Q2 2022 California Water Service Group Earnings Call
Good morning, and welcome to the California Water service group quota to 'twenty to 'twenty two earnings release call.
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Thank you I'd now like to welcome David Healey, Vice President and corporate controller to begin the conference over to you.
Thank you Polly.
Welcome everyone to the 2022 second quarter earnings call for California Water Service group.
With me today is Marty crop with Nicky, our president and CEO .
Tom <unk>, our Vice President Chief Financial Officer.
Replay dial in information for this call can be found in our second quarter earnings release, which was issued earlier today.
As a reminder, before we begin the company has a slide deck to accompany the earnings call this quarter.
The slide deck was furnished with an 8-K. This morning and is also available at the company's website at Ww Dot Cal water group Dot com.
Before looking at this quarters 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.
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 uncertainty.
And in our Form 10-K.
Form 10-Q press releases and other reports filed from time to time with the Securities and Exchange Commission.
I'm going to pass it over to Tom to begin.
Thank you, Dave and good morning, everyone. Welcome to the second quarter earnings release call I want to start talking about the financial summary on slide five and I'll get into some of the details in just a moment.
But just to give everybody the top line, our net income attributable to the group.
Is $19 5 million or <unk> 36 per share and that's down considerably from $38 2 million and 75.
Per share in the second quarter of 2021.
For the year to date period.
That is a relatively similar resolved in that our net income is $26 million or <unk> 38 per share.
As compared to $30 $35 2 million or <unk> 69.
<unk> per share in the comparable year to date period in 2021 flipping to slide seven where we get into some of the details of this the primary focus of the change in earnings has to do with our Unbilled revenue accrual.
I've been with the company now 25 years and I've been in management talking about financials I think for about 12 week 12 years with you all.
And we often talk about our unbilled revenue accrual.
The thing to remember is that this is the calculation that we do.
The value of water that has been used by our customers, but is not yet billed and is therefore outside of our regulatory mechanisms and this has some fluctuation within the year.
And we talked about it in every quarter, if if you've been with us for a little bit in the second quarter of 2021, there was a substantial increase in our unbilled revenue accrual.
And however that came down to a normal range at the end of the year.
This year in kind of in reflection of the large increase last year, we have a large decrease in our unbilled revenue accrual that was $15 2 million change in revenue associated with that.
And a big impact on the earnings per share as well for the quarter, but just as a reminder, the company's unbilled revenue accrual at the end of the year is very stable and.
Management believes that we are very likely to see a result for the unbilled revenue accrual at year end, which is within plus or minus $2 million of the year before and so.
While it's a big swing here in the quarter and definitely a big swing from last year do you want to emphasize that by by year end, we expect that all of that volatility will go away and we will have a relatively normal unbilled revenue accrual.
The other thing Thats impacting the quarter that is outside of our control is that we have a change in the measured valuation of our.
Nonqualified plan assets.
Due to market conditions and the value of those of those assets decreased $6 2 million relative to the first the second quarter of 2021.
Our general rate increases this is the step rate increase in California and changes in rates in other states.
Added $6 $9 million. So that's a very positive element for the year and that is partially offset by changes in wages depreciation interest and other operating and maintenance expenses that.
That we would normally expect given given the passage of time and inflation, our capex for the quarter and.
Year to date are both to plan and a little bit higher than in the prior period.
I will skip over the bar charts, because they largely talk about what I just mentioned the unbilled that being the primary driver.
Along with the Mark to market.
And then I am going to turn it over to Marty to talk about the California General rate case, great. Thanks, Tom and good morning, everyone. Thanks for joining us here today for the second quarter results discussion.
General rate case, the 2021, California General rate case, California, being our largest operating entity.
Has continued we have concluded on our hearings and briefs have been filed with the administrative law judge.
We still anticipate that the JRC to have an effective date of January one 2023.
No change in the contested items among the party, having said that there is still no major disagreement between the parties.
Of our sales in water.
Our mix of production that was that was included in the general rate case. Accordingly, we alerted the administrative law judge that a partial settlement may be filed sometime in August Tom do you want to cover the cost of capital I think you're a lot closer to that one Gerard. Thanks. Thanks, Marty So very similar story procedurally with respect to our cost of capital proceeding.
In California.
The hearings have concluded the briefs have been filed in the ALJ has that.
Has the cost of capital case under consideration.
I wanted to remind the investing public that.
In our filing for cost of capital.
We requested a lower cost of debt then had last been adopted in the last case.
And if that were adopted.
Along with no other changes to cost of capital, we would expect to see an $11 million reduction to our revenue coming out of California. As a result of the lower cost of debt, that's our financing and refinancing program that brought our cost of debt down from 551% in the last case to four 2%.
3% on a weighted average basis in this case and so we have not taken a reserve for that amount.
In part because we don't know the timing on the effective date of the cost of capital case and in part because there's two other elements to the cost of capital case that are unknown. At this time those elements are the cost of equity return on equity and also the capital structure for the company and so investors should be aware that that.
Out there and the commission could make that retroactive.
But we have not yet booked that into our results here in 2022.
Marty I'll turn it back to you for drought update great a couple of things going on with the drought.
First and foremost the drought continues I think as we've seen the heatwave not just in the U S, but really around the world.
It highlights the continue need to focus on supply of resiliency and sustainability.
California are as we mentioned last quarter that the California State water project deliveries were cut to 5% that was impacting some of the regions solar who solely rely on the water from the state.
For us customer usage is down 5% in the second quarter compared to 2021, but I think the broader trend is the most important.
If you look at the water savings number a conservation number year to date, it's 2%, it's 5% for the quarter, but if you look at just the month of June it was over 11% and that's a good sign that our drought programs and our messaging to our customers is starting to take hold and I would expect that number to grow as we go into the drier summer months.
July August and September .
Yes.
In terms of drought spending.
Can you remember all the state is on our stage two drought alert for the state of California.
What about $400000 during the quarter that is recorded in a memorandum account, which is incremental cost that has been used to respond to the drought for.
For recovery at a future date and the total balance of that balancing account now since 2021, which is when the government declared the drought is about one $2 million. So drought messaging is starting to take hold going into the dry summer months, and we want to push that number up as high and as close to that 20% target that we have as a state is Pos.
<unk>.
Couple of other items to watch in the second half of the year.
One is capital spending as Tom mentioned, our capital spending was up 6% year over year and while we're very very happy with that I want to make sure. We're very clear about this as supply chain issues has continued around the globe.
We're not immune from those supply chain issues. Our team internally has done an excellent job at mitigating those risks that threaten our ability of capital in the ground, but the longer those risks continue to go on the greater the probability of an effect on Cal water and so there's some uncertainty and as we go into the second half of the year on our ability to get all the cash.
On the ground, if we had any supply chain issues as I mentioned the team has done an excellent job at mitigating those issues, but obviously it gets harder as the as these delays and supply chain.
Our procured items that we need to get the capital in the ground go go on.
In addition to that with the rate case.
We don't have regulatory approval on some stuff yet so if you recall the rate case the way our rate case cycle works. It includes the 2022 capital program. So as we go through this <unk> cycle.
We're making some assumptions and we're prioritizing the high risk capital are things that we think we need to get done as a company that are top of the list in terms of critical.
But we don't have assurance.
Until the commission actually approves that 2021 general rate case, the other thing I'd like to point out is that our bad debt.
Reserves remain high at about $6 $7 million.
Primarily driven by California now in the other states. We have started the collection process coming out of the Covid.
<unk> in California, we are just starting that process now it's a 90 day process to start shutting off people for nonpayment.
Our first notices actually went out this week to start the process. So prior to this week collection activities have been zero as we waited for a commission on commission approval to start the process. So customer response will be critical what we've seen in the other states that we operate in once we started the collection process cut.
<unk> started to pay their accounts, so that'll be something to watch in the second half of the year.
Going on to the next page.
Slide 13, just a quick update on business development. The business development pipeline remains strong as we go into the second half of the year on this page is the highlight of projects. We've closed projects that the commissions of recently approved and projects. We've had we've announced trained 2022 in total there's over at <unk>.
600 water connections that are in process as well as over 4000 wastewater connections. So as we go into the second half of the year. The BD team is very busy and.
And we expect that activity to continue as we move into 2023, Tom you want to cover the capital and depreciation sure and just as a reminder, slide.
Slide <unk>.
Excuse me, we've made no changes to these slides and we wouldn't expect to make changes until we had a significant event coming out of California regulation or any new project we.
We announced and so Youll see slide 14, the capital spending targets shown there those are relative to the California General rate case request no changes except for the update on the year to date figure and the same with the rate base.
That rate base is relative to the California General rate case request plus the rate base in our other states.
And Marty I'll turn it over to you for a summary, great. Thanks.
Thanks, Tom So where are we in.
In summary, as Tom mentioned the change in the Unbilled for the quarter was a major item market volatility that we've all seen and live with.
<unk> 2021.
Lower the unrealized valuation of certain retirement plan assets in our nonqualified plans and those will float up and down based on market condition changes and volatility the core business remains strong as we as we await regulatory outcomes in California.
For those of you that have been with US a long time as you know its a third year of the rate case process for us it's always the hardest time at the three year cycle.
Water, the California entity as we wait for regulatory approval of our general rate case. So we have the most amount of regulatory lag.
At this time and as we weight all eyes are on the commission as we try to resolve the cost of capital and the 2021 general rate case.
Management is remains focused on the drought, that's a big deal in California.
Going into the peak summer months August September and October for fire season, and obviously mitigating supply chain issues and of course the collection now of re.
<unk> for past due for customers, who haven't paid their water bill in awhile.
Between that and focusing on the general rate case, it's going to be a very busy second half of 2022 for the company.
And of course in closing I'd, just like to say that the growth opportunities at the BD team worked on have remained strong and I expect that to continue as we go into the second half of the year. So what that poly, we will open it up to questions.
Yeah.
Yeah.
Paul are you there.
Sorry apologies at this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad.
And your first question comes from the line of Ben <unk> from Baird. Your line is now open.
Hey, gentlemen.
Good morning, everyone. How are you.
Good how are you good.
Maybe just on Tom.
How you started with.
The Unbilled revenue.
<unk> estimates.
If I look at slide 15.
And maybe my first question is have you guys thought about giving.
Giving annual guidance range.
A range, maybe too robust all in all it's just because.
Intricacies of working in California.
So.
<unk> discussed that internally, we've not come to any conclusions on giving annual guidance. The reminder is of course with slide 15 that we are a company whose profits are relative to its rate base.
And so what we're showing showing there is the estimated regulated rate base of the corporation in total, including California, and the other states.
And the opportunity to earn a return on investment is what drives the company like ours right. So.
Generally speaking over time, we would hope to earn the authorized return.
On the investment in rate base.
Generally that was shown on slide 15 that would be $1 95 for torture.
Yes.
No I'm sorry.
That 195%, that's 195 billion of rate base.
I understand sorry, I was reading that incorrectly.
And then Marty just on.
Capex deployment.
Deployment.
You noted that you guys are on schedule for the year.
Obviously, all the risks out there could you just maybe talk through growth.
How it's changed since last quarter I think maybe I'll ask the same question.
Sure.
It's gotten better in supply chain or core.
Safe to say, where it got worse.
Sure.
I would say better than a lot of ways, it's gotten worse.
And it's just the lead times that we're seeing to order icon capital inputs, but.
Pipes valves and fittings.
We just finished the study internally and as we were pulling the report together over the last two weeks.
The lead time for ductile Iron went from eight to 12 weeks to 26 weeks.
So if you think about the number of capital projects that we do on an annual basis and.
The time line to do design permitting and then procurement.
That procurement piece, what what order preordering going out that far out now.
It has a real potential to slow us down a little but now when I say slow down it just means that capital will take longer to get into the ground right, especially in California, where we have a perspective.
Test year. So the capital is approved as part of the rate case than what our job is to get it into the end of the ground. So we're not a historical state where a prospective state in California.
So we're just seeing those timelines taking longer to order stuff and so some of the things that team has been doing they've been putting stuff out debate earlier, they have been expanding our supplier base, we have loaded up on <unk>.
Items, we can get now that we may not have a need for right now, but we know we're going to need them in the next six months to 12 months. So the team really has done an excellent job at keeping us on track, but again, it's a global supply chain issue and it's just taking longer to get stuff in especially especially water main and so.
Our goal is to have zero effect, but I think the probability of that is very low because of the supply chain is getting more constrained at this point in time, so that makes sense. It does.
Back to the cost of capital obviously interest rates have changed since you filed.
Does that have any bearing on the decision or is there a way for you guys to go revisit that or no.
So <unk> been theirs.
Is it a little bit of an interesting question from a regulatory process standpoint, and I don't mean to be vague about it but the data that was supplied in the initial case was really 2020 data.
Going back to the end of the end of that year as far as what was put into the input models from the analysts we did have hearings and we did have brief.
Briefs in the case, where I'm certain this pub.
Documents you can go read them.
We tried to draw the commission's attention to the fact that since those data points had been drawn actually the interest rate environment.
The market environment had changed really dramatically.
It's up to the commission the administrative law judge and the five commissioners to recognize that and.
Make a decision that incorporates that newer data.
Theyre not necessarily obligated to.
<unk>.
One of the things, though that the parties agreed to and we've had as a mechanism in California for many years is a water cost of capital adjustment mechanism. So.
Looking at a baseline period of the Moody's double a utility bond curve, if theres a change of more than 100 basis points upward or downward it triggers a change in the return on equity.
50% of that so 100 basis point change in the Moody's double acre would change that cost of equity by 50.
50 basis points.
That's like.
Our caller, however, if you get to 99 basis points it doesn't change.
And so it's.
And Thats something Thats out there for extreme events when we look at that data now.
Compared to the baseline Moody's double a and what's out there in the market right now is.
It appears that we're close to triggering for 2023.
So if the commission were to just leave the data alone and just react with the cost of capital adjustment mechanism. There is a possibility that we would get a bump from their authorized amount to.
50, 50 basis points higher amount for a return on equity.
However, it's a 12 month weighted average and so its very dependent actually on what's happening with interest rates over the entire period is not at a point in time.
And so we don't know if that would trigger here for 2023, it seems more likely that it would trigger for 2024.
Given that the rates the instantaneous rate as.
Is now much higher than the trigger point, but you'd need those many months of higher rates to trigger the weighted average so.
All of that being said, we're hopeful that the commission can do the right thing look at the data that's come out lately and make sure that the companies have a fair return on equity.
That is reasonable in the current environment.
Great. Thank you then my last question.
Just with you.
Energy utilities increasing rates.
I don't know if across all of your service areas, but.
We read about a lot of that how does that impact you.
From I guess.
The rate case.
Does that factor in at all with commission receivable payable.
Raise rates here because the read raise over there.
And then also your.
How does it impact your ratepayers fighting.
Okay.
Your rate case as well thank you.
Okay.
Let me try to address it just from a mechanical standpoint first.
And as a reminder, the California since the 19 seventies has allowed the water utility companies a tracker mechanism for our power costs.
<unk> water cost and pump tax costs as well and so there's no material financial impact on the company win win electric power rates change.
That's essentially a pass through.
But from the from the psychology of the Commission standpoint, I think that.
We're.
We're really kind of in a little bit of a whipsaw situation, which is interesting I've read the brief from the ratepayer advocate and a rate case and they initially back when they filed their testimony back in <unk>.
January February they were talking about how awful the economy was and how how everything was.
Barry.
Everyone was jobless and they're reacting to the pandemic.
They're later statements have to do with inflation and have to do with the impact of the very hot economy on our customer base and the people in California, and so it's obviously theres a populism factor when you talk to any appointed or elected official anyone thats representing the public.
In total the electric power cost is not the biggest impact to the company.
It's probably our fifth or sixth biggest cost.
<unk> two.
Purchased water in employee wages and that sort of thing. So so it's certainly a factor we think when the commission evaluates our rate cases, but we're hopeful that it's a little bit more mechanistic and Marty I don't if you have anything yet.
Think back Tom.
At my time here with Cal water with you I mean, I've never had a commission.
Not considered input cost of production.
And then to your broader point of wealth that are raising rates you can't raise your rates.
Never heard that argument raised by the commission, that's always been a input cost into our production.
The other thing I would say in terms of just affordability in general.
If you look if you look on page four where we have kind of our corporate strategic map. The first thing you see is affordability and so we try to base stay very focused on affordability, what it means to our customers.
Encompassing everything that we deal, including those power input costs. So when we do our rate case planning.
And look at where we're driving to for the next 369.
12 years, we tried to take affordability.
Advisement and I think that's really kind of paid off for us because the last part of your question was talking about customers who might be intervening in a rate case.
We have a couple of intervening parties in this current rate case, there are two cities.
<unk> always kind of been involved but they've been pretty silent. The last couple of rate cases. So we don't have a lot of intervenors kind of hitting us on that side about affordability I think it's because we've done a pretty good job of trying to balance that with the needs of growing the rate base and the capital needs of the company and the needs to protect protect and promote.
Water health and conservation within the state.
Thank you guys very much I appreciate it.
Have a good day.
As a reminder, if you would like to ask a question. Please press Star then the number one on your telephone keypad and we'll pause for any final questions.
There are no further questions at this time I turn the call back over to Marty.
Hi, Paul I. Thank you everyone. Thanks for joining us today as mentioned all eyes.
On the California regulatory activities and fire season, and the startup of the collection process in the state of California.
And we will look forward to giving everyone an update when we end Q3.
And I guess that will be Tom the end of October will be the next earnings call that we'll update everyone. So thanks for joining us be safe have a great day, and we'll talk to you soon thank you.
This concludes today's conference call you may now disconnect.
Okay.
Okay.
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