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Edited Transcript of CWT earnings conference call or presentation 31-Oct-19 3:00pm GMT

Q3 2019 California Water Service Group Earnings Call

SAN JOSE Nov 13, 2019 (Thomson StreetEvents) -- Edited Transcript of California Water Service Group earnings conference call or presentation Thursday, October 31, 2019 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, Corporate Controller, Assistant Treasurer & Principal Accounting Officer

* Martin A. Kropelnicki

California Water Service Group - President, CEO & Director

* Paul G. Townsley

California Water Service Group - VP of Corporate Development & Chief Regulatory Matters Officer

* Thomas F. Smegal

California Water Service Group - VP, CFO & Treasurer

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Conference Call Participants

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* Hasan Doza

Luminus Management, LLC - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the California Water Service Group Third Quarter Earnings Result. (Operator Instructions). Please be advised that today’s conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Mr. David Healey, Vice President and Corporate Controller. Please go ahead, sir.

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David B. Healey, California Water Service Group - VP, Corporate Controller, Assistant Treasurer & Principal Accounting Officer [2]

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Thank you, Shantal. Welcome everyone to the 2019 third quarter earnings call for California Water Service Group. With me today is Marty Kropelnicki, our President and CEO; Tom Smegal, our Vice President, Chief Financial Officer; and Paul Townsley, our Vice President of Business Development and Chief Regulatory Officer.

Replay dial-in information for this call can be found in our third quarter earnings release, which was issued earlier today. The replay will be available until December 31, 2019. 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.

Before looking at this quarter's 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 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, 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.

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

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Thanks, Dave. Good morning, everyone, and happy Halloween. I'm going to go quickly over our financial results starting on Page 6 of the slide deck. And there, I'd like to point first to net income. And the net income was up to $42.4 million. That's up 17% from the third quarter of 2018. Our earnings per share were $0.88. That's up $0.13 from the third quarter of 2018, which was $0.75, a 17% increase in EPS. Our capital investments were down slightly at $73 million for the quarter as compared to $79 million for the same quarter last year.

On a year-to-date basis, if you go to Slide 7, our net income rose slightly to $51.8 million, a 3.1% increase from the net income in the year-to-date period of 2018. Our earnings per share is $1.08. That's up again slightly from $1.04 in 2018 same period. Our capital investments for the year-to-date period are also down, $194.9 million as compared to $212.9 million in the year-to-date period through -- for 2018.

So flipping to Slide 8 for a general sense of what happened during the quarter. So the net income increase of $6.2 million is largely attributable to 3 to 4 factors here. The primary big driver here is our unbilled revenue accrual was $5.5 million higher than in the third quarter of 2018. That represents really a bounce back from the lower unbilled revenue accrual that we had in the first 2 quarters of the year. And you'll recall on our first quarter earnings call, we had a pretty major reduction in that quarter in unbilled revenue. It didn't come back in the second quarter. Now it seems to have come back.

So that's what we're seeing here in the third quarter.

The core components of our CapEx. If you look at our rate increases of $6.1 million. Operating expense increases, including depreciation, wages and property taxes kind of offset that rate increase a bit. Embedded in the paragraph -- second paragraph on Slide 8, we spent about $800,000 on preparation for the electric utilities' Public Safety Power Shutoff programs and other wild fire mitigation efforts. We'll be talking about that a little bit more in detail later in the deck.

We had a reduced amount of business development expenses of $1.3 million. That was -- obviously, in 2018, we were going through a business development process. And finally, we had an increase in our AFUDC of $0.8 million during 2019 third quarter.

I will skip over the Slide 9 and 10, which are the earnings bridges. You can look at them at your leisure. And I will turn it over to Paul Townsley to give us an update on the 2018 California General Rate Case.

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Paul G. Townsley, California Water Service Group - VP of Corporate Development & Chief Regulatory Matters Officer [4]

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Thank you, Tom. Good morning, everybody. In July 2 of last year, 2018, we filed our triennial California General Rate Case with the California Public Utilities Commission. And in that case, we requested $828.5 million of new capital investments over the prospective 3-year period, 2019 through 2021.

Earlier this month, on October 8, we filed a settlement agreement with the California Public Utilities Commission. The settlement agreement was one that we had reached with the California Public Utility -- Public Advocates Office, formerly known as the Office of Ratepayer Advocates. And the settlement agreement covered the majority of the issues that were in play in the rate case.

Included in the settlement agreement was $609 million of new capital improvement over that 3-year period, 2019 through 2021, and approximately $200 million of authorized capital improvements that were initiated in 2018 and prior years. There were a few items that we did not reach settlement on and these are items that are being requested of the Commission to make a determination on. You can see those on Slide 11. They include the WRAM and the sales reconciliation mechanism, some of our balancing accounts for pension and medical costs, depreciation rates, working capital, AFUDC and AMI, or advanced metering.

The settlement agreement and the disputed items will be decided by the commission. Our anticipation is that, that will be decided by the commission in December and that new rates will go into effect effective January 1 of 2020. Thank you.

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Martin A. Kropelnicki, California Water Service Group - President, CEO & Director [5]

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All right. Good morning, everyone. It's Marty here. I'm going to talk briefly about our capital program. Two accomplishments I want to cover with you -- or 2 things I want to accomplish today talking to you. One, give you an update on our spending year-to-date, which is down slightly. We're about -- just shy about $195 million year-to-date. That's a decrease of about 8.5%.

That's primarily driven by, one, the General Rate Case. As Paul said, we have settled the capital components of the General Rate Case.

The step up from the last rate case to the current rate case is about a 30% increase in capital spending, which is very significant. This is the highest percent of ask we've ever received in a rate case. And you don't get those results without significant support from engineering. And in the process, during the year we used a lot of engineering hours that would normally be dedicated to getting the capital on the ground. They were diverted to getting the capital secured in the rate case.

So that clearly has affected our capital investment this year.

In addition, we've been dealing with Public Safety Power Shutdowns and wildfires. The PSPS program I'll talk about and the Wildfire program I'll talk about in just a minute. But clearly, those 2 things have slowed down our capital spending for the year.

We now estimate that our 2019 capital spending levels will be between $250 million and $260 million for the year, with higher capital spending in 2020 and 2021, again, following the increase that we have in the rate case.

So while I would have liked to have gotten a little more capital on the ground this year, under the circumstances of the rate case and the exhaustive effort that the engineering team had to go through to prove out the capital needs of the company and dealing with this PSPS mess that we have in the state of California, I think it's understandable why we're a little short of our capital targets this year and we plan on making those up next year.

In addition, the company filed a registration statement this morning with the Securities and Exchange Commission for a $300 million common stock offering to be at the market or ATM program. And Tom, why don't you take us through the ATM program?

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Thomas F. Smegal, California Water Service Group - VP, CFO & Treasurer [6]

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Thanks, Marty. So this morning the company signed an equity distribution agreement and filed that registration statement. As Paul mentioned, we have identified more than $806 million of capital improvements that are covered by the proposed partial rate case settlement in California, plus the capital that we'll be completing in other states. And so this really gives us a need for capital to fund those additional improvements.

We do plan to maintain a balanced equity structure that's consistent with our regulatory authorizations. And we've chosen this market equity approach because we believe it's a long-term spending plan. It's not one big chunk of money that we're going to spend all at once. And therefore, we like to be issuing equity over the course of the 3-year period in an effort to match that up reasonably well with the capital spending.

And in addition to that -- you can see the difference between $806 million and $300 million. Obviously, we will be using our retained earnings and other funds to finance the capital. And we do expect that we will probably issue debt from time to time to balance that capital structure and continue financing those CapEx programs.

I'm going to turn it back to Marty to talk about wildfires.

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Martin A. Kropelnicki, California Water Service Group - President, CEO & Director [7]

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Thanks, Tom. It hasn't been the best year -- or the best week, excuse me, in the Golden State, the last 7 to 10 days, as we've dealt with multiple power shutdowns and then as wildfire season has kicked in. I'm going to talk about the PSPS program first and then I'll give you an update on the wildfires in the state of California.

We had -- in the last 10 days, we've had multiple outages across our service territory. Specifically, we had up to 62 of our locations without power. One of the largest being the San Francisco Peninsula area. We have approximately 75,000 meters, which serves about a 250,000 people that were without power for a number of days.

Having said that, I'm very pleased to report that the company is planning around the PSPS program. And our approach to emergency response has executed flawlessly. Despite the multiple outages throughout the state, none of our systems lost power -- or, excuse me, lost pressure or went dry. We had adequate backup generation to fire up all of our locations and none of our customers went without water.

We've spent about $1.1 million total between the 2 programs, the PSPS program and the Wildfire program. The details are in your slides there. And we anticipate spending approximately $2 million in total expenditures for the rest of -- for total of 2019, with the bulk of it remained associated with the PSPS program.

It's been a really, really rough week from a power supply standpoint in the state of California. I think if you watched the national news programs or if you read it in the local newspaper, The Wall Street Journal, it's really been a big issue in the state of California.

As Gavin Newsom has said, it's unacceptable. It's been very disruptive at multiple levels. Having been born and raised in California and lived through the Loma Prieta earthquake and a whole bunch of other disasters, this is about as worse that I've seen it. And when you lose power, a lot of things don't happen.

Again, we're very happy and very proud of our employees that kept all of our systems pressurized and working. But that has been at a substantial cost, a lot of overtime running generation -- backup generation, our fuel cost associated with that, [et cetera]. So I think we'll see more of the effect of that as we close out the quarter. We will seek regulatory recovery of our cost for the PSPS program and for the Wildfire program later on in the year and into next year.

Taking a moment to talk about the wildfires. So 2 events happened kind of concurrently here: these massive outages; at the same time, we kind of went full steam into fire season. There are a total of 4 major fires that we've been following in the state of California. There is the Easy fire, which erupted yesterday in Simi Valley near the Reagan Presidential Library, which is right next door to our Thousand Oaks, Westlake system.

That was the same -- close to the same area that was hit by a wildfire last year. That was so devastating. That fires burned almost 1,700 acres. It's 5% contained as of this morning. The real issue down there are the red flag warnings and the fact that you have the eastern winds. And at one point, the east winds, which are the east winds, they blow eastward -- east to west, and they're very dry, warm winds.

At one point, someone there has clocked east winds at almost 100 miles an hour yesterday morning and yesterday afternoon.

The Getty Fire, which erupted right around the Getty Museum off Highway 101, not a real big fire, but it's a heavily populated area. 745 acres that burned, 27% contained. Again, the same red flag warnings in Southern California.

The big fire we've been dealing with in Northern California is the Kincade fire, which is up in Sonoma County. If you recall, Sonoma County got hit really hard last year during wildfire season with the Mendocino Complex Fire and the year before that the Santa Rosa fires.

That's almost an 80,000 acre fire. It's 45% contained as of this morning. And believe it or not, we went from record heat last week to now we have freeze warnings taking place in the same area. So big swings in weather temperature, in weather conditions.

Around the Sonoma area, we had 185,000 people displaced, who were evacuated. We have a handful of small systems up in that area, which usually it's not a problem. With the evacuations, a lot of people went to the beach and it's -- Dillon Beach is one of our systems. And so keeping that small system going when you have thousands of evacuees showing that are camping on the beach has been a bit of a challenge. But again, that system has stayed in operation and has stayed pressurized.

As of this morning, there is another fire in San Bernardino County called the Hillside fire. It just started off. Again, small, about 300 acres, 15% contained. But those east winds are what's really damaging down in the south.

Governor Newsom declared a state of emergency in the state of California. In one 24-hour period, we had approximately 334 wildfires flare up in the state. So it's been just a really busy time for firefighters and water providers to make sure that the systems stay pressurized.

So it looks like weather conditions are going to level out this week, which is good, and give everyone a chance to get their arms around these fires. We still have approximately 45 days of fire season left, and we will see how that goes. But again, for -- all the systems owned by Cal Water, our systems have all stayed pressurized and we have provided water services to our customers and anyone in the fire zones.

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Thomas F. Smegal, California Water Service Group - VP, CFO & Treasurer [8]

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And Marty, let's let Paul talk about the perfluorinated compounds.

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Martin A. Kropelnicki, California Water Service Group - President, CEO & Director [9]

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Okay.

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Thomas F. Smegal, California Water Service Group - VP, CFO & Treasurer [10]

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Yes.

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Paul G. Townsley, California Water Service Group - VP of Corporate Development & Chief Regulatory Matters Officer [11]

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Yes. Thank you. So Slide 15 is on our perfluorinated compounds. We call these PFOS and PFOA. These are among the contaminants that have received significant regulatory attention and media attention this year. The EPA -- U.S. EPAs required utilities to sample and test for these chemicals between 2013 and 2015. But what's happened is that the detection levels of the analysis have improved in recent times and the EPA is actually going to require more testing in the coming years.

California has -- often, as is the case, leads the effort and has added additional testing in 2019 in some areas as well. California has set notification levels of between 5.1 and 6.5 parts per trillion, very low levels. This is not an enforceable water quality standard, but complying with the regulation requires notifying customers about the presence of the chemicals.

Of the almost 1,000 wells that the company has throughout California, about 30 of these wells -- so a very small percent -- have tested above the notification level and we are notifying customers. We are very much involved in tracking the regulation. And as these regulations evolve, we anticipate that we'll be able to construct and operate treatment systems to remove the chemical and reduce the chemical to be in compliance with any future maximum contaminant level requirements.

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Thomas F. Smegal, California Water Service Group - VP, CFO & Treasurer [12]

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Thanks, Paul. I'll give a quick update on our decoupling balancing accounts. That's Slide 16 and 17. The WRAM receivable balance net is up to $62.6 million. That's up from $56.1 million at the year-end of 2018. And that's really been driven by our lower sales this year. Our sales are about 84% of adopted in the third quarter and they were in the 80s year-to-date before that.

So we're seeing definitely lower water sales in California, at least in our systems this year in 2019. We do have that SRM, sales reconciliation mechanism, that allowed us to adjust our adopted sales at the beginning of the year. That has helped somewhat. And if we hadn't had the SRM, we believe that our balance in the WRAM/MCBA would have been about $11 million higher at the present time. And so it's good to have that regulatory mechanism working for us.

And next, I'm going to flip to Slide 18, which is our CapEx history and projection. So Slide 18 and 19 have been updated now for the California partial rate case settlement. As Paul mentioned, that rate case settlement is subject to the approval of the CPUC. And there are a couple of outstanding issues related to capital that are fairly minor in terms of the total capital that would be allowed, but nevertheless provides a little bit of uncertainty here.

So for Slide 18, our CapEx projection. We're now, as Marty said, projecting between $250 million and $260 million in 2019. We expect that to rise to about $275 million in 2020 and $285 million in 2021. And that, if you add it together, totals up to about $810 million, which is approximately what we have in the rate case settlement. So that could go up if we get some of the disputed issues and if other things move around.

If you flip to Slide 19. This shows the effect of the CapEx and the projected rate base settlement on the rate base of the total company. And the box that I've added on this chart from the last few times that you've seen this shows the range of outcomes that we see. The top line for 2020 through 2022 represents the base settlement, plus our rate base that we have in another states or project in other states. So that's kind of the low-end.

The disputed items are on the second line. Those include 4 wellhead treatment plants as well as the AFUDC element of the rate case that are in there, as well as the potential changes due to the depreciation rates that are being disputed.

The third line represents the advice letters that are included in the settlement. We believe those advice letters will not be effective in rates until 2021, although we could be authorized to file those advice letters as soon as the middle of 2020. We just don't believe that the projects that are identified there will be complete and in service and able to process those advice letters for effective rates until 2021.

And so finally, the fourth line there represents the potentially allowable rate base if we were to win on the disputed issues as well as get the advice letters filed and in service.

So what you can see is this is very consistent with what we were describing prior to the rate case settlement, that we do anticipate a pretty large increase in the company's regulated rate base. We talked about this a couple of quarters ago, but just to refresh, obviously the company's capital program from 2014 onward has been a big driver of our rate base. However, up until the latest federal tax law, we were taking advantage of bonus depreciation and accelerated depreciation that was limiting the growth of our rate base. That has shrunk considerably under the new Tax Cuts and Jobs Act. And so what we're seeing is the effect of -- combined effect of increased CapEx as well as decreases in the tax deferrals associated with those items, resulting in a pretty big change in the trajectory of our rate base.

So that's something that we talked about, it's something that is coming forward, and we believe that, that will be in place when the rate case gets adopted.

And Marty, I'm going to turn this over to you for wrap up.

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Martin A. Kropelnicki, California Water Service Group - President, CEO & Director [13]

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Sure. So obviously, our focus between now and the end of the year is getting the General Rate Case closed up, buttoned up, and the items of dispute hopefully resolved before the end of the year. As Tom mentioned, we've been busy getting this ATM program put in place and getting it off the ground, and that's been filed. And as I mentioned, wildfire season is well under way and dealing with these PSPS, Public Safety Power Shutdowns, and making sure that we minimize the disruption to our customers.

So kind of 3 focal points going into the end of the year. That's what we're going to focus on. And with that, we will open it up for questions, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question will come from the line of Hasan Doza with WAM.

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Hasan Doza, Luminus Management, LLC - Analyst [2]

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I have a few questions if you don't mind. The first one is for Tom or Paul. I got the color on your settlement, very helpful. And just curious. What kind of additional details can you give in terms of the revenue requirement that you agreed to in the base settlement relative to your -- for example, the $50 million revenue requirement ask in year 1?

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

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Sure. Hasan, we've not been able to publish that yet because of the disputed issues. But let me give you a little bit of color if I can. Remember that the rate case was filed back in July of 2018, and since then, we've received rate increase for -- the step rates or the escalation rate increase for 2019. That was about $16 million. We've received additional water offsets which were contemplated in the case. So in total we kind of already received about $20 million of the $50 million that we asked for.

So there have been several other adjustments that were made through the course of the settlement process. And so we would anticipate that -- the big disputed issue is the depreciation. That's going to have a big swing on the revenue requirement. But we would anticipate a significantly smaller general rate increase than the $50 million that was proposed there.

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Hasan Doza, Luminus Management, LLC - Analyst [4]

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Okay. That's helpful. And the second for you, Tom. Coming to the WRAM balance, the WRAM receivables. My question is from an accounting rule perspective, how many months do you have -- please remind me -- do you have to collect these receivables?

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Thomas F. Smegal, California Water Service Group - VP, CFO & Treasurer [5]

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So there's an accounting rule which allows for us to treat this as a current asset and liability as long as it's recoverable within 24 months from the date that it was incurred. And if you look through our 10-Qs and 10-K, you will find description there, where we are deferring a small amount for those balances which we don't believe are recoverable within that period.

Those have to do with balances that exceeded 10% of the operating district's revenue requirement. And there are special rules at the commission to deal with that. And those end up being longer amortization periods. And so the calculations done there, we have a deferral of revenue that's built into all of our operating model. And you'll see that in every Q and in the K.

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Hasan Doza, Luminus Management, LLC - Analyst [6]

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Yes, I had noticed it, but just wanted to make sure I understand. And just for argument sake, let's just say you're not able to collect any of the receivables or a big chunk of the receivables -- again, argument sake -- within that 24-month period. Let's just say out your $60 million or so, you are not able to collect, say, $30 million within that 24-month period. From a pure accounting rule point of view, would you have to then reverse the revenue entry in your books if you're not able to collect it within that 24-month period?

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

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I got David Healey here. But -- Dave, you want to take a crack at that?

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David B. Healey, California Water Service Group - VP, Corporate Controller, Assistant Treasurer & Principal Accounting Officer [8]

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Yes. So this is -- when we are unable to collect the receivable, we reapply for collection and we reset the period for the collection of that amount. So there's more certainty of collection once the commission allows you to bill the remaining amounts. And typically, the remaining amounts are small or minor. Does that help you?

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Hasan Doza, Luminus Management, LLC - Analyst [9]

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Not quite what I'm looking for. Just very simply, just trying to understand the accounting rules. And I'm happy to follow up after this call. But my question really is, Dave or Tom, is -- let's just pick a number, $10 million, $20 million, whatever the amount is of the $60 million that's currently outstanding or receivable. For argument sake, let's just pick $20 million that's not collected within the 12-month period, argument sake. Do you then -- from a pure accounting requirement in your income statement, do you then have to write off or write down that $20 million in revenues. That's my question.

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Thomas F. Smegal, California Water Service Group - VP, CFO & Treasurer [10]

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Hasan, we understand the question. I think what you're missing is that when we defer the revenue, we're also deferring a cost associated. So when you see the $30 million and you imagine that we have a scenario where that's not collectible within 24 months, there's a cost component associated with that, that according to the accounting rules we're booking that. And so it's a really much smaller impact if that hypothetical were to be adopted.

But I think we have to go to the next question and let's take this offline and we can have a conversation about it if you still need more detail.

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Operator [11]

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(Operator Instructions) I am showing no further questions at this time. Do you have any closing remarks?

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Thomas F. Smegal, California Water Service Group - VP, CFO & Treasurer [12]

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No. I just want to thank everybody for their interest in the company, and we look forward to talking to you at the year-end earnings call. Thanks, everybody.

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Operator [13]

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