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Edited Transcript of CWT earnings conference call or presentation 26-Jul-18 3:00pm GMT

Q2 2018 California Water Service Group Earnings Call

SAN JOSE Jul 31, 2018 (Thomson StreetEvents) -- Edited Transcript of California Water Service Group earnings conference call or presentation Thursday, July 26, 2018 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

* Thomas F. Smegal

California Water Service Group - VP, CFO & Treasurer

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Conference Call Participants

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* David Francis Katter

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

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the California Water Service Group's Second Quarter 2018 Earnings Results Announcement and Teleconference. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to David Healy, Vice President and Corporate Controller. Sir, you may begin.

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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, Shannon. Welcome, everyone, to the 2018 second quarter earnings call -- results call -- earnings results call for California Water Service Group. With me today is Martin Kropelnicki, our President and CEO; and Thomas Smegal, our Vice President and Chief Financial Officer. Replay, dial-in information for this call can be found in our year-end earnings release and our quarter -- or our quarterly earnings release, which was issued earlier today. The replay will be available until September 25, 2018.

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 available at the company's website at www.calwatergroup.com.

Before looking at the 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 Marty to begin.

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Martin A. Kropelnicki, California Water Service Group - President, CEO & Director [3]

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Thank you, everyone, good morning. You have the deck. I'm going to start off just briefly talking about page 6 to reaffirm our commitment to the San Jose Water offer that we put forth on March 14 of this year. First and foremost, we're confident in the superior value that our offer sets forth for all SJW stockholders. One of the things that has changed, since our last meeting is on June 7th of 2018 of this year, we launched a tender offer for SJW shares. A couple of things to point out, first and foremost, we cannot compete -- complete the tender offer without CPUC approval and we need SJW's cooperation in order to do that. The second thing is, we had to extend the tender offer deadline to September 26 in light of San Jose Water's unwillingness to cooperate with us in the regulatory process and in their delay in calling the special meeting to vote on the Connecticut Water deal. Having said that, we've had positive feedback on our tender offer. We haven't seen a significant number of shares. I mean, shares are coming in, but we haven't seen a significant number of shares coming in yet, that's because in reality shareholders will typically tender in the final days of an offer once regulatory clearances have been made and we are otherwise ready to close.

Having said that, we remain very confident in this commonsense combination and believe it will create significant value for both the Cal Water and the San Jose Water stockholders and we will move forward with our tender offer as planned.

And with that, I am going to turn over to Tom to give us the update on the financial results for the quarter.

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Thomas F. Smegal, California Water Service Group - VP, CFO & Treasurer [4]

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Thanks, Marty. So just to go over our second quarter results in brief on Slide 7, the table of the results. Our operating revenue was up, it's $172.6 million, up from $171.1 million. However, net income is down in the quarter it's $13 million, in the same quarter last year, $18.5 million.

Our earnings per share $0.27 for the current quarter and $0.39 in the comparable quarter last year. Our capital investments are up, we'll talk about that in a little bit to $63.3 million in the quarter.

Flipping to Slide 8, for year-to-date. Again, operating revenue is up, $304 million -- $304.9 million as compared to $293.2 million in the year-to-date period last year. Net income, however, is down, it's $10.5 million on a year-to-date basis compared to $19.7 million on a year-to-date basis in 2017. And similarly earnings per share also down $0.22 in the year-to-date period this year as compared to $0.41 in the year-to-date period in 2017.

So flipping to Slide 9, our financial highlights. The major factors involved in our second quarter earnings decrease, business development costs of $3.6 million, primarily the focus on the SJW offer and all the things surrounding that, that is the bulk of the business development costs for the quarter. We did see a decrease in revenue for the quarter from the California cost of capital decision, if you recall, we discussed that on the last call, $1.7 million of reduction to revenue there. We also had changes in our expenses for the quarter that are pretty typical of our industry and what you would expect to see from us increases in depreciation and amortization due to more capital investment over the years, increase in wages, increase in maintenance costs and increase in interest expense, which is also related to the CapEx. Those are offset partially by $4.5 million of revenue from general rate increases. If you recall at the beginning of the year we did receive a step rate increase, the second year of our California General Rate Case.

Other factors, which we consider outside our immediate control include a $2.5 million reduction in our unbilled revenue. $600,000 reduction in our unrealized income from our benefit plan investments. And that was offset by $1.1 million of benefit in the company-owned life insurance proceeds. Those results may not be indicative of results that you'll see in other quarters this year. And as I mentioned, the CapEx year-to-date, we have $133.9 million of CapEx and that's an increase of 23.2% compared to 2017. We still anticipate our capital investment to be between $200 million and $220 million for the entire year of 2018. And just as a reminder, that is going to be down a little bit from what we did last year probably because we front-loaded the spending in the 2015 General Rate Case authorization for California, so we had a lot of capital spending in both 2016 and 2017. So I have covered the changes to net income. I'm going to skip the bar charts that are there on 10, 11 and 12 and jump right into the rate case. And Marty, take it away.

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

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Great. I'm going to take a few minutes here to go through the next couple of slides to update everyone on what's happening on the rate case front within the 4 states that we operate in. Really the big news for the quarter was that we filed our 2000 rate -- 2018 General Rate Case for our California utility on schedule on July 2, requesting approximately $829 million in capital for the period covered 2019 through 2021. This represents approximately a 20% increase in the capital request that we had in the 2015 General Rate Case. And the breakout of the capital request was approximately 45% is related to our main replacement program, pumps, wells and treatment represent about 17% and other routine replacements for our infrastructure, which includes the 6,000 miles of mains that we operate within the state, approximately 17%.

With the main replacement program being the largest piece, one of the things we've requested in this rate case is that we step up or increase the amount of main replacement each year and going from a 200-year main replacement cycle down to approximately 120-year main replacement cycle with 6,000 miles of main, we have a lot of main to replace and we want to continue to step up that program to get to where we're meeting the AWWA standards.

In addition, this rate increase would take effect, if everything stays to schedule, on January 1, 2020, from a typical customer standpoint, the average increase with this rate case is approximately 7%, but it does vary significantly district by district. This covers a number of districts. In each of the districts in the State of California, we establish rate tariffs specifically for those districts. So you get a high degree of variability. So we did something new in the update here.

We talk about it from a dollar basis. So for a typical customer in the California service area, 90% of our customers would have a $6 a month or less increase on their bill beginning in 2020. It's also noteworthy that 75% to 80% of the cost driving the General Rate Case really are capital related as we continue to try to hold corporate overheads and noncapital-related costs flat as we ramp up our capital programs. So the General Rate Case is off and we are on schedule, and moving into the part now waiting for the ORA or the advocate to start their review.

A couple other details on the next page I want to point out, under the GRC details. The proposed revenue increases associated with this capital request of $829 million, it would be a step up of $50.7 million in revenue in 2020, with a potential step increases. And again, these are subject to inflation multipliers as well as an earnings test and that being our ability to complete our capital on time of $31.5 million in 2021 and $33 million in 2022. In addition, included in the rate case, we requested 9-year amortization of a $108 million change in deferred income taxes generated by tax reform. So the offset to that, as you eliminate this deferred tax as it comes down your increase in rate base so you'll see a corresponding rate base. And you'll see Tom talk about that as we talk about rate base later on the slides. In addition, we request a 100% sales reconciliation mechanism, as Tom will cover a little bit later, we've been actually very pleased with how our RAM and how our sales mechanisms, de-couple mechanisms have been perform at a -- continue to go down. That's really driven by the usefulness of the sales reconciliation mechanism, so we've requested to continue that. In addition, we are proposing that we consolidate 2 more districts. We did a number of consolidation in the last rate case. In this rate case, we're proposing that we consolidate Stockton and Dixon, which are in close proximity to each other. And we request a continuation of key balancing accounts for certain corporate items such as pension, medical and conservation expenses.

In addition, in keeping with the state mandate, we are proposing to increase the service charge from a 30-70 split, 30% fixed, 70% variable to a 40-60 percent split. So moving the fixed charge from 30% up to 40% and bringing the variable down from 70% to 60%. So that is also included in the rate case.

Moving on to Slide 15. Just want to reemphasize and recap a couple of the changes that's happened on the cost of capital impacts and the impacts specifically on cash flow. As Tom mentioned, the cost of capital that was previously reported in the first quarter, the total annual effect of that reduction will be a $6.9 million adjustment to revenue that -- again, that's from the return on equity adjustment, so that does affect the bottom line. In addition, we had the Tax Cuts and Jobs Act that also -- we reported in the first quarter, the revenue reduction of approximately $11.1 million anticipated -- is anticipated to be offset by a corresponding reduction in the tax liability. So there's no real impact on net income with the Job Act, but you will see an impact on revenue. So when you combine those 2 things together, the rate reduction took effect for July 1 in California and though it's been approved in California is approximately $18 million annually. So you'll see a reduction in billings of approximately $18 million, it was associated with the California Utility. We continue to work through the regulatory process in the other 3 states and given the above, we anticipate paying federal income taxes starting in approximately 2020. We are still amortizing off the books as some of our NOLs and a few current other kind of tax deductions. Tom, you want to cover the regulatory balancing accounts.

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

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Yes. Thanks, Marty. So the big balancing account that we talk about every quarter is our RAM MCBA, that's the water revenue adjustment mechanism and the modified cost balancing account. This is our decoupling mechanism in California. So the great news is that in California we are on a year-to-date basis at 95% of our adopted estimated sales. So we're very close to adopted, that's much better than prior -- probably the last 5 or 6 years. Part of the reason that we're so close is that we had a change in our adopted sales due to triggering the sales reconciliation mechanism. We triggered that in every one of our districts last year and that allows for a sales true-up when annual sales are above or below, adopted by more than 5%. And last year, our sales were below adopted by more than 10% in almost every district.

The current RAM receivable balance, because our sales are closer to adopted has come down from $69.1 million at the year-end to $65.8 million at the end of the second quarter.

In addition, we continue our annual recovery process. In April, we filed to recover $50.1 million of that balance through surcharges on our customers.

And so just graphically on Slide 17, you'll see that we did make hay cutting down that RAM balance over the course of the drought and spiked up last year in 2017, and we're again making progress in bringing that balance down in 2018. Marty, you want to talk about other rate filings?

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

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Sure. So we have a number of other rate filings that are in process. On the Big Island of Hawaii, our white Colorado rate case, which was filed in December of 2017 requesting increases of revenue about $3.8 million. Those proceedings are ongoing and we anticipate that the commission will have a decision before year-end. In addition, on July 2nd of this year, we filed a General Rate Case for our Washington water subsidiary up in the State of Washington requesting additional $1.6 million of revenue. Washington has a fairly quick process and we anticipate a decision before the year-end from the State of Washington. Both Hawaii -- the State of Hawaii and the State of Washington are historical test years meaning we have to spend the capital and then apply for the relief for the dollars spent versus California was prospective or forecasted rate case date. So you'll see a little bit of lag on the subsidiaries because we have to spend the money first put it in service and then go apply for rate relief.

In addition, on -- through July 1, 2018, the California Public Utilities Commission approved advice letter projects totaling an additional $4.9 million of incremental annual revenue out of an authorized amount up to $30 million. These are a number of advice letter projects were approved. So these are projects that were part of rate case but were not included in the capital component and we filed for rate relief once they are completed. Of that $4.9 million, $2.1 million of additional revenue was effective July 1 of this year. And we will continue to chip away at that $30 million as we go through the rest of 2018. You want to do the update on capital?

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

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Absolutely, thanks. So in the slide deck on the quarter, we are showing our projected capital investment and projected rate base. Because we field the California Rate Case, we're able to project out further than we have in the past, and so you'll see on Slides 20 and 21, which are our projections, we've added 3 years to the projections. These borrowers are, again, highly uncertain. They're the request that we've made in the California General Rate Case in addition to the expected -- anticipated investment in rate base in the 3 other subsidiaries. And so the important thing to think about here is that our CapEx is growing, as Marty said, 20% of proposed increase over what was filed in the 2015 General Rate Case. You do see a bit of a front-loading of the CapEx in 2019 for the 2019 through 2021 period. And again, that has to do more with certainty of projects, the starting of projects that we're going to be commissioned with. And so you see a growth -- expected growth in CapEx.

I want to highlight on the rate base slide, which is, again, Slide 21. With the increase in CapEx that the company has done over the last 10 years, increasing our rate of spending capital by more than 10% on a compound annual growth rate basis, you haven't seen a very significant increase in our overall rate base. And part of the reason for that has been the deferred taxes as well as bonus depreciation, accelerated depreciation due to the repairs deduction and a lot of that has been taken away through the tax reform the past last year. And so what we expect to see with the new CapEx in the rate case at California as well as CapEx and other states is that you should see an acceleration of rate-based growth relative to CapEx growth. And so as you see the projection here, again, the bulk of this is the California requested the commission, but you see a much higher percentage increase in rate base as relative to the CapEx projection.

So with that, Marty, I'll turn it over to you for summary.

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

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Great. Just one thing to emphasize on the point Tom was making on the spending. Just to remind everyone, we strategically made that change to front-load the capital because we -- as we did a lot of analysis internally, we were leaving a lot of value on the table associated with the step increases. And so when you look at 2018, it had been down from '17 that's by design and the proof of the put in that's really in how well we perform in our step increases. So the step increase that took effect this year, we achieved about 90% to 93% of the total step in the fall of this year. We will apply for a step increase that will take effect on January 1, 2019. And based on our preliminary estimates, I think we will do as good if not better than what we did on the stepped increase for 2018.

So that was a strategic change we made in our execution of the business plan and I believe it's really important to emphasize and it is helping us achieve the maximum value associated with our step increases.

Looking at Page 22. Just a brief summary, obviously, what we are look -- working on for the rest of the year, focus is on the 2018 General Rate Case. Thousands of hours go into prepare this rate case and thousands of hours are burnt in -- during the process with the California Public Utilities Commission. So it'll remain our key focus for the rest of this year. As Tom mentioned, we're on track to invest between $200 million and $220 million in water infrastructure during 2018, which enables us to continue to provide safe, reliable water service to our customers. And then lastly, we remain committed to pursuing the San Jose water acquisition. We believe that the commonsense combination creates opportunities for all stockholders, customers and employees, that the combined company would benefit from economies of scale from our customers that we serve in the Bay Area, we serve approximately 400,000 people in the Bay Area with centers around the SJW service area. So we think there are great economies of scale to be had here and greater access to capital being a large company that helps drive our growth strategy.

In addition, we expect this transaction would be accretive to earnings and deliver meaningful costs synergies through the reduction of key corporate costs, again, which is 2 public companies, 2 boards of directors, 2 sets of officer teams, 2 public company audits and there's a cost savings there that would be beneficial for all the ratepayers as well. And we also believe that the continued investment in our rate base would drive long-term earnings per share growth and support steady growth of our dividend, which we've had a long history of being able to increase our dividend.

So Shannon, with that we are going to 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 we have a 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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First on the -- there's debt costs in the quarter. Do you have any side on that moving forward or how should we think about modeling that for the balance of the year?

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Martin A. Kropelnicki, California Water Service Group - President, CEO & Director [3]

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Right now, I would anticipate that cost, if we go kind of full cycle here in this process, it was probably about $6 million. The bulk of the cost is associated with SEC filings. Obviously, we had to file a proxy statement than we had to modify it for a tender offering. So events like that eat up a lot of legal time. So where -- it just depends on kind of what the next steps are with San Jose Water and their willingness to engage with us. If it's on the sooner side it's going to be cheaper, if it's on the longer side it gets run out because we have to keep a team warm ready to go, we can get to that point where we can consummate a transaction. So right now we would anticipate probably about $6 million total for the year.

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David Francis Katter, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [4]

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Understood. And now as you're talking about the process, what are the kind of next dates we should look for or next developments that will give us more clarity on how long the entire process might take?

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

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Yes. I think the big thing to look for is the San Jose Water vote on the Connecticut merger. And what's going to be the outcome of that merger, does it get approved or do the shareholders shoot it down. That will be a thing to watch for and we do not have the date, at least, we haven't seen as of this morning that they have called for that shareholder vote. And so I don't think you would do it in August. August is a pretty slow month from a capital market perspective. But could be September, could be October. And so that is clearly out of our control that's purely speculation on my part. But I think, you want to watch and see when that vote happens for the Connecticut SJW merger.

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

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And David, the other thing to mention is that, the recent development was that San Jose was asked to participate in an investigation at the California Public Utilities Commission. The Commission is looking at whether they should weigh in on the merger between San Jose and Connecticut, that is scheduled to go forward here starting in August, and so you'll start to see some points of interest along the line of that case, I would suspect.

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David Francis Katter, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [7]

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Understood, that's helpful. And then, maybe one more from me on the rate case that you guys filed. I know you stepped up CapEx targets. What gives you, maybe, what went into that decision and what gives you confidence that the commission might be more receptive to those elevated targets in this cycle than they were in the last one?

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

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That's a very good question. And I think if we go back to some of the changes that actually Paul and I started working on probably 10 years ago, which was improving our capital planning program management. And in the rate case process, we submit everything at the project level. So essentially, there'll be 2,000 to 5,000 projects that gets submitted as part of a rate case. And in that process you tend to lose sight kind of the forest from the trees. There are so many individual projects that you lose sight of the program. So the last couple of rate cases, we have been keenly focused on, like our main replacement program, our well rehabilitation program, our meter exchange program. And that's allowed us to, as we've gone through the process with the commission, focused on what's the overall, kind of, life cycle replacement of our asset cycle replacement needs. And I think that's enabled us to better position to secure capital dollars. I think the main replacement program is a good example of that. We were on a 300-plus-year main replacement program. The American Water Works Association standards are 100-year main replacement program. And we can't in 1 or 2 or 3 or even 10 rate case cycles say, we're going to replace 6,000 miles of main in the State of California. So we embarked upon a process of moving that number down kind of piece by piece, rate case by rate case. And so we've moved it from over 300 to 200 in the last rate case. In this next rate case that we just filed, we're trying to take it from 200 down to about 1.2. And in the rate case after that we'll try to bring it down to 1.0. So we believe that -- we're probably the best prepared for the discussion on capital this year. Our engineering department is just on fire as you see by our ability to execute our capital program, we're hitting our budgets, we're hitting our targets and it's really a question of just sitting out the commission and making sure they understand how we're justifying the need for that capital. So I'm actually feeling pretty good about it. I'm probably more optimistic than Tom. Tom, as a CFO, gets to be more the cynic in the relationship, but I think both of us have been generally very, very happy with how well the General Rate Case came together in the planning side of the General Rate Case.

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Thomas F. Smegal, California Water Service Group - VP, CFO & Treasurer [9]

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No, I actually would agree. But I think that the key thing for us -- as many of you know I was the VP of rates and Manager of rates before I was in this role. The key stumbling block in prior rate cases that we've had was the ratepayer advocate saying, well, if we give you authorization to build capital, we're not sure if you're going to be able to complete it because we don't know about your execution. And over the last really 3 or 4 years, we have really proved execution in the Engineering Department, Operations Department, here we've been able to put the capital in and really feel as though the ratepayer advocate isn't going be able to use that argument anymore. The fact is that we do what we say we're going to do and I feel that arguments going to get taken away. So I'm as optimistic as Marty at this point.

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Martin A. Kropelnicki, California Water Service Group - President, CEO & Director [10]

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Tom, and I don't always agree, which is why our relationship just doesn't go well. I think, David, I'd add to that, as we went through a major drought in State of California leaky mains are not acceptable. You have parts of the state that ran out of water, none of them were our service territories, so long-term water supply planning is really important and as this state has now become the fifth largest economy in the world. Our long-term resiliency and sustainability of water assets are really key in order to keep that -- to help continue to drive the economy.

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Operator [11]

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(Operator Instructions) And I'm currently showing no further questions at this time. I'd like to turn the call back over to Marty for closing remarks.

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Martin A. Kropelnicki, California Water Service Group - President, CEO & Director [12]

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Great. I -- on Bloomberg on the way in, I heard that there were 70 companies reporting today, S&P 500 companies reporting today. So I think it's a busy day for our earnings releases.

I want to thank, everyone, for your time today and sticking with us. Certainly, you have any questions, feel free to give us a call we'll be here today doing calls. And we'll look forward to sharing with you other results of the third quarter. The third quarter is always our busiest quarter of the year. So as we move into the third quarter, things will be busy between the General Rate Case and SJW and it's our busiest quarter, we're going to be pretty hedge down getting through this quarter and racing into year-end. So thank you for your continued support, and we will talk to you next quarter. Bye-bye.

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Operator [13]

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Ladies and gentlemen, this concludes today's conference. Thanks for your participation, have a wonderful day.