 2020

Operator, Operator

Thank you for joining us. Welcome to the Water Service Group's First Quarter 2020 Earnings Results Teleconference. I will now turn the call over to Mr. David Healey, Vice President and Corporate Controller. Please proceed.

David Healey, Vice President and Corporate Controller

Thank you, Jimmy. Welcome, everyone, to the 2020 first quarter results call for California Water Service Group. With me today, Martin Kropelnicki, our President and CEO; and Thomas Smegal, our Vice President and Chief Financial Officer. Replay dial-in information for this call is available in our first quarter results release, which was issued earlier today. The replay will be available until June 30, 2020. 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 on the company's website at www.calwatergroup.com. Before looking at the first quarter 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 risk 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. Now I'm going to pass it over to Tom to begin.

Thomas Smegal, Vice President and Chief Financial Officer

Thank you, Dave, and good morning, everyone. I'm going to start the presentation by going through the slide deck. If you can find that on our website or attached to the press release this morning, that will be helpful to you. I'm going to start on Slide 6, where we have a table of our financial results for the first quarter. As you probably have seen already, our net loss for the quarter was $20.3 million or $0.42, which is a larger net loss than in the same quarter last year, where the loss was $7.6 million or $0.16 per share. We had flat operating revenue, and our operating expenses were up. One note here, and we'll talk about this in greater detail later, is that our capital improvements were better than they were in the first quarter of 2019. Flipping to Slide 7, our Q1 financial highlights. What we're mainly going to be talking about today is the effect on the quarter of the California General Rate Case, which, as we've talked about before, the decision has been delayed. This delay has meant that we cannot record the rate increase that we expect due to the settlement, and we cannot determine whether the commission will grant us regulatory mechanisms that we have had for many years, which were litigated in this case and were not part of the settlement. We estimate that $15.4 million of pretax income would have resulted from a timely favorable resolution of the California GRC, and that breaks down as follows: $7.9 million represents the delayed pretax income that would result from the approval of the settlement and would accrue to the benefit of the company, regardless of whether the disputed items were granted in the company's favor. Additionally, $7.5 million in the quarter represents income that would have been booked had the regulatory mechanisms been active in the quarter. As I mentioned, we are not booking the regulatory mechanisms as we have in past years. Other factors affecting the quarter include a loss in our nonqualified benefit plans due to the stock market, which was $7 million lower than in the first quarter of 2019. We also had an increase in our unbilled revenue accrual, largely due to a very negative number in 2019 that returned to normal due to dry weather and increased demand. More general increases in costs, depreciation expenses, and maintenance expenses also affected the quarter, along with a $1.1 million decrease to our operating income from the deferral of RAM revenues, which I think we'll talk about in detail in a little bit. So flipping to Slide 8, I want to take a pause on the quarter just to give everyone a full update on our expectations for the General Rate Case for the year. That is the top bullet on this slide, and there's a table that shows if this settlement is adopted, which the company anticipates it will be, we expect an increase in top-line revenue, although not very large, about $12 million in the best case and minus $12 million in the worst case. The reason we feel that the rate case is successful, despite the top-line revenue growth being modest, is that it also incorporates a reduction in water sales quantity estimated, which causes a large reduction in the adopted production costs. Additionally, the rates in the rate case incorporate the giveback of the excess deferred tax resulting from the Tax Cuts and Job Act. That $9.4 million is reflected in the top-line rate to the customer and is also backed out as a reduction in expense. At the bottom of the table on Page 8, we anticipate that if the settlement is adopted, the net increase to 2020 pretax operating income will be about $40 million in either the high or low scenario. The difference between the high and low scenario is primarily a dispute over depreciation expense, which results in lower revenue being matched by lower depreciation. Flipping to Slide 9, I want to talk in detail about the disputed GRC items. The depreciation is a pass-through and is a disputed item. We also have a dispute over the decoupling mechanism, which we call RAM and the MCBA. This mechanism is designed to make the company indifferent to water sales, allowing it to promote water conservation, which has been a favorable mechanism for the state's policy goals for the last 11 years. We anticipate that this mechanism is still needed to support these goals. In the quarter, the recognition of the RAM and MCBA would have added approximately $4.5 million of additional revenue. The third bullet here on Slide 9 pertains to the pension and medical cost balancing accounts, where approximately $3 million would have been credited if we had recognized these accounts. Our pension costs were higher due to a lower discount rate used to value the future liabilities of the pension, while our medical costs were somewhat lower, offsetting each other slightly. These balancing account mechanisms have been in place for the company for three rate case cycles and are standard across the industry. We remain confident that past amounts recorded in balancing accounts continue to be recoverable from customers. Our other disputed items from the rate case include a small number of capital projects, construction financing costs, and working capital requirements, which we don't believe would have had a significant impact in the quarter regardless of the direction the commission takes on those disputes. On Slide 10, you can see a summary of the earnings per share bridge, indicating the factors we've discussed. I'm going to turn it over to Marty to talk about COVID.

Martin Kropelnicki, President and CEO

Thanks, Tom. Good morning, everyone. Thank you for joining us during these unprecedented times. I want to take a moment to call everyone's attention to our logo on the front page of the slides, which expresses solidarity with our customers who are sheltering in place. We've changed our logo where the states have been solid states, and we've broken those into dots with a note saying, even though we're six feet apart, we are all in this together. I think that reflects the moral of the story with this first quarter. I want to talk about our pandemic response. As many of you know, Washington was one of the early epicenters for COVID-19, prompting California and Washington to take early steps to limit public activity to help curb the spread. We had planned for pandemics among other emergencies, as part of our response protocols. In fact, we published our emergency response manuals in 2016, which every employee has a copy of. This manual includes a full section on pandemics and flu outbreaks. So we continue with that. We actually conducted updated pandemic training in the last week of January and early February, and we formed a task force in early February to monitor and outline our next steps regarding the coronavirus. We also opened our emergency operations center, which has been in operation since March 9. We believe we were somewhat ahead of the game in preparing our response. Our primary objectives were straightforward: keep our employees healthy and provide uninterrupted water supply to our customers. So far, we've only had two employee exposures who tested positive for COVID-19, contracted while on vacation and did not return to work. We took several steps to protect our employees starting in February, including travel restrictions, implementing social distancing, using personal protective equipment, and conducting a higher frequency of cleaning, including wiping down vehicles and common workplaces. We've received excellent support from the Utility Workers of America on our safety program, for which I want to give a shout-out for their assistance during our pandemic response. We also retained a nationally recognized infectious diseases expert from Stanford University, who has been advising us on our employee protocols on managing illness at home and the transition in and out of the workplace. We began protecting our customers in March by implementing four major measures: first, we suspended all collection activities on delinquent accounts; second, we closed our customer walk-in centers; third, we managed our rate filings to defer any rate increases for the year 2020; and fourth, we managed our construction activities to ensure we do not disrupt water supply for neighborhoods that are sheltering at home. We've also set up a program where we'll match employee contributions, donating $500,000 to local charities in our service areas that provide pandemic relief, such as food banks and meals on wheels. Our hearts go out to our customers experiencing severe job loss and challenges while sheltering at home, and we're doing everything we can to support them through this crisis. As for the business impacts from COVID-19, while we suspended all collection activities in March, it's still too early to ascertain its full impact. However, as we learned from the downturn and recession of 2008-2009, our bad debt expense typically runs around 25 basis points of revenue. During the last economic downturn, it rose about 20 basis points to 0.45% of revenue. While we're currently witnessing significant unemployment with over 30 million claims in the U.S., historically, people have continued to pay their water bills. Additionally, because this is a nationally and state-declared emergency, our California utility, Cal Water, activated a catastrophic event memorandum account, which is standard protocol in California for such events. This account allows us to record additional costs related to the crisis, and while we expense it during the period, we can apply for collection at a future date. So far in the first quarter, we had minimal expenses incurred, but I expect those costs to rise in the second quarter, especially for PPE and sanitizers. As for liquidity, as of March 31, it remained strong, with $140 million cash on hand, up from $42 million at year-end, alongside additional capacity under our lines of credit exceeding $200 million and $100 million. Tom, I'm going to turn it back to you to discuss the General Rate Case.

Thomas Smegal, Vice President and Chief Financial Officer

Thanks, Marty. Just a couple of other quick updates related to the General Rate Case, which I talked about extensively at the top of the call. From a procedural standpoint, Cal Water and the Public Advocates Office jointly met with the assigned commissioner's office on April 9 and requested an expedited processing of the General Rate Case. Both the company and customers would benefit from a timely resolution of this rate case. As announced in a press release yesterday, on Monday, we issued a motion in the case, asking the commission to delay the rate increase component of the rate case until January 1, 2021. We believe we are covered by the interim rate memorandum account, which tracks the lost revenue associated with the rate case for 2020. We do not want the commission to raise rates during 2020, which is why we requested a delay. That cash is estimated at between $12 million and negative $12 million in terms of the overall rate increase. However, differences exist within that depending on different customer classes and types of customers due to our adjusted rate design to enhance conservation. We want to avoid surprising any customers with unexpected bill increases during this crisis, which is why we made that motion to the commission. We have the support of the ratepayer advocate in this motion, though we cannot predict if the commission will adopt it. Additionally, we deferred a portion of our annual RAM surcharge filing, resulting in a $1.1 million reduction in income. We did this to ensure we only filed for surcharges that would maintain the same rates, as we did not want to raise rates by adding surcharges during this period. We expect to file for those rate surcharges in 2021 at the regular time. We also received permission from the commission to delay the filing of our cost of capital proceeding, originally slated for May 1, until May 1, 2021. The authorized cost of capital and capital structure for California Water Service Company will remain unchanged throughout 2021 and will be reviewed during that year, with adjustments taking effect in 2022. This is positive news from the customer’s perspective as well as ours. Now, I'm going to hand it over to Marty to update on capital investment.

Martin Kropelnicki, President and CEO

Thanks, Tom. As you saw in the press release, our investments in the first quarter increased by 9% from the first quarter of 2019. We completed $65.3 million of capital investments in Q1. One significant advantage was the relatively mild winter in California, which allowed us to continue working on projects that might have stalled due to adverse weather conditions. As previously announced, we expect our range of capital investments for the year to be between $260 million and $290 million, which may fluctuate due to the ongoing pandemic. Fortunately, California water employees are considered essential services. This designation has allowed us to continue working on vital projects, such as main replacements, in preparation for fire season and other improvements. In fact, we completed 28,000 feet of mains in the first quarter, approximately 5.3 miles. We may need to adjust some of our work due to the need to maintain water supply for customers sheltering at home, particularly as people require more water for hygiene. We've implemented some adjustments to construction projects to ensure social distancing and increased PPE usage. Kudos to the union for their help with that. Additionally, some cities have closed down, causing delays in permitting processes. However, lighter traffic conditions have facilitated some work. The largest project in our company's history, the Palisades pipeline replacement project, has been expedited due to lower traffic volumes. Capital spending looks strong, and we'll continue to monitor its impact in the second quarter while maintaining focus on our infrastructure improvement plan, especially projects to prepare for fire season during the fall. On the next page, I want to discuss our business development activities. On March 27, the Washington Utilities Transportation Commission, also known as the UTC, approved our acquisition of Rainier View Water Company. We are finalizing the transaction and transition plans and anticipate closing sometime in late June. Rainier View Water has approximately 18,000 service connections, serving about 30,000 to 35,000 people near our existing franchises in Washington. This acquisition will nearly double our customer connections in Washington and is the largest transaction we've undertaken since 2000. Tom, I'll now hand it back to you for an update on capital investment history and our projections.

Thomas Smegal, Vice President and Chief Financial Officer

Great. Thanks, Marty. Once again, these are relatively unchanged charts on Slide 16, summarizing our capital investment history. The charts mark the capital expenditures (CapEx) we've deployed in the quarter and the midpoint of our estimate of $275 million for the year. The regulated rate base remains unchanged. There is still some uncertainty regarding the rate case, but we expect some resolution soon. With that, I'll pass it back to Marty for wrap-up.

Martin Kropelnicki, President and CEO

Thanks, Tom. In closing, I want to recognize the unprecedented times we are living in, particularly the role we play as an essential utility with essential service employees. While the regulatory context is rarely perfect in the short run, we believe that the process will correct itself in the long run, and I expect our regulators will agree. Moving into the second quarter, our focus will be on helping our customers transition back from shelter-in-place orders to work and a return to a somewhat normal life. Additionally, we look forward to working with the California Public Utilities Commission to wrap up our General Rate Case, advance our infrastructure improvement plans, and prepare for the upcoming fire season. Closing the Rainier View Water acquisition is another priority for this quarter. And with that, Jimmy, we'll hand it back to you to start the Q&A session, please.

Operator, Operator

Our first question comes from Durgesh Chopra with Evercore ISI.

Durgesh Chopra, Analyst

Thanks for all the color today. I appreciate it. I just wanted to - I have a couple of questions and wanted to start with just a quick clarification. As it relates to your deferral filing, do you guys have interim rates in place in the first quarter or no?

Thomas Smegal, Vice President and Chief Financial Officer

We do technically have interim rates in place, but the interim rates are set as the existing rates. So there was no actual increase upon filing for interim rates.

Durgesh Chopra, Analyst

Got it. That makes sense. Perfect. And then maybe, obviously, this dispute is a big one, pretty material. And the rate case timing is uncertain here. So in light of those elements, can you comment on your capital markets needs for this year? How are you thinking about your liquidity position? And your capital markets need for 2020?

Thomas Smegal, Vice President and Chief Financial Officer

Certainly. We have a great team in finance, customer service, IT, and accounting that monitors any changes to our customer collections and cash position. We’re tracking that on a very regular basis, likely every day as we see cash collections coming in and monitor delinquencies. We currently do not anticipate a critical need for new capital for the company. Our lines of credit are sufficient to meet needs even amidst possible declines in cash collections. If that cash collection need gets more severe, then we will, of course, take additional actions. But based on our current situation, we don't expect that to be needed. Regarding long-term financing, it's anticipated that our capital program will require additional capital, regardless of the COVID pandemic and other external factors.

Durgesh Chopra, Analyst

Got it. And this is my last question. Regarding timing, I know you mentioned you were communicating with the commission, but could we see a decision in the second or third quarter this year regarding the General Rate Case and some of the disputed items? Any color you can provide on timing would be helpful, and I understand you may not have all the answers, but I appreciate any insights.

Thomas Smegal, Vice President and Chief Financial Officer

We expect to learn when everyone else does regarding the proposed decision. The commission has set a statutory deadline for themselves of July 1, which they extended late last year. There are indications they are working on the decision. It does not appear to be on the back burner due to the COVID pandemic. While we hope to see a proposed decision in the second quarter, no guarantees can be made at this point.

Durgesh Chopra, Analyst

Got it. And that is July 1, 2020, correct?

Thomas Smegal, Vice President and Chief Financial Officer

Yes. Correct. Correct. Yes.

Operator, Operator

And our next question comes from David Katter with Baird.

David Katter, Analyst

I have a clarification question. Do you see the delay in the rate case being primarily related to the disputed items you outlined, or is there something else driving the slow decision?

Thomas Smegal, Vice President and Chief Financial Officer

If you look back at how California regulates water utilities, our 2015 General Rate Case decision was one of the few that was decided on time. Typically, even with largely settled cases, the commission wraps up proposed decisions slowly. If we had a complete settlement, it would have facilitated the judge's work. We indicated to the judge what the disputed issues were in September 2019, and we filed the settlement in October 2019. Several administrative processes must occur behind the scenes, which could lead to delays within the commission's administrative structure.

David Katter, Analyst

Understood. Why do you think the RAM and other account issues are currently disputed when they weren't historically? Do you have any insights into what might have changed?

Thomas Smegal, Vice President and Chief Financial Officer

The ratepayer advocate has been contesting the decoupling mechanisms we agreed to implement since a few months after our 2008 settlement. We've been unable to reach a settlement this time. While other water utilities have had recent decisions favoring decoupling mechanisms, our experience indicates a policy perspective affecting negotiations.

Martin Kropelnicki, President and CEO

It's important to note that decoupling has been effective in California since the '70s, especially in the electric and gas sectors. We believe it has successfully promoted conservation in the water sector as well. Given the current drought conditions and the growing population in California, it remains a sound policy that aligns with state preparedness for drought.

Operator, Operator

And our next question comes from Jonathan Reeder with Wells Fargo.

Jonathan Reeder, Analyst

I want to clarify: the catastrophic event memorandum account covers bad debt expense increases above the embedded 0.25% rate, correct?

Thomas Smegal, Vice President and Chief Financial Officer

Correct.

Jonathan Reeder, Analyst

What do you expect the headwind will be from this in 2020? I know there are many uncertainties, but could you ballpark it? I'm assuming recovery won't be filed until 2021?

Thomas Smegal, Vice President and Chief Financial Officer

It's too early to know for certain. The extra PPE costs and added safety precautions would largely drive expenses at this point. While we're still about six weeks into the current billing cycle, we find it's quite challenging to predict bad debt expenses, especially since delayed payments might become paid later. Thus, there's still uncertainty around these figures.

Martin Kropelnicki, President and CEO

From a preparedness standpoint, we were well-prepared and had adequate PPE, sanitizer, and wipes. However, replenishing stocks is challenging due to increased demand. Fortunately, we had a surplus stock from experiences learned during fire seasons. While we have not faced shortages, replenishing PPE supplies may increase costs moving forward as demand surges.

Jonathan Reeder, Analyst

I understand; I appreciate your insights but consolidating those expectations is hard to quantify at this point. I remember during the last financial crisis, the spike in bad debt expenses was relatively modest, something like $0.02 to $0.03 headwind. I assume you can't frame expectations on that here?

Thomas Smegal, Vice President and Chief Financial Officer

No, I apologize. It's simply too early to tell. We'll have a clearer picture by the end of the second quarter.

Jonathan Reeder, Analyst

Do you think there could be offsetting O&M expenses to potentially cancel out that headwind? Many companies are seeing that due to remote work arrangements leading to found savings. Is that something Cal Water is experiencing as well?

Thomas Smegal, Vice President and Chief Financial Officer

You will likely see some of that as well. We canceled all travel plans very early in the pandemic, which typically incurs costs. We'll also likely have deferred training costs due to the shift to virtual training, which will help offset expenses.

Martin Kropelnicki, President and CEO

It should also be noted that over 90% of our employees are actively working each day. While some corporate and engineering staff may work remotely, our essential frontline employees maintain operations to ensure continuous water supply. Tom's projections will become clearer in the second quarter as costs come into focus.

Operator, Operator

I'm showing no further questions in the queue at this time. I'd like to turn the call back to Marty Kropelnicki for any closing remarks.

Martin Kropelnicki, President and CEO

Thank you, Jimmy. Thanks, everyone, for reviewing our quarterly results. Typically, the first quarter isn't one we get too excited about, and we've experienced a loss, which the General Rate Case delay exacerbated. However, we are navigating through this maintaining focus on our customers and getting through the pandemic. In these unprecedented times, our priority is to support our customers, and if we're successful in doing so, we expect the regulator will work on wrapping up the rate case fairly for all parties involved. With that, we'll close, and I look forward to speaking with you again in July. Thank you, everyone.

Operator, Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your program, and you may now disconnect.