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Edited Transcript of CWT earnings conference call or presentation 27-Apr-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 California Water Service Group Earnings Call

SAN JOSE May 3, 2017 (Thomson StreetEvents) -- Edited Transcript of California Water Service Group earnings conference call or presentation Thursday, April 27, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David B. Healey

California Water Service Group - VP, Controller and Assistant Treasurer

* Martin A. Kropelnicki

California Water Service Group - CEO, President and Director

* Paul G. Townsley

California Water Service Group - VP of Rates & Regulatory Matters

* Thomas F. Smegal

California Water Service Group - CFO, VP and Treasurer

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Conference Call Participants

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* David Francis Katter

Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst

* Jonathan Reeder

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Spencer Everett Joyce

Hilliard Lyons, Research Division - Analyst for Natural Gas and Water Utilities

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the California Water Service Group's First Quarter 2017 Earnings Results Announcement and Conference Call. Today's call is being recorded.

I would now like to turn the meeting over to David Healey. Please go ahead, sir.

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David B. Healey, California Water Service Group - VP, Controller and Assistant Treasurer [2]

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Thank you, Christina. Welcome everyone to the 2017 first quarter earnings results call for California Water Service Group. With me today is Martin Kropelnicki, our President and CEO; Thomas Smegal, our Vice President, Chief Financial Officer and Treasurer; and Paul Townsley, our Vice President in Regulatory Matters and Business Development.

Replay dial-in information for this call can be found in our first quarter earnings release, which was issued earlier today. The replay will be available until June 27, 2017. 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 www.calwatergroup.com\docs\2017q1slides.pdf.

Before looking at this quarter's results, we'd like to take a few moments to cover forward-looking statements. During the course of this call, the company may make certain forward-looking statements. Because these statements deal with future events, they are subject to various risk 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 and other reports filed from time to time with the Securities and Exchange Commission.

Now let's look at the first quarter 2017 results. I'm going to pass it over to Tom to begin.

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [3]

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Thanks, Dave, and good morning, everyone. I'm going to jump in on the summary of the financials for the quarter, and then Marty and Paul are going to add some comments as well. We are going through the slide deck, and I'm starting on Page 5 if you're following along on that slide deck.

Our operating revenue for the quarter was $122 million. That was up from $121.7 million in the first quarter of 2016. Our operating expenses were $114 million. That's down from $115.5 million in the first quarter of 2016. The result of those 2 things is we did have net income of $1.1 million for the quarter as opposed to a loss of $800,000 in the first quarter of 2016. And that meant that our earnings per share were $0.02 as opposed to a $0.02 loss in the first quarter of 2016.

Jumping to Page 6, the key components of this. Primarily, we had rate relief that came out of our 2015 general rate case, the decision that was granted at the end of 2016. That drove up our revenue by itself, $11.5 million. And there are some offsets to that we'll talk about in a moment. We also had a decrease of $1.8 million in our incremental drought-related costs, and we also had increases in our other income related to the implementation of allowance for equity funds used during construction or AFUDC. That and a number of other accounting issues drove up the other income to $1 million there. Our CapEx for the quarter was $51.9 million. That is lower than our CapEx for the first quarter of 2016 in part due to the wet weather that we experienced in a lot of our California service areas over the last 3-month period.

Flipping to the EPS bridge on Page 7 and the discussion on Page 8. What you can see here is that the rate relief is the major component adding to our EPS. The unbilled revenue adjustment, we've talked about this in prior quarters, particularly in the first quarter and third quarter over the years. I do want to kind of mention this. Outside of our WRAM mechanism, we do accrue revenue that has not yet been billed to customers for water usage that we know that they have had. We bill daily. And so those customers who have not yet received the bill by the end of the quarter for that stub usage that generates an unbilled revenue accrual. Because our weather was wet and our demand was down significantly, we did have a lower unbilled revenue accrual for this quarter as compared to the first quarter of 2016. So that is seasonal, and that is dependent upon customer usage. Once the time has elapsed and we did -- have billed those customers, all of that difference rolls into the WRAM mechanism. So it's a very limited effect on us. It will change from quarter to quarter.

The other negative was the depreciation. As we proudly talked about last year, we had a significant amount of CapEx that resulted in closing projects of $236.3 million. That is added to our depreciation expense as well as changes in depreciation rates associated with the general rate case decision in California.

On the positive side, the drought expense added $0.025. We are in the very trailing stages of the drought. Marty will talk about that. And so the drought expense is really minimal for this quarter in 2017 as compared to the height of the drought last year. The AFUDC issue added about $0.015, and then other items were a pretty small component.

So next, I'd like to just quickly turn it over to Marty to talk about revenue curve on Slide 9.

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [4]

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Yes. Thanks, Tom. This is actually one of my favorite slides that Tom and I use in our IR presentations because it shows the adopted revenue by month. So this information is derived right out of our general rate cases, and it rolls up. And you can drive a couple of things from looking at this graph: One, the first quarter is typically a flattish quarter for us. So we never get too excited about the first quarter. Two, the majority of our revenue is derived in the second and third quarters, in particular the July, August and September. And three, our EPS, if you overlay our historical EPS on this chart, you'd see that our EPS typically follows the same distribution curve unless there is an unusual material event within the quarter.

So we always like to show people this graph. We don't -- we never get too excited about the first quarter as we start a year even when it means coming out of a general rate case that's been put into effect, as we saw in this quarter. You'll start to see a little bit of rate relief start to trickle in, but we anticipate the majority of that rate relief will start hitting us more in the second and third quarter as we move into the peak consumption periods of our customers.

I'm going to turn over to Paul for a regulatory update. Paul?

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Paul G. Townsley, California Water Service Group - VP of Rates & Regulatory Matters [5]

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Thank you, Marty. So as Tom reported earlier, we have now implemented new rates in customer bills beginning in January of this year. It has gone quite smoothly, and that was as a result of the California Public Utility Commission decision last December approving our general rate case for years 2017, '18 and '19.

Earlier this month, we also filed with the commission an application for a new cost of capital, and we filed this application concurrently with 3 other Class A water utilities. The commission will process this and they should -- and will establish new rates effective January of 2018. In our application, our cost of capital application, we proposed a 53.4% equity capital structure and we requested a 10.75% return on equity in our application.

We are also -- and even though we just received the decision from the commission last December, we're already well into our planning for our next general rate increase. We anticipate filing that in the middle of next year, and we've had a lot of work going on throughout the company, getting ready for that.

Turning to Slide 11. There's a couple of other items, regulatory items, I would like to mention on the call today. First of all, we will be filing later this year our escalation filing with the commission for a 2018 step increase. Now in the commission that the -- in the commission's decision, they authorized us a $17.2 million step increase, but that is dependent on an earnings test calculation and that earnings test will be included in our application that we will file later this year.

And then finally, we are working on yet another application with the commission, and that is to expand our service territory to include the Travis Air Force Base. You'll remember that we looked forward earlier that we were awarded the potable water system for the Travis Air Force Base from the Department of Defense. We will own and operate that utility system for the next 50 years, and we're right now in the process of filing an application with the commission because what we are requesting is that it be treated as another service area and that our rates and the rules of service will be governed by the commission.

With that, I will turn the meeting back over to Marty Kropelnicki.

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [6]

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Great. I want to give everyone a quick update on the drought and where we are with the winter in California, in particular. Some of you heard me say the only thing predictable about California is the unpredictability of the weather. Certainly, we went from the -- a 5-year drought to the wettest year on record for the State of California. As of April 21, precipitation levels along the Northern Sierras were in excess of 200% of the annual average, and the snow accumulations are 191% average for date.

So as of April 7, the Governor declared an end to the drought emergency in 54 of the 58 counties. Four counties are still under a drought emergency. That's Fresno County, Kings County, Tulare County and Tuolumne County. So we still have 2 service areas, Selma, which -- and Visalia, which are 2 areas that we serve in the Central Valley. They will remain on a drought program. We -- as most of you know, we suspended our drought surcharges July 29 of last year.

Well, the drought is over. The state has continued scheduled to work on their long-term drought resiliency plans. And the first steps towards permanent water use regulations were released by the State Water Resources Control Board in January. That plan covers 4 kind of key areas that are important: one, using water more wisely; two, eliminating waterways, so main brakes, things like that; three, strengthening local drought resilience; and four, improving agricultural water use and water efficiency and drought planning.

So of these 4 objectives, there is really 4 that are more impactful to Cal Water going forward. One is the permanent provision on wasteful practices, so watering your lawn within 48 hours of it raining. That's kind of remaining in place, reducing leaks, so water supply items. There is language in it though that orders investor-owned utilities to accelerate works on their main programs to minimize leaks. So we feel we're in good shape on that because of the planning we did a few years ago on our main replacement program.

And then you're also going to see the use of new targets based on trying to strengthen the standard. In particular, you'll see the difference between outside use and inside use. So you'll have a target use rate per capita per home based on inside plumbing but then a separate calculation for outside irrigation. And so these things will be implemented starting in '17. Some of that will be implemented by executive order by the Governor, some of it legislatively through the state. We have been very involved with -- that's with the State Water Resources Control Board. Some of our districts in our data have been used in studies with the State Water Resources Control Board, and we'll continue to work with the State Water Resources Control Board on these evolving plans.

Also noteworthy is the federal water project that delivers water to the farmers in the Central Valley. The allocation has recently been bumped up to 100% for the farmers in the Valley, the first time since 2006 they've had a full allocation. So I think that's just indicative of the snowfall and the -- or excuse me, the rainfall and the snowpack levels that I mentioned earlier in my comments.

Financial effects from the drought?

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [7]

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Thanks, Marty. Wanted to talk briefly about the financial mechanisms that the California Commission has allowed us that mitigate the effects of the drought. First of all and most importantly for us is our decoupling mechanisms. Since 2008, Cal Water has been decoupled, meaning that sales and production cost changes are not a big impact on our income statement. We have seen during the drought that our WRAM receivable -- that's the customer receivable from lower sales actually declined during the drought period. And primarily, the reason there was drought surcharges that we were putting on folks that haven't met their drought budget. Now the drought surcharges have been gone since last July. And one of the things that we've seen in the quarter, if you are looking at Slide 14 for a second, is that our WRAM receivable balance has jumped quite a bit from the end of the year to March 31, 2017, there up to $48 million. The big reason for that is that we had about 75% of our adopted production in the quarter. The big deal there is, obviously, the weather. There is a residual conservation that's going on. And after every drought in California, you'll see residual conservation, but right now, we believe that the lower water sales were primarily because it was raining all the time both in Northern California and Southern California.

Regarding the drought expenses, you'll recall last year, we received recovery of $2.9 million for 2015 drought expenses. Because the Governor has announced an end to the drought, our plan now is to file for the 2016 and the remaining 2017 drought expenses later this year. So we will incorporate the expenses from the first quarter, which were about $200,000, and any expenses that come up here as we wrap up the drought in the second quarter. We'll put that all together into a filing with the commission, and we'll expect to file that mid-year and right now anticipate that we would be able to get that in place by the end of the year. So more to come on that as we go forward in the year.

So just keep in mind that the WRAM receivable may grow in 2017. That, obviously, has already grown in the first quarter because of the sales decline. The under-collections in 2017 will be recovered in surcharges starting in 2018. So even if we do see this receivable balance grow in the year 2017, we have a good mechanism to recover that balance starting the next year. We also have our provision in our rate case where, with the escalation increases that Paul mentioned, we'll be able to adjust the sales targets to reflect the actual recorded sales. This is called the Sales Reconciliation Mechanism. So we'll be able to lower the sales targets, raise unit rates for our customers beginning in 2018, and that will also have a mitigating impact on the WRAM receivable balance starting in 2018. So if we do see it grow throughout the year here, keep in mind that we have some good mechanisms for next year to bring that down.

And I will turn it over to Marty to talk about water quality.

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [8]

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Great. So there is a couple evolving items in water quality. And again, those of you that have seen our IR presentations in the past, this won't be any new to you. We've talked in the past about 1,2,3-TCP or Trichloropropane. So the state has come out with its draft regulations on TCP, and the maximum contaminant level is 5 parts per trillion. In the draft regulations, we don't believe this is going to change. We believe that the draft regulations will be approved probably in June or July and go into effect on the 1st of January. So we have treatment plan for 40 sites throughout our service territory throughout the state. We expect to invest about $25 million. This is included in our capital projections for 2017. Again, we've been monitoring this and factoring that into our capital planning program. And we believe we'll be in position to meet the new MCL for TCP by January 1, 2018.

In addition, there in California, new legislation requires us to do specific testing for schools for lead in the lead and copper rule from the EPA. There is a series of -- kind of requirements you do when you pick an area that you're testing for lead, how old is the neighborhood, the homes, sort of newer homes. You're typically not sampling a newer neighborhood. You're looking at kind of the pre-1950, pre-World War II homes in areas around there. So we will work on our own plan to start school testing this year. So we're basically rolling that out, which is we will go test every school in our service territory. There are 700 -- over 700 schools in the service areas that we serve. So we're aggressively going after that to offer this test to schools in the communities that we serve regardless of the age of the school. We have already filed and received approval from the California Public Utilities Commission for a memorandum account to track these accounts, and we are moving forward full steam ahead with the lead testing at schools in the State of California.

If you turn to the next page on the capital investment history and program. Tom gave us the number just under $52 million during the first quarter this year. Well, that's a little soft compared to last year. Clearly, the rain had a big impact. And I expect that we'll pick some of that steam back up here in the second quarter, but it's just been raining so much in the State of California. It's really hard to go work in a trench when it's raining so much. So we believe we're still on track for the $210 million this year, and I expect that number to move up as we move into the warmer summer month in the state. So we think we're on track with our capital program.

Looking at our regulated rate base for CWT. Again, we think we're on track. There's been no change in the slide since we issued it during our year-end conference call. So this just gives you what we anticipate the plant additions to be for '17, '18 and '19.

So going forward, what to expect in 2017? Obviously, as Paul mentioned, the ongoing proceeding in the cost of capital application. We'll continue to give you an update on that on the second and third quarter conference calls to keep everyone in the loop. As I mentioned, TCP regulation, now that the draft regulation is out, we're moving full steam ahead with getting our treatment in place and making sure that we can meet that new MCL requirement effective January 1, 2018.

And as Paul mentioned or Tom mentioned, our earnings test, we've spent a lot of time the last 5 years on our capital planning cycle, on scope, on schedule, on budget. So you may recall that involved bringing in a new VP of Engineering. We reorganized the engineering department. Tom and Paul and Dave, they've all been part of the Capital Committee that meets on an ongoing basis with Rob Kuta, our VP of Engineering. The team has done a very, very good job at speeding up our ability to get capital into the ground. And so for me personally, I'm pretty excited about going into the earnings testing here and the filing that Paul is going to be working on in the fall. Historically, we've gotten 50% or less of our earnings test. And I believe we're going to be in a situation where we grossly exceed that number going into the fall. The one thing I would add to the points that we talked about earlier about the earnings test, it does get adjusted for inflation. So while that target is out there of $17 million with the commission, there is an inflation modifier that goes along with it, so the earnings test, the inflation multiplier or adjuster and then have the amount of capital that we get into the ground. Drought expenses should be dropping off here rapidly and continue to drop off given the fact we're down to 2 cities now that will be ending their drought watch and drought program; and then the lead testing in the schools. And then as Paul alluded to, obviously, the GRC planning is a big deal, and a big part of what we'll be doing is holding our capital summit here shortly, doing the capital planning for the next 6 to 10 years for the company.

So with that, we will open it up to questions, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will take our next question from David Katter with Baird.

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David Francis Katter, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [2]

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I was hoping you could provide a little more color on the sales decline. Understanding it's going to be billed as surcharges in 2018, can you maybe comment on the -- quantify how -- your expectations there? And maybe another way, how might that be offset? Would you recover any of the drought expenses in 2017? Or is that purely going to be in 2018 as well?

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [3]

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So 2 questions there. Let me take the last one first. So our revenue recognition policy is that when we get authorization for recovery, we will book the revenue at that time. So if we -- we'll be filing an advice letter for drought expense recovery midyear once we conclude on the drought expenses. And assuming that the commission issues a resolution adopting our drought expenses as surcharge before the end of the year that will be booked as a 2017 item. If it drifts into 2018, then obviously, it's a 2018 item. So that's the first thing. The second thing is going back to the sales decline. We don't really have much a way of knowing how our customers are going to react the rest of the year. Obviously, we've seen, historically, if you look back to the drought that we had in 1975 through 1977 and the drought that we had from 1990 to 1995, there is an increase in sales that occurs after a drought that's relatively slow. It's not a snapback. If you think about 5 years of drought in California, there has been a lot of changes that people make as far as their landscaping, taking out lawns, taking out high-water-using fixtures and putting in more efficient fixtures. A lot of the behavioral changes due to a drought do slack off pretty quickly. So people who take short showers are not going to take short showers anymore now that they know that the drought is over. But those embedded changes from new washing machines, drip irrigation on their landscape, changes in landscape, those things tend to continue for some time. So it's very difficult to predict where the water sales are going to go the rest of the year. I always have to continue to monitor that. Again, with the decoupling mechanism, that doesn't affect our P&L. It does affect the balance that is a receivable balance and what we have to collect from customers in future years.

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [4]

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Yes. And I would just tack on the 76% of adopted sales that you saw in the first quarter, I'm not too concerned about that because when it's raining, people aren't using as much water. I mean, obviously, for us personally, I don't think any of us have had our sprinklers on in the front yard. And that includes rain that actually took place after this week. I was -- when I was up this morning, I had the TV on CNN and they were -- this is on national news and local news. They just cleaned up a mudslide in Northern California and they're wrapping up and a lady stuck in traffic and has her phone out. She's videotaping the workers and, "Oh, it's a nice day. And all of a sudden, the mountain starts to fall again. And you hear, "Oh, my god. Oh, my god," and you hear the rumbling. And the mudslide they just cleaned up, more of that mountain came tumbling right back down. And so that will be on the news tonight. You can look for it. So the 76% of adopted sales, that's not uncommon when you're in the wet summer months. I think last year, overall, we were about 86% of adopted sales if my memory serves right. So we'll see that kind of inch back up, I think, as we move into the summer months. But I think Tom's point, we don't expect a big snapback where people will go to 100% of where they were or 10% of where they were a year ago or 2 years ago and frankly being decoupled. That's the benefit of being decoupled. It allows us to stay focused on our conservation program, our conservation messaging without affecting our margins.

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David Francis Katter, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [5]

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Got it. That was really helpful. And then one more question on the TCP initiative. It seems like another good opportunity to deploy capital, but what's -- is there any risk that the regulation doesn't pass? And how would that kind of affect your plans? And also, how do you kind of select partners for these initiatives? I know you expected Calgon for the TCP. How do you evaluate potential partners there?

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [6]

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That's a really good question. What's hard with the regulation is once they start to move, they move fast. And as a public utility, our goal is to always be in compliance to meet and exceed water quality standards. And so this one, we -- let me start, we have a very effective water quality department and a very good lab. We do the majority of our own testing. So they're very involved in tracking things as their evolving. Once we see them start to get to a point where we believe they're going to start moving to become a new law, we start looking at what type of treatment may be necessary. We might start piloting treatments, doing a little R&D on what's the lowest cost treatment. So that's one we've been watching for about 2 years. We will evaluate vendors during that time. Typically, any project, anything over a couple of thousand dollars, frankly, we tend to put out to bid, competitive bid. On something like this, we will work with a science, technology provider to look for the lowest cost treatment alternative for our customers. So this one, because word is the draft regulation is out, we did attend the draft regulation hearing, there was a lot of support for the TCP initiative from ourselves, the public utilities, the Municipal Water Association, AWWA, et cetera. So I don't see this not slowing down. It's going to go live, and it's going to be effective January 1. The adoption of the draft, I think, will be in June or July at the latest, but it will be happening. So things are competitively bid. We tend to look at the cycles early so we can stay ahead of treatment options, and then we look for the lowest cost provider and implementation schedules that we can to make sure that were in compliance with the new regulations.

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Operator [7]

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We'll take our next question from Jonathan Reeder with Wells Fargo.

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [8]

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Just wondering has the procedural schedule been established in the cost of capital?

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Paul G. Townsley, California Water Service Group - VP of Rates & Regulatory Matters [9]

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Jonathan, this is Paul Townsley. No, it has not yet been established by the commission. So we're watching for it. We're expecting it anytime now, but we've not seen anything yet.

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [10]

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Okay. Can you kind of discuss the prospects of maybe settling the cost of capital? I know you weren't able to achieve the extension, but should we think that, that precludes the opportunity to potentially settle this? And what might the timing be around the settlement if one is achievable?

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Paul G. Townsley, California Water Service Group - VP of Rates & Regulatory Matters [11]

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Jonathan, the procedural schedule will provide for the opportunity for settlement. We've now filed our application. I'm sure that the Office of Ratepayer Advocates will provide testimony in this case along with anyone else that chooses to intervene after everyone's positions have been made clear. There -- that then provides the opportunity to sit down and discuss settlement. If settlement is not achieved, then there will be evidentiary hearings. So these types of things will be occurring later on this year, enabling the commission to make a decision by the end of the year.

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [12]

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Okay. And on that, if we just isolate the true-up on the cost of debt in your application, it looks like it could be roughly $4 billion kind of negative revenue impact or roughly $0.05. Is that accurate?

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [13]

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Say that again. So if we're just talking about the true-up on the cost of debt, that's your calculation?

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [14]

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Yes, yes. If we're just -- the lower cost of debt in this new application. I just want to make sure I'm kind of doing the math right that it looks like it may be lower -- with lower revenue, just that aspect by kind of $4 million or maybe a roughly $0.05 EPS impact?

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [15]

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Jonathan, I haven't looked at those calculations lately. I might have to get back to you on that. Obviously, we do lower the cost of debt. Our latest debt offerings that we did last October and March are lower than our average, the weighted average that was in existence before. It's also because it's an estimate for 2018 cost of capital. We have talked about our significant capital program, and we do likely have forecasted in there some new debt. And again, the new debt rates, if you kind of project out over the next 12 to 18 months, are still likely to be lower than our embedded cost of debt.

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [16]

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Okay. And then as you look at kind of financing your CapEx budget, is it something you can achieve just with debt? Or do you think equity will be needed as well?

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [17]

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So we're going to balance to the commission's adopted equity capital structure. Right now, in our view, we're leaning a little bit more on the equity side as far as where we are currently, the current snapshot. So it's likely that our next round of financing when that occurs is going to be debt financing just to keep that in balance, and we'll take it from there.

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [18]

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And I think in fairness to Tom, we don't have any plan to do any debt financing now -- right now or anytime this year, anytime soon.

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [19]

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No. And one of the things that we've talked about is that the commission last year gave us authorization to be on our line of credit for up to 2 years. And so we've currently been on the line of credit with the balance for the operating company for about 6 months. So we certainly have some runway there. We have space in terms of borrowing power on the operating company line of credit. So there's no real need to go out for debt financing in 2017, and we're really looking at 2018 at this point.

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [20]

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Okay. So finance the line of credit at that point in '18 and then possibly evaluate the structure in terms of needing for equity after 2018, I guess, the debt financing is what you're kind of thinking?

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [21]

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That's right. And then obviously, we'll get ruling from the commission at the end of the year here about what the adopted capital structure and we'll try to match to that to the extent it is possible.

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [22]

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Yes. That 2-year runway that Tom and Paul were able to achieve with the commission that gives us so much more room to maneuver. Jonathan, as you may recall, we were going out, it seems like, every year for something. So we would do a big slug of equity, and then we could follow up with a couple of years of debt. And a lot of times, we had to go to market for debt because we're going to bump into that, that 12-month rule of the commission. So having that freedom over 2 years really gives a lot more room from the planning perspective to not be running to the market all the time, which is nice. I'd rather have our resources focused on getting the capital on the ground and on the rate case planning, the long-term capital planning than going to the market all the time and -- because there's a cost of doing that and there -- it takes up a lot of Tom's time and Dave's time and the cost of the auditors and cost of the attorneys, and it gets pretty expensive. So having that extra -- that 2-year window is a big plus for us.

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [23]

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Yes, it makes sense. And then you can see kind of the outcome of this proceeding then factor that into the plans as well. And one thing I did notice, all the other 3 utilities filed for increases in their proved equity ratios. Do you expect kind of the capital structure will get more scrutiny in this proceeding? Given those requests, I know you guys aren't asking for any change in your current capital structure.

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [24]

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That's a difficult one. I've been through a couple of these, and it does come up. But I think the most contentious one was 2 cycles ago, where there was a proposal for a flat, 50-50 debt equity structure. I don't remember it. I think we did settle the last case, 2011 case. So we'll see what ORA, DRA wants to emphasize and what the other interveners want to emphasize.

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [25]

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Okay. And then just on the capital planning process, has there been any feedback from the CPUC or other influential parties that would materially kind of alter the level of spend that you see being needed going forward? I know you had a nice bump up in the CapEx in the last rate case and you feel there is room to accelerate beyond that. But then also, in addition, how do you, I guess, balance the capital needs with affordability issues? Are you already kind of bumping up against those pressures?

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [26]

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Affordability is always a problem that you bump into. But as we've done our rate case planning and as we looked at kind of the average household budget, the smallest part of the utility budget has continued to be and we don't see it changing in water. Water is significantly less than a cell phone bill, than the cable bill, the power bill and, a lot of cases, even the garbage bill. So I think it's more important to look at what's the long-term structure that the state is driving towards. That's why I want to mention the Executive Order B-37-16, which is the -- making water conservation in California a way of life, specifically calling out the idea of eliminating water waste. If you look at our main replacement program, we've ramped this up a couple of steps ahead of the state. So our timing was pretty good. So given where we are, the state doesn't have enough supply. I mean, the drought may be over in the short term, but the need for a long-term supply and long-term supply planning is going to be critical. I think that's going to remain on the Governor's radar screen, and you'll continue to see capital needs being driven by the long-term planning, water quality, things like that.

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Paul G. Townsley, California Water Service Group - VP of Rates & Regulatory Matters [27]

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And Jonathan, this is Paul Townsley. Cal Water has long been a leader in affordability issues and working to address those. We've had our Low-Income Rate Assistance program in place for a long time. We've had our Rate Support Fund in place for a number of years. We have -- in the last case, you may have seen we proposed consolidating some of our smaller high-cost districts in with some of our larger lower-cost districts. So as Marty said, affordability is always at the front of our mind, but at the same time, continuing to invest in making the system reliable and safe for customers is also critical. So as we put together our rate case, we're really looking at both of those elements and seeing how we can achieve prudent investments but at the same time working to address concerns from customers on water rates.

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [28]

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Okay. And then one last one. Any update on kind of M&A opportunities not just within your existing states but also in new states, Marty?

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [29]

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Well, it's funny you mentioned M&A. So with Stan Ferarro retired, Paul Townsley took over the M&A team. And we've been busy with the Travis Air Force Base. We have retooled the team a little bit and kind of tightened up our M&A planning. So again, we're always out there looking. As you know, Jonathan, what's always hard is once you start paying about 2x rate base, you'll get to a diluted transaction pretty quick. And so we're -- we continue to be out there looking. We continue to participate when there are sales [that they've got], but really, I think where most the opportunities lie are probably rolling up smaller systems that may not be in other people's radar screens in other states. California gets a lot of attention, but we've been successful in Hawaii. We did a roll-up in '08 And we have those companies all profitable now. Washington is a big state with some room there. So Paul is a busy guy. I don't know, Paul, if you have any comments, but I know you've been spending a lot of time on looking at things and retooling the team and looking at our strategy behind M&A.

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Paul G. Townsley, California Water Service Group - VP of Rates & Regulatory Matters [30]

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Yes. Thanks, Marty. Clearly, we can't talk about anything that we are looking at, but we do have a very sharp focus in this area, and we're bringing some internal resources onto the team so that we can look at both the tuck-in opportunities that Marty mentioned -- and there are a lot of them in our different states as well as some of the larger acquisition opportunities. So just stand by on that, more to come.

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Jonathan Reeder, Wells Fargo Securities, LLC, Research Division - Associate Analyst [31]

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Okay. And then is it fair to say you're also still evaluating more military base opportunities?

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Paul G. Townsley, California Water Service Group - VP of Rates & Regulatory Matters [32]

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Yes. It is fair to say that we're actively engaged in that sector as well.

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Operator [33]

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We'll take our next question from Spencer Joyce with Hilliard Lyons.

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Spencer Everett Joyce, Hilliard Lyons, Research Division - Analyst for Natural Gas and Water Utilities [34]

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Just really one quick one from me and actually kind of flows in line with Jonathan's final thoughts there. Rightly so, California and kind of the drought specifically has kind of dominated the conversation over the past several years. And Marty, I was just wondering if you could kind of give us a state of affairs maybe with some of your other states, be it Washington or New Mexico or Hawaii. And then as kind of a follow-up to that, I'm sure those states have seen what has transpired in California this year, and I'm sure they've seen the Flint crisis and some of the other issues back East here. Are there any legislative initiatives in those ancillary states for you guys that may change the way you all do business there over kind of the next few years?

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [35]

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Good question. Paul and I do spend a fair amount of time meeting with the regulators in other states. California gets -- has the biggest chunk of our time, but we are meeting with regulators 2 to 3, sometimes 4 times a year. The concept of the drought that you had -- the kind of the whole West Coast, including the parts of Washington, were in a drought. Likewise, they've gotten clobbered this year with a ton of rain. That continues. In Hawaii and the many meetings Paul and I have had with the commission in Hawaii, they've been very interested in what have been the long-term policies in California around drought planning. Hawaii continues to grow, frankly, and it's an island. So there's not an unlimited source of supply in Hawaii. So we've been talking more about conservation programs in Hawaii. And not that there are actionable items yet in Hawaii, but I think the commission is actively listening. In Washington, we have a great relationship with the regulators. They've said, "Hey, why don't you guys come pick up some of the small systems so we don't have to deal with them?" Well, that's a great concept. It's easier said than done. Being a publicly traded, investor-owned utility, public utility, we're always concerned about compliance. There is no amnesty period for compliance when you pick up an underperforming system. And in New Mexico, we did pick up a couple of small systems there last year. We're always careful in New Mexico as well for compliance issues. So it's an active dialogue. I think all eyes have been on California, and I think the Governor has, frankly, done a really good job at managing through the drought. But I think all eyes will continue to be on California because simply, while the drought may be over in the short term, it's not over in the long term. And with the state with 40 million people and ag crops, that, I believe, will exceed $56 billion this year. Our long-term water supply plan is going to stay at the front and center. It has to because we don't have enough supply and storage. There are supply alternatives, but they're not to the point where those are harvested yet, whether it be desal or wastewater recycling. So continue to watch the policies in California, I think, especially on wastewater recycling, and I think you'll see that they will continue to lead the U.S. in terms of how they deal with long-term supply planning and I think -- then you'll some of the other states follow, especially as they are more water-constrained. Probably, Hawaii will be right behind California and followed Washington. I don't know, Paul, if you have any thoughts on that.

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Paul G. Townsley, California Water Service Group - VP of Rates & Regulatory Matters [36]

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No. I think it's -- we are very well regarded in all of the states that we operate in by the regulators and key officials in the state. So we continue to talk with them. So we -- and we will continue to do that. But as Marty said, when you have a state the size of California, that's really where our focus is because there is so much opportunity here.

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Spencer Everett Joyce, Hilliard Lyons, Research Division - Analyst for Natural Gas and Water Utilities [37]

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Very helpful on that front. I thought the quarter was pretty clean. So that's all I had for you.

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Operator [38]

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And it appears there are no further questions at this time.

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Thomas F. Smegal, California Water Service Group - CFO, VP and Treasurer [39]

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Okay. Well, thanks, everyone, for your interest in California Water Service Group. We look forward to talking with you at the end of July with our second quarter results. And I did want to mention that we do plan to file our 10-Q later today so you can -- if you really want to delve into the details, they're all there. And anyway, we appreciate the interest. Have a good day.

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Martin A. Kropelnicki, California Water Service Group - CEO, President and Director [40]

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Thanks, everyone. Bye-bye.

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Operator [41]

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And this concludes today's call. Thank you for your participation. You may now disconnect.