May 8, 2012
Operator
Good morning, ladies and gentlemen. Welcome to the California Water Service Group First Quarter 2012 Earnings Results Conference Call.
Today's conference is being recorded.
Operator
I would now like to turn the meeting over to Mr. Martin Kropelnicki.
Martin Kropelnicki
Thanks, Jessica. Good morning, everyone, and welcome to the first quarter 2012 earnings call for California Water Service Group.
With me today is Pete Nelson, President and CEO. As a reminder a replay of today's proceedings will be available from today, May 8 through July 7 at 1 (888) 203-1112, passcode #4304013.
Martin Kropelnicki
Prior to reviewing the results for the quarter, I would like to remind everyone that during the course of this conference 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 stockholders as well as all interested parties to carefully read and understand the company's disclosures on risk and uncertainties and other information found in the Form 10-K, 10-Q and other reports filed from time to time with the Securities and Exchange Commission.
Martin Kropelnicki
Now let's go to the results for the quarter. The press release is out on our website as well as the earnings release came out close of business last night.
Revenue for the quarter was up 19%, or $18.6 million to $116.7 million. Included in revenue was an increase of $8.7 million due to the reversal of deferred WRAM revenue from year-end.
Martin Kropelnicki
Water production costs increased $7 million or 21.9% to $39 million. As a reminder, water production costs are covered by the modified cost balancing account.
The company does not get any marginal, but does true up that balancing account every month.
The following 3 components make up to modified cost balancing account
purchased water was up $6.3 million, or 24.8% to $31.9 million; purchased power increased $300,000, or 6% to $5.1 million; and pump taxes increased $380,000, or 24% to $2 million. The increases that we experienced in purchase water costs and production costs was driven by one increased demand by our customers, as well increased costs associated with purchase water.
The following 3 components make up to modified cost balancing account
Looking at the demand year-over-year for purchase water, our full water production overall for California Water Service Group, we produced approximately 8,000 more acre-feet during Q1 2012 over Q1 2011.
The following 3 components make up to modified cost balancing account
Looking at A&G or admin and general for the quarter of 2012 it increased $2.5 million, or 12.3% to $23 million. This is primarily driven by wage increases that took effect on January 1, 2012, as well as increased benefit cost.
When we talk about increased benefit cost please keep in mind that the pension costs is covered by a balancing account and more specifically the cost increases are associated with medical, workers comp and other fringe benefits of the company provides for its employees.
The following 3 components make up to modified cost balancing account
Other operations increased $9.2 million or 62.8% going to $23.8 million. That was primarily driven by the increase in production costs, which includes the reversal of $7.1 million of deferred net costs associated with the WRAM, as well as increased costs associated with water production that was experienced because of increased demand noted in the quarter.
Maintenance cost for the quarter increased $600,000 or 10.8% to $5.8 million driven by increased maintenance associated with pumping and mains.
The following 3 components make up to modified cost balancing account
Depreciation and amortization for the quarter increased $1.4 million or 10.8% to $14 million. That was driven by the increases in utility plans that the company put into the ground last year.
Income taxes for the quarter increased $1.3 million driven by one, a favorable one-time adjustment recorded in Q1 2011 $1.6 million, that's Q1 of last year, and also driven by higher income tax rates driven by bonus depreciation, which has reduced our QPAD deduction, so it takes that deduction away and increases the tax rate as well as our estimates that have to do with the changes in tax laws associated with repairs and mains.
The following 3 components make up to modified cost balancing account
Property taxes were slightly higher at $4.6 million. Looking at other income and expense net or other operations, they increased $670,000 or 124% to $1.2 million.
It was primarily driven by a favorable mark-to-market adjustment associated with the change in value of long-term assets held by the company and its non-qualified retirement plans.
The following 3 components make up to modified cost balancing account
Interest expense for the quarter was down approximately $1 million or 13.3% to $6.7 million. That was driven primarily by lower financing cost, as a result of the company renegotiating its line of credit last year, as well as we are getting more plant in service.
So as you may recall we had a couple of projects last year that got deferred or delayed. New capital is coming behind that and those dollars have now been allocated to that new plant.
The following 3 components make up to modified cost balancing account
Net income for the quarter was $1.1 million or $0.03 for the quarter. So just to summarize there is a couple of important changes that have taken place in the quarter and the analysis.
One, again to remind everyone in Q1 2011 as disclosed in a previous 10-Q the company included a $0.04 or $1.6 million onetime tax adjustment in Q1 of last year. And then in Q1 of this year as a result of the April 2012 WRAM decision the company recognized $8.7 million of deferred WRAM revenue, $7.1 million of deferred net cost and $900,000 of deferred net income.
And I am now going to turn it over to Pete Nelson. Pete?
Peter Nelson
Okay, thanks, Marty, and welcome everyone. For those of you who follow us regularly know that the first quarter is always our slowest.
Results came in within our expected range. In fact, we expect to break-even in the first quarter especially in years 2 or 3 of the rate case and we're now in year 2 of the 2009 General Rate Case.
Peter Nelson
So as everyone who knows who follow us that we make the vast majority of our income in this spring, summer and fall of the year. So today I am going to touch on 4 issues, quickly.
They are all regulatory. First I'll talk about the WRAM decision where we were actually pleased with the decision and I'll also talk about the sales forecast, how that's done and how that is the source of the problems here.
Peter Nelson
Second, I will talk about the cost of capital proceeding, not much new there. And then talk about some small rate changes outside of California that have taken place since the last call.
And then talk about both the progress on our 2012 GRC. So first the WRAM decision, which is really the regulatory news of the quarter for us.
As you know, 4 water companies are all parties in the same proceeding here, and April 19 the commission issued their decision that did 2 things.
Peter Nelson
First it adopted the all-party settlement on the amortization schedules, so now we are generally collecting those balances in 12 or 18 months recovery. That shortens the amortization periods and that's good.
But the decision also directs us to address changes to the WRAM mechanism in our 2012 General Rate Case.
Peter Nelson
My take here is that there is real interest from all parties in minimizing the magnitude of the customer surcharges. I mean no one benefits when we had these large receivables sitting out there.
But the de-coupling mechanism of sales and revenue itself is a well-accepted public policy, it's in the Commissions water actions plan, which is their public policy document. The company has worked well in electric and gas for decades and electric and gas have now very small surcharges and they collect those over 12 months.
So that's, there is light on the horizon there.
Peter Nelson
Obviously in water we've hit some road bumps in the WRAM collection so this is where I get into the detail about the sales forecast. And I'll talk about -- I think I will talk about this for about 4 or 5 minutes, because the commission does adopt a sales forecast and that forecast is used to set rates in a General Rate Case.
In fact it's an important part of a General Rate Case.
Peter Nelson
From the sales forecast which estimates future customer usage or sales, the commission sets rates. So the sales forecast really is a major process in the rate case and in our case with the WRAM balance, that's the source of the problem.
And when I say problem, I mean the large WRAM balances. So let me use an example.
Our 2009 General Rate Case we filed 2009 for rates effected to 2011, 2012 and 2013. Now we filed this in July 2009, but it used historical sales, customer usage, up to and through 2008.
So year 2008 usage and previous usage was before our conservation programs, before the drop in usage we saw the last 2 or 3 years.
Peter Nelson
So that's problem number one, is the sale forecast modeling is based on historical average and the 2009 General Rate Case could not have foreseen the drop in usage. So the forecast is too high, rates were set on the high forecast, customers use less water and we had this large receivable balance.
Peter Nelson
In fact, when you think about the forecast is already 2 years old by the time the first rates change, because it's using 2008 data. So you got a 5-year forecast, you are living with that starts 2 years out of date as its being applied.
So that's problem one, is the forecast itself. The problem 2 is probably a little more problematic in that once the forecast is adopted it is inflexible.
There is no mechanism to update or change it as we go along here, so we are forced to apply the high sales forecast in our years 2011, 2012, 2013 without regard to the actual sales that are going on, that we're experiencing to those years and there is no true up mechanism until the next General Rate Case which for us is 2012.
Peter Nelson
To say this another way, there is no mechanism to change the forecast and then change rates to better reflect the reality of what customers are really using. So we think the 2012 General Rate Case is a good forum to iron out these 2 problems, and there are 2 problems there.
And it's important to fix these 2 problems because it's -- we don't really -- in fact nobody wants large surcharges to be collected from customers. And we also are incurring, as you know, unanticipated interest in financing costs to carry these balances.
Peter Nelson
So it's important to find the solutions here that are fair to the company, so we're not carrying a large surcharge, are fair to the customers, so that they pay the costs of service as close as possible to when they use the service. And it's also important to align what we are doing here with the commission and the states policy of strong water conservation programs, as they have in the electric and gas business.
I mean, we should be able to pursue conservation programs to meet the state usage goals without penalizing the company. Well, enough said there.
Peter Nelson
Next issue is cost of capital. Not much new here.
As you know we are still awaiting approval of the settlement of 9.99% adapted ROE. We have budgeted and are planning for the 9.99%, in fact we are assuming it's going to be retracted to January 1.
The only really change here is the Commissioner Ferron, who is the assigned Commissioner, was just confirmed by the States Senate in March, which is good because now we have 5 sitting commissioners who are all confirmed, which allows all 5 some degree of independence, so that's a good thing. So we're just waiting for the decision here from Commissioner Ferron's office.
Peter Nelson
Third issue is outside California rates. Some of these have been adopted since and put in place since our last call.
State of Washington implemented a $1.6 million General Rate Case increase in February this year. Hawaii, where we serve 2 islands, the Island of Maui, our Ka'anapali systems, we put in $1.2 million in new rates in March.
Our Pukalani system on Maui, which is all waste water, we're still working through our proposed $1.3 million in new revenue there. And on the Big Island, the Waikoloa Systems, which is 50% of our customers, the entire Hawaii subsidiary, will file that General Rate Case this month, in May, and that will most likely impact 2013 rates, and I'll have those numbers on that rate case in the second quarter call.
New Mexico did receive a rate increase this year but it's small in comparison to the others.
Peter Nelson
So fourth issue and last is our 2012 General Rate Case. It's our next major General Rate Case.
We filed our first paper work May 1, which starts the process. We do our full filing before July 1 and so you'll have much more information about that rate case on our next call.
These will be for new rates starting 2014, 18 months processing time. And so we'll give you those numbers when we have them.
Peter Nelson
So summarizing for us, 2012 is an attrition year, we're very focused on cost management and operating efficiently. We have good efficiency ratios, we watch them all the time, but it's still a tight budget year, and we're managing it to be just that tight.
Peter Nelson
So I think now I'll go back to Marty for the balance sheet and to take questions.
Martin Kropelnicki
Great, thanks, Pete. And just to remind everyone that the 10-Q will be filed this morning, we're waiting to get conformation from the SEC it's been received and more information about the events for the quarter will be in detail in the 10-Q.
Martin Kropelnicki
Looking at the balance sheet for the quarter. Net utility and plant increased $100 million or 7.1% to $1.4 billion as of March 31st.
Happy to see that continued growth in the net utility plant. Company funded CapEx for the first quarter was a healthy $29 million.
That's usually a little bit more than we do in the first quarter, but with the mild winter, we've taken advantage of that to get more capital on the ground. Again, our target for the year is approximately $125 million of capital for the year.
Martin Kropelnicki
Cash flow from operations was $23 million and with the recent WRAM decision, we expect to see a 20% to 25% increase in cash flow as those balances start to amortize here in the second quarter. And as Pete said, Q1 really is one of our softest quarters.
For the utility in California there was no draws on the line of credit for the quarter. We did draw $3 million on the line for our subsidiary operations to fund plant expenditures in Hawaii.
Martin Kropelnicki
So overall Q1 is always pretty tight from a cash flow perspective, but we did get through the quarter without drawing a line for the major California utility, just a minor amount for the Hawaii utility. In looking at liquidity, we did end the quarter with $16 million of cash and have $350 million availability on our line of credit.
So overall, we think we're -- liquidity is looking good.
Martin Kropelnicki
So Jessica, with that, we will open it up for questions, please.
Operator
[Operator Instructions] And we'll go first to Ryan Connors with Janney Montgomery Scott.
Ryan Connors
I'm interested in your comments on the PUC and their idea of using the sort of the GRC process to make adjustment to the WRAM mechanics. Obviously whatever is decided there, I assume will set precedent for your peer company.
So are the ideas you laid out in terms of what the issues are and how they can be rectified, are those to your knowledge in line with the general industry thinking on the part of your peers to the extent where they would be supportive of that approach? Or are there other takes out there on what the issues are?
Peter Nelson
I think you've nailed it, I think our peers would definitely agree with what I said, what the problems are and it's kind of a precursor to our rate case, you can kind of see where we're going there. And we knew way back, when we first talked about decoupling years and years ago that the sales forecast was going to be important, and that mechanism just has not changed to keep up with the WRAM accounting and the WRAM mechanism.
So it's time to fix it.
Martin Kropelnicki
Ryan, and one thing I would add on that. If you look at the broader utility base in California, the electric and gas industries, they true up their forecast every year.
And so we've had this built in lag in the process. You fix the sales forecast, you fix that lag, you fix that WRAM receivable growth.
So the case law within the state of California is pretty clear.
Ryan Connors
Okay. And then just in terms of timing, can you just walk us through how that will play out?
So you apply for that in the rate case, and I assume there's -- I mean how do you envision that playing out in terms of, is there going to be some kind of public comment period or will that just be kind of a closed black box and we'll get a finding along with rate case decision.
Martin Kropelnicki
Not sure how that plays out in the rate case. This is kind of a new directive to us, to take this into the rate case.
Timing is going to be 2014 for rates and we will be applying the amortization period you saw from this decision until then.
Ryan Connors
Okay. And then, last question, related issue, but I mean, it seems to me from the outside watching in that one of the issues also has just been, I mean, the reason why the forecast has been an issue, is that the steepness of the decline curve in per capita usage has been more pronounced than people had envisioned it would be.
And so, I mean, is there anything -- as you look at your data on customer usage, is there anything to suggest that, that decline curve might be getting a little bit less steep and therefore that, that issue would take care of itself even without corrective actions to the WRAM? Or do you think that the per capita usage will continue to sort of plummet at the rate that it has?
Peter Nelson
Don't know, but you did see the perfect storm here of a high forecast based on old data, quick turnaround in customer usage driven by the drought partially and also by our conservation program. So you've got 3 or 4 things that came together to really make the difference and -- it was kind of a perfect storm, actually.
Going back to your question about the proceeding and how we'll work through the WRAM there. There will be -- I'm sure parties commenting, and the Department of Ratepayer Advocates will be in the middle of this.
So this will be fully aired. And I think if we stick to the public policy as the basis for the decision, we'll be fine.
Martin Kropelnicki
And I think it's important to underscore that and tell them '14 rates come into play, we do have this -- the WRAM decision that came out that was going to cover '12 and '13. So the issue that we experienced looking backwards should be somewhat minimized, because there is no threshold figure now for filing for WRAM balances.
Operator
And we'll go next to Heike Doerr with Robert W. Baird.
Heike Doerr
I want to follow-up a little bit on Ryan's questions about this WRAM, I'm sure it will be popular topic on your call today. I'm trying to understand or to reconcile why your forecasts are more off than the other companies.
If you look to the ALJ document, the other companies don't have the same level of surcharges that they are asking to recoup from customers. Why would your forecast be off more so than the others?
Martin Kropelnicki
A couple things Heike, on that. I can't speak for anyone else's balance sheet, but the real question is how big is that WRAM receivable on the books.
And obviously for us the WRAM receivable was around $50 million and that was material, which is why we've had a lot of disclosure on that. The other thing to keep in mind is that we were the first kind of company to come out of the chute with decoupling and therefore our forecast as Pete talked about was based on 2008 and prior data.
And as Pete mentioned that the perfect storm that really was it. So you had older data that you used in your forecast, you had the inability, given the regulatory process to true up that mechanism, and then you had a pretty steep decline in consumption, approximately 16% on average for our customers.
And so from my perspective, or our CFO perspective, what I look at as that receivable turning and how fast that receivable we can collect that cash. And so for us the receivable was essentially flat from year-end to Q1 and we will start to see that receivable I think come down a little bit because we are collecting that cash.
But I think the real question is how big is the receivable on everyone else's balance sheet?
Heike Doerr
Okay. And we are still at the proposed decision phase, right?
We are still pending a commission approval?
Martin Kropelnicki
Of the WRAM decision?
Heike Doerr
Of the WRAM decision.
Martin Kropelnicki
That's decided, it's done.
Heike Doerr
Its decided. So was there a cap put, a percentage cap put on this surcharge.
I know that, that was part of the proposed decision?
Peter Nelson
Yes. There was a couple of things.
There's after -- there is a 10% cap going out after '14, but what the decision really did that's really going to speed up the amortization as it took away a trigger. There was a 2.5% threshold trigger there.
So if you have a large district that balance had to get to be $2 million or $3 million before we can collect it. And if it didn't trigger, then we were carrying it on the books and that's where the accounting literature and the PUC policies kind of crashed into each other.
And so the decision that's been adopted and by the way for everyone, if you look at page 7, 8 on the Q when it comes out, we give you a full reconciliation, all the components are [indiscernible] are changing here, it's allowing us to collect that cash. So in almost all of our cases, all those WRAM balances, we were not able to collect.
We are able to collect with the exception of 2 very, very small districts that we'll be able to collect in the next 24 months or less.
Heike Doerr
Okay, final question on this topic. I believe the proposed decision also asks that Cal-Water specifically break out the surcharge as its own line item, because that's something that you hadn't been doing previously.
Will we see increased operating expenses in the second quarter as you meet that requirement?
Martin Kropelnicki
No, it's really one of the things we've prided ourselves on is we're really focused on our IT platform and we have a very robust billing system. So we have to go in and make some tweaks to the system, but it's not significant.
Heike Doerr
Okay and my final question, let's switch gears, the mark-to-market gain in the first quarter, can you refresh our memory as to what the market-market allocation was in the first quarter of last year and how it looked this year?
Peter Nelson
Yes, the first quarter of last year, it was about $500,000 positive, the first quarter this year it's $1.7 million positive, so your debt is about $1.2 million.
Operator
[Operator Instructions] And we will go next to Jonathan Reeder with Wells Fargo.
Jonathan Reeder
Hey, Marty. Just going off of Heike's last question there.
The $1.7 million and the $500,000, is that pre-tax or is that after tax?
Martin Kropelnicki
That is -- it's down as other income and expense, which is net.
Jonathan Reeder
So those are net numbers?
Martin Kropelnicki
Yes. So it's not flowing through the utility lines, it's down in other income and expense and when you look on the income statement, it's in the other income and expense net line.
Jonathan Reeder
Okay. And then going back to the whole usage numbers.
If say the rules don't change if you're not successful in getting that changed, what would I guess the period be for usage in the 2012 filing? Is it just -- I guess my understanding was it was like a 3 year rolling historical?
Martin Kropelnicki
The team accumulates data over a 10 to 20 year period and then they do their analysis off of it. So its 10 years for 2011.
But we're in the process -- obviously part of the rate design here is recommending mechanisms to fix the sales forecast, and it's a little premature for us to go into details about that. The only thing I would draw everyone's attention to is, look at the electric and gas industry and how the mechanisms work and obviously we're studying that, and that will be part of our blueprint as we try to make corrective measures to our sales forecasting process.
Jonathan Reeder
Right, but under current form, if it's based -- I mean, is it based on just the actual historical data, or can you make a forecast as of 2012? Do you know what I'm saying?
Peter Nelson
It's a very complicated formula as I understand it. For the 2012 rate case it will be through 2011 usage, looking back 10 years of usage and weather normalized back 30 years.
Try to figure that one out. That's why I didn't get into that much detail on the sales forecast.
it's a very complicated calculation that really doesn't work when usage is going up and down.
Jonathan Reeder
I can't see. I mean, is it skewed at least towards the most recent data given the high degree of conservation and the drop in usage so that at least that forecast would be much more accurate than the 2008 forecast?
Peter Nelson
I wouldn't say much more, because now it's using 2 years of better data, 2 or 3 years of better data, but still averaged against 7 years before that. So it's not going to change the line that much.
Jonathan Reeder
Okay, so it's not heavily weighted towards the most recent years. You're saying it's kind of an equal average type?
Peter Nelson
It's an arithmetic average.
Jonathan Reeder
Over the 10 years.
Peter Nelson
It's an arithmetic average.
Martin Kropelnicki
And I think part of the -- take the best analysts in the world, give him 10 years of historical data and tell him to predict out 5 years, which is essentially what we lived through in the last 3 years, and good luck. I mean, if you read Malkiel's book, A Random Walk on Wall Street, he talks about kind of the monkey stock-pickers versus the experts stock-pickers and statistically they come out about the same.
So as Pete said, the perfect storm, I think that, that's a good analogy with the sales forecast. And the trick is you got to have the ability to true it up at some point in the process.
Jonathan Reeder
All right, last question. If we strip out, I guess the deferred WRAM net cost from you know the operating expenses which obviously kind of skewed those percentages a little bit, it still seems like the underlying expenses are trending pretty high in Q1.
What do you kind of expect the trend to be as the year progresses and kind of for the full year?
Martin Kropelnicki
Keep in mind Q1, we always have the least amount of gross margin available because that adopted consumption curve that the revenues are just distributed based on that consumption curve. So Q1 is always our lowest quarter and yet our fixed cost go up, we know effective January 1.
So as Pete said, we really budget for breakeven to just slight profitability in Q1 and we are really happy with that. We're happy we didn't have to draw a lot on the line.
For example, you'll see a 75% increase in gross margin dollars between Q1 and the top of Q2. So that will give you an idea of what the delta looks like kind of quarter-over-quarter.
Jonathan Reeder
Right. But on those, I guess those operating expense lines I mean for the full year, we're still going to see a lot of kind of double-digit year-over-year increases, kind of like the Q1?
Martin Kropelnicki
No, I think you'll see them level out. I think you feel it more, because we are a high fixed cost provider and there is not a lot of margin there to cover it, but as your margin goes up and your revenue goes up, it will shrink as a percent.
The big thing to really watch for us and it's really no different than I think than any other company in America right now, is really healthcare costs. Production costs are covered by the modified cost balancing account, revenue is covered by the WRAM, pension is covered by a pension balancing account, we have a balancing account -- memorandum account for conservation.
So you really get -- you're really left with just the A&G cost and other operations. So in A&G costs, labor we're fairly good at managing that cost and we have a large Union population where a percent of our employees are Union within California, but that, that's fairly predictable.
It's really kind of the healthcare cost, and then as you see big changes in demand, we have the cost of other operations, which is where your chemicals and filters. And it was interesting to note that we did see a fairly big uptick in water produced and consumed at this quarter over last quarter.
If that continues, obviously there will be some more cost in other operations. But Q1 is just always the softest quarter and I think as we move into later parts of the year, medical is really the thing you want to watch.
Yes. And one other things, I would note is, as we're preparing the General Rate Case, we've had our actuary study kind of our plan versus the broader market and other plans.
And we'd show that we are about 15% cheaper than going to yourself and short of going to a fully insured plan. And so if our costs are going up by 8%, the general market trends going up 12% to 15%.
Operator
[Operator Instructions] And it does appear that there are no further questions. At this time, Mr.
Kropelnicki, I'd like to turn the conference back to you for any additional or closing remarks.
Martin Kropelnicki
Okay, thanks, Jessica. Everyone thanks for calling in today.
Again there is a lot of stuff that was talked about. The 10-Q will be coming out this morning.
For the information on the WRAM look to Page 7 and Page 8, that will give you the information, the reconciliation of the changes in the WRAM balances. As Pete said, we are keenly focused on our General Rate Case for California and continue our capital program while tightly managing our MG cost.
So thank you for being with us here today and give us a call if you have any questions. Have a good day.
Thanks.
Operator
That does conclude today's conference. We appreciate your participation.