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Edited Transcript of CWT earnings conference call or presentation 23-Feb-17 4:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 California Water Service Group Earnings Call

SAN JOSE Feb 23, 2017 (Thomson StreetEvents) -- Edited Transcript of California Water Service Group earnings conference call or presentation Thursday, February 23, 2017 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Healey

California Water Service Group - VP, Corporate Controller

* Tom Smegal

California Water Service Group - VP, CFO

* Paul Townsley

California Water Service Group - VP, Rates and Regulatory Matters

* Marty Kropelnicki

California Water Service Group - President, CEO

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Conference Call Participants

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* Tyler Frank

Robert W. Baird & Company - Analyst

* Jonathan Reeder

Wells Fargo Securities - Analyst

* Jim von Riesemann

Mizuho Securities USA - Analyst

* Spencer Joyce

Hilliard Lyons - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to the California Water Service Group fourth quarter and year end 2016 earnings results announcement and teleconference. I would like now to turn the meeting over to David Healey, Vice President and Corporate Controller. Please go ahead sir.

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David Healey, California Water Service Group - VP, Corporate Controller [2]

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Thank you Don. Welcome everyone to the 2016 year end and fourth 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 of Regulatory Matters and Business Development. A replay of today's proceedings will be available beginning today, February 23rd, 2017 through April 23rd 2017 at 1-888-203-1122, or at 1-719-457-0820, with a replay passcode of 7406571.

As a reminder, before we begin, the Company has a slide deck to accompany the earnings call this quarter and for the year-end results. The slide deck was furnished with the 8-K this morning, and is also available at the Company's website at www.CalWaterGroup.com/docs/2016Q4slides.pdf. Before looking at this quarter and year end results, we would like to take a few minutes 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're subject to various risks and uncertainties, and actual results could differ materially from the Company's current expectations. Because of this, the Company strongly advises all current shareholders, as well as interested parties, to carefully read and understand the Company's disclosures on risks 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 year-end and fourth quarter 2016 results. I am going to pass it over to Tom to begin.

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Tom Smegal, California Water Service Group - VP, CFO [3]

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Thanks Dave. This is Tom Smegal. I have a bit of a head cold this morning, so somebody else will jump in if I get into a coughing fit. Hopefully that won't happen too quickly here. I will start on page five of our slide deck, and work through the year-end and fourth quarter financials. We did have a positive year. We earned $1.01 on an earnings per shares basis for the entire year, that is $0.07 higher than the $0.94 last year, and net income of $48.7 million, as compared to $45 million last year. Revenue was up. Our operating expenses were up as well. And if you flip to the next page on slide six, just for the fourth quarter, we had a $0.31 earning for the fourth quarter, as compared to $0.18 in the fourth quarter of 2015. Primarily the result of regulatory activity in the quarter.

Primarily want to talk about the entire year, and that will be on slide seven, our financial highlights for the full year. As I mentioned, our earnings increased $3.7 million, largely attributable to the conclusion of the 2015 California general rate case. We had a $2.8 million increase in net income from the resolution of several regulatory memorandum and balancing accounts in the GRC, that were effective with the GRC decision being adopted in December. A $1.9 million increase in net income relating to the recovery of drought costs. These are the drought costs from 2014 and 2015 in the amount of $2.9 million that were recovered, again in December of 2016. We had an increase of $1.9 million in net income, in Other income area, and that is mostly due to a settlement agreement on litigation proceeds relating to MTBE.

Those of you who have followed us for a long time know that I think about seven or eight years ago, the Company received a settlement of around $50 million to remediate MTBE contamination. This is the remainder amount. The Company was awarded part of that for stockholders, and part went to the ratepayers there. We did have an increase in our unbilled revenue accrual that is oftentimes a topic here. Unbilled revenue is an accounting accrual that we do based upon the number of days that we have not sent bills to some of our customers, multiplied by the average bill that was up this year, $1.7 million. And then just as a reminder, in the third quarter we had a $2.1 million decrease in net income as it related to the Bakersfield water treatment plant that we wrote off as part of the rate case settlement.

And then the other big factor affecting our earnings for the year was $3.1 million, decrease in net income relating to increased maintenance costs and interest expenses. One of the big highlights for the year, Marty will touch on this later, that our Company and developer funded capital investments were $228.9 million, that is absolutely a record for us. We had $177 million of CapEx last year in 2015. So that is really great news for the Company all-around, both in terms of getting the plant in the ground, and also just the execution aspect of that. Again, Marty will touch on that as well.

So the EPS bridge on slide eight, reflects those items that we discussed. You can see that laid out graphically. On slide nine, I'll just mention for everybody's understanding, we do look at our return on equity a little bit differently than just simply booked return on equity, for evaluating how the Company performed.

You will see on slide nine, the California adopted ROE is 9.43, slightly different in other states, but again the bulk of the rate base is in California. So the California regulatory ROE, however, is based upon a rate base which excludes construction work in progress. And so when we deduct out the construction work in progress, you can see that our booked ROE of 7.48%, actually calculates to a 9.03% ROE for the year based upon removing that balance.

Generally remember that we have net drought costs in the year. We are in the third year of the general rate case. We had maintenance expenses that were higher due to the drought and other things going on that we identified throughout the year. So really 9.03% for the year isn't too bad. I think all-in-all we'd be very happy with that when we get to the third year of a California rate case cycle. So next I'm going to turn it over to Paul Townsley to talk about the GRC implementation.

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Paul Townsley, California Water Service Group - VP, Rates and Regulatory Matters [4]

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Thank you Tom. I'm on slide ten. As was previously announced, California Water Service received a final rate case decision from the California Public Utilities Commission on December 15th, 2016, late last year. And with that decision, new rates were authorized, and went into effect on January 1st of 2017, and were reflected in our customers' January bills. The decision about authorized California Water Service increased revenues by $45 million in 2017. Of that amount $11 million was for increased water production costs.

Over the three-year period as a result of this decision, California Water Service was authorized to invest $658.8 million in capital and utility assets in California. Because California Water Service has decoupled revenue from water sales, we anticipate that our revenue across the year will be very close to the adopted revenue in the rate case. Then finally I would just like to point out we anticipate the total adopted rate base for California, plus our other three states, Hawaii, New Mexico, and Washington, should be about $1.1 billion this year.

Moving on to slide 11, this slide shows the adopted revenue distribution across the year. You can see that most of our sales, and therefore most of our revenue comes during the summer months, when there's more outdoor irrigation that occurs in California. To the extent that there's a variation between actual revenue collected and the adopted revenue from the rate case, our decoupling mechanism, which is known as our water reconciliation adjustment mechanism, or RAM, will capture that difference for a later true-up. Also in this rate case, the Commission authorized continuation of the Company's sales reconciliation mechanism, which readjusts sales forecasts each year of the rate case cycle to account for changes in sales. So really the SRM, the sales reconciliation mechanism works in concert with the water revenue adjustment mechanism, they work together, they adjust customer bills gradually as sales change, while protecting shareholders from changes in water revenue collection.

Moving on to slide 12, I also wanted to point out a few of the other features from the recent rate case decision. The first one is that we have been authorized to consolidate a number of our smaller high cost, or higher cost service areas, with some of our larger, lower cost service areas. This really helps to address affordability concerns in some of those smaller districts, while having a minimum impact on customer rates in the larger districts.

Also as Tom Smegal mentioned a few minutes ago, the Commission decision resolved a number of outstanding balances in some of our memorandum of accounts, allowing for recovery of costs of those accounts in this rate case cycle. In 2018 and 2019, the Company is eligible for escalation adjustments in revenue of $17.2 million in 2018, and $16.3 million in 2019.Those escalation increases are subject to the Company passing the Commission earnings tests. And then finally as a part of our approved capital program in this rate case, we have advice letter projects included in our total capital forecast, which would provide about $30 million in revenue upon their completion and approval by the Commission. And with that, I will turn it over to Marty.

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Marty Kropelnicki, California Water Service Group - President, CEO [5]

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Thanks Paul. Good morning everyone. What a difference a year makes. I think some of you have heard me say this before, the only thing predictable about California is the unpredictability of the weather. As we went from a 5-year drought, to now what is one of the wettest winters in history for the State. As of February 21st, the precipitation in the northern Sierras is about 150% of average. A lot of parts of northern California are actually about 200% of average, it just depends on where you look. The snow accumulation year-to-date is 186%. Last night many of the ski resorts in the Tahoe area mentioned that they anticipate staying open through the Fourth of July weekend, which would be a new record for us in the State.

To give you an idea of kind of the change in weather, I went in and just looked at a couple of spots. I looked at the date range from October 1st to yesterday, in terms of the time span, what was the rainfall last year at this time versus this year. If you look at Mount Shasta, last year for the same time period of October 1st to February 22nd, they had 25 inches of rain. This year it is over 43 inches of rain for the same period. Sacramento Airport last year for that time frame was 9.7 inches. Over 28 inches year-to-date so far this year. Santa Rosa was 20 inches last year at this time. Santa Rosa this year is at 52 inches of rain. San Francisco Airport, 11 inches last year, 26 inches this year. When you move down to southern California, the numbers typically are in the single digits. So 7, 8, 9, as high as 11. This year they are already in the mid to high teens.

Even though we've had more rain in northern California, southern California is certainly above their average rainfall as well. As of 2/21, most of the reservoirs are well above their historical averages. Many are starting to let water out to make room for some continued rainfall. We're expected to get more rain later on this weekend. I think many of you probably saw the news of Oroville Dam. We operate the water system in the Oroville area. We don't own the dam, the dam is owned 80% by the State, and 20% by the Federal government, but we do operate part of the water system around the city of Oroville, as well as some other lower lying cities that are downstream. So we serve about 18,000 people through about 8,000 connections in that area.

What's happened with the weather situation this year, is what they call the atmospheric highway, or also called the Pineapple Express, when you get these warm, tropical storms that move in, and in the absence of not having a high pressure system off the coast of California, which would normally shoot the storms north, if there's a low pressure front, it shoots those storms right into California, and they hit us head on. That's really what's happened here over the last 60 days of this year.

With Lake Oroville and the dam itself, it is the largest state-owned reservoir. It's the second largest reservoir in the state. Shasta is bigger. It holds about 3.5 million acre feet. Just to remind everyone, an acre foot is about 327,000 gallons. It is the highest dam in the US at 770 feet. You can compare that to Hoover Dam, which is 726. Some of you may recall a famous photo that The Atlantic published about two years ago, that showed the before the drought and after the drought shot of Lake Oroville, it was almost empty, down to about 32%. Well, all of that changed about two weeks ago. Oroville, the Oroville area, gets about 32 inches of rain. There are a lot of microclimates that center around the lake. In the winter they typically get about 17 inches of rain total for the winter.

So with this Pineapple Express, or the atmospheric river, plowing into northern California, we had back-to-back storms, and that resulted in an unprecedented equivalent of about 20 inches of rain. Let me explain what that is. That was actually about 7 to 8 inches of warm, tropical rain, but when you include the results of that warm rain falling on the snow capped mountains the runoff equivalent is about 20 inches of rain in about a two-day period of time, which is significantly more than what they've seen in the Oroville area.

As a result you've had massive inflows into Lake Oroville. Everyone on the media is talking about CSF. I'm not sure everyone knows what that means, but if you convert that to gallons it's the following, that meant 1 million gallons a second was flowing into Lake Oroville. That is 61 million gallons a minute, or 3.6 billion gallons an hour. So that reservoir quickly filled up. When they went to release some of the water through the spillway, part of the spillway washed out. They're not sure why. That's being investigated. So they quickly turned the spillway off. There was about 10 to 20 feet of head room left in the lake.

Just to the left of the spillway is what's called the emergency spillway, which has never been used or tested since the dam was put in operation since 1961. As a result of the spillway being put out of service, the emergency spillway was used, and as a result of operating that for about a day there was massive erosion around that spillway. There are some photos out there on the web you can look to give you an idea how much of the emergency spillway eroded. That all led to an emergency evacuation for 180,000 people in northern California, including our employees, as well as the all of the local residents.

Overall it was a very chaotic evacuation. There was not a lot of coordination between state and local government. I'm sure many of you have seen the news. It was all over the national news. Having said that, I will say Cal Water responded very well. We were able to use our reverse 911 system to notify customers, to direct them to our website. Social media, like we saw in the Erskine Fire, social media was a big tool, where we had elderly, our people who were handicapped, couldn't get out, couldn't get through to the authorities. They were communicating with our operators through our webpage, and we worked with authorities to connect them to help get them evacuated.

We set up our emergency operation center in Chico, California, which is our largest northern district. We were able to cut over our SCADA system, our engineering department was able to cut over our system, and we were able to operate all of our systems in Marysville and Oroville remotely. So overall I think the Company's response was very well overall. We also spent time a lot of time distributing water to the thousands, and tens of thousands of people who were in the emergency evacuation shelters.

So it looks like things are back on track now. They decided to go ahead and run the spillway, even though it was damaged, and they've been able to lower the lake levels. Of course, we're monitoring that daily as the new storms come in. We'll just have to see how it goes. The state office of emergency services has advised everyone to just be on standby, but obviously there's been a lot of attention given to the story, and it looks like things are under control.

One kind of fun story associated with this, a Good Samaritan story, is we were contacted by the Department of Fish and Game while all of this was happening, and the turbidity levels of the river, the rivers that feed into Lake Oroville, was very high, and you had a lot of debris and tree branches coming through it. As a result the fish hatchery that's operated by the state of California on the Feather River, they couldn't use the water, which meant that all of the eggs they were currently hatching and all of the newly-hatched fish, were most likely going to perish.

We were contacted by Department of Fish and Game, we quickly got a letter of agreement put into place, and we were able to run a line that provided 60 gallons per minute to the fish hatchery, and we were able to save approximately 1 million fish. That's would be the Steelhead and the Chinook Salmon. Partnering with Department of Fish and Game, despite what was a very chaotic time, we were able to save about 1 million fish.

Despite all of the rainfall that we're seeing in California, groundwater still remains a concern. Obviously surface water is not. We have plenty of it. In fact, we need more storage. That surface water is being rushed out now to the ocean as the reservoirs have all filled up. So we're still concerned about groundwater, and also recharging kind of the Central Valley, which is where most of the farming takes place. It was overpumped. So more to come on that as we get through the winter season. Cal Water reduced its conservation mandate in July 2016 as required by the state water resources control board. The regulations were left in place, but it was voluntary conservation.

Looking at year-end 2016 when you compare 2016 to our baseline 2013, which is our measurement point for measuring conservation, our customers saved an average of 23.5%. Even with the relaxing of the mandatory drought restrictions, our customers still did a good job at conserving water. We saw in January of this year, the state water resources control board put out their regulations. That is taking the first couple of steps toward budget-based rates. This is the start of what will be a multi-year process, looking at better ways to manage water, and more efficient ways to manage water in the state of California. We have been intimately involved in the process, and have provided comments and reviews on the information that the state water resources control board has shared with the participating member companies, so water companies within the state. And we will continue to do so.

Also on February 8th, the state water resources control board extended the drought emergency for an additional 270 days. They have also committed to reviewing that in May, depending on how the winter conditions go. Obviously winter is off to one of the wettest winters on record for the state of California. So we'll have to see what happens in May. Keep your eye on the long-term drought regulations, and what the impact will be on consumption and use in the state, and how they're trying to make that more efficient.

Turning to page 14, a couple of things to remind people about, as Paul mentioned, we are fully decoupled in the state of California, which is the biggest utility that we operate. So sales declines generally do not reduce profits, it goes through that two way balancing account, that can change up and down. Revenue accrual is not included in the RAM. So you do get some impacts on the timing of revenue. So as consumption changes, and we book the accrual at the end of the period, that accrual is not included in the RAM. It goes into the RAM when it becomes billed consumption. So you do get some variability around the revenue accrual, and the timing of the year that we're making that accrual.

During the drought, and given our rate design for the drought, our RAM receivable X actually declined. We were very happy with the rate design that we had in place. I believe our customers and our regulators were happy with that as well. Our drought costs for 2015 were an estimated $4.3 million. On December 15th, 2016, California Public Utilities Commission authorized us to collect $2.9 million, the drought costs that were recorded to a memorandum account. For 2016, we've incurred another estimated $4.3 million, and Paul and his team plan on filing a regulatory filing later on this year to try to collect those amounts during 2017. In addition, looking at 2017, and the continuation of the drought emergency, we anticipate the spending for the drought has gone way down, but we anticipate there will be $500,000 to $1.5 million of costs that we will incur, it will get expensed, but then get recorded into a memorandum account, that we will track and hopefully will get recovery on at a later date.

Looking at slide 16, as Tom mentioned, this is a new record for us on our capital, the $229 million of investments during the year. In addition we closed approximately $230 million of projects to plant, meaning that is now in queue, and put into service, which we believe positions us really well for a step increase that we'll be filing later on this year. Just to remind everyone, approximately two years ago we did a major reorganization of our engineering department, and focused on how efficient we are at delivering projects on scope, on schedule, on budget. And as you can see, when we made those changes, we've had a nice increase in productivity of our engineering group and our operators in the field. So we're very happy with the results of the capital investment program for 2016. And with that, I'm going to turn it back to Tom.

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Tom Smegal, California Water Service Group - VP, CFO [6]

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Thanks Marty. Just a couple of informational tables on slide 16. We have the adopted regulated rate base of the Company. This is the same chart that we published in the third quarter slides, showing that our estimated 2017 rate base would be $1.14 billion, with the addition of the advice letter projects we are prioritizing those advice letter capital projects for inclusion in rates, and we'll be completing them throughout the year. So when we talk generally about $1.1 billion being the rate base, when Paul mentioned that earlier, that is an opportunity for us to increase the regulated rate base throughout the year.

On slide 17, our net RAM balance, just again for information, $37 million at the end of the year. It was a bit lower than that at the end of the third quarter. We have seen a little bit of back-sliding on this since we got rid of the drought surcharges, but remember the drought surcharge in 2015 and 2016 made a substantial impact on this receivable from the decoupling mechanism. What we will see in 2017 is unknown at this point. Our sales forecast in the general rate case is about the same as the sales forecast that we had in the last year. It's really going to be dependent upon our customer usage, how they react to a very wet winter, and the tailing off of a lot of the drought communications. So we'll be monitoring on that, and obviously reporting on that as we go quarter to quarter throughout 2017. Now I am going to turn it over to Marty, for some final comments about what we expect in the coming year.

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Marty Kropelnicki, California Water Service Group - President, CEO [7]

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Great. Thanks Tom. First and foremost, we're in the process of preparing our cost-of-capital application that we'll find at the end of March with the California Public Utilities Commission. The three water utilities will be joining us, and we'll go through that process concurrently. This will result in a review of our debt and equity structure, as well as our ROE, and whatever is the outcome of that proceeding, we plan to adopt that on January 21st, 2018. For the year 2017, we anticipate investing between $200 million and $220 million in our capital investment program, in accordance with our authorizations from the California Public Utilities Commission. We have a couple of focal areas that are interesting to note.

One TCP regulation. So that is one on the horizon that we see coming. We've been busy looking at what are the lowest cost treatment alternatives for our customers that we could put in place, and meet the projected requirements for water quality. In addition we're very focused on our earnings tests, as you may recall to get our step increases we have to pass an earnings test. As I mentioned earlier, the $230 million that we put into service and closed, we think will help position us very well as we get closer to that filing date. And then of course we have a lot of advice letter projects that we're working on, and making sure that they stay on scope, on schedule, on budget.

The drought response will start to transition to what was more a tactical to a long-term strategic water use efficiency program. Again, we're coordinating with the state of California on that, the state water resources control board and the California Public Utilities Commission. Our effective tax rate for 2017 is expected to be in the range of 37% to 39%, as we expect less of the investment will qualify for the repairs reduction, that is really a function of how much pipeline we get into the ground. We do have a lot of pipeline to get into the ground, but we factor that into our forecasts.

So what drives our planning around all of our strategic plan are really kind of five core elements that we use to run the Company. First and foremost, it's about affordability and excellent service. We're always looking at ways where we can improve service and bring costs down. Enhancing stockholder value. The capital program, making sure that we continue to execute our capital investment program, and we get projects in the ground on scope, on schedule, on budget. Those are now three of my favorite words, that I run around the office and the districts talking about. Make sure we maintain high-quality water and wastewater.

Once again in 2016, in the state of California, we had zero primary and zero secondary water quality violations for the entire state. So we've had a nice track record of not having any violations on the water quality front within the state. And seeing that continue in the various areas that we service. Our strong brand reputation, making sure that we continue outreach to the local communities, our environmental stewardship, water conservation leadership, and maintaining a very high corporate governance score. Ultimately, perhaps one of the most important ones, is our employees are our best advocates, focusing on safety, focusing on employee development, effective and transparent communications, and teamwork. So those are the items that drive our strategic planning. With that, Done, 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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Thank you. (Operator Instructions). We'll take our first question from Tyler Frank with Robert Baird. Mr. Frank, your line is open. Please check your mute button.

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Tyler Frank, Robert W. Baird & Company - Analyst [2]

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Hi guys. Thanks for taking the questions.

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Marty Kropelnicki, California Water Service Group - President, CEO [3]

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Good morning.

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Tyler Frank, Robert W. Baird & Company - Analyst [4]

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I guess I have a few questions I want to follow-up on. First and foremost, can you discuss how a change in corporate tax rate may affect you guys, if taxes were to be lowered, to let's say 30% or 25% under the Trump administration? How would you think about that impacting your earnings going forward?

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Tom Smegal, California Water Service Group - VP, CFO [5]

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Sure. One of the things that, maybe Paul could jump in here as well. One of the things you should know is that the California commission takes every advantage to make sure that the ratepayer benefits completely from any tax law changes. For instance, a couple of years ago when we had bonus depreciation out of the federal government, the commission immediately passed a memorandum account resolution, to track the benefit from the bonus depreciation that was in place at that time. I would expect that the California commission would do the same with any tax law changes.

If you think about what might happen if the tax rate is lowered, there's a customer benefit over time from that lower tax rate that is good, but then we do have a reduced value of the deferred depreciation, which constitutes the deferred tax that is actually a lowering rate base in the regulatory model. It lowers the expense of rates, but it raises the rate base. And so from a customer standpoint we're not quite certain where it would come out, but from a Company standpoint I'm not sure that you could expect any big benefit there. That's just because of the strong regulators that we have. There's been a discussion of the possibility that there's an elimination of the tax break for debt, the tax deductibility of long-term debt. California Water Service Group doesn't have any long term debt at the holding company level. All of our debt is in the regulated equated debt capital structure at the utility level. We would expect to be compensated in the rate-making structure for any change in the deductibility of debt.

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Paul Townsley, California Water Service Group - VP, Rates and Regulatory Matters [6]

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Yes. Tyler, that's a hard one to answer, because there's been about three or four different models that have been floated out there. We were originally modeling those to figure out the net effect. As Tom said, there's some customer benefit, but the problem is there's nothing concrete out there. If we had something more solid, we can calculate the impact, but it's really hard to speculate, especially with fake news, and everything else that's going on. We're just going to continue to do what we do best, which is execute our business plan, and we will adjust our tax planning to optimize whatever we need to do on behalf of the customer benefit and stockholder benefits. And wait to see what they come out with. I've read in the Wall Street Journal today, that they're saying probably by August they would have something out, but that's to be determined.

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Tyler Frank, Robert W. Baird & Company - Analyst [7]

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Okay. Great. And then just a quick question on the drought. When should we expect I guess the recovery costs to be, or for the costs to be recovered, both for the remaining 2015 costs, and for the 2016 costs? And then as you look into 2017, as far as I understand, California's no longer in a drought in several areas, or at least that's what the assumption is, depending on the snowpack, and so how does that, how will this process work in 2017? Do you expect to have less drought-related costs this year, and when will those also be recovered? Would that be a 2018 event?

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Marty Kropelnicki, California Water Service Group - President, CEO [8]

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I'll take the last part of the question. Then I'll hand it off to Paul on the recovery. Yes, we anticipate our drought costs dropping, well, first of all, the drought has been extended another 270 days. That was extended on February 8th by the state water resources control board. They said they would come back at the end of May and evaluate that. But voluntary conservation remains in place, and we report on that every water to the state water resources control board. Based on where we are, and seeing things change, we think our drought costs, that will be expensed during the year, but ultimately recorded in a memorandum account, will be between $0.5 million to $1.5 million. So it's dropping a lot, but there's still a lot of work to do. I think where the state's coming from with the continuation of the drought is you have got to remember we have almost 40 million in the state of California. And people will say, well, look at Australia, look how fast they responded to their emergency drought. And that's true, Australia did a great job with their crisis, but people don't realize we have twice as many people in the state of California as the country of Australia. And so obviously the state is being very diligent and very conservative when they look the at the amount of water needed to run the state. Hence we've spent a lot more time up in Sacramento, participating in the workshops on what the state water resources control board is considering for their long-term water use efficiency program. Paul.

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Paul Townsley, California Water Service Group - VP, Rates and Regulatory Matters [9]

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Yes. Tyler, Paul Townsley here. In terms of recoverability of drought costs, as Marty mentioned we actually record those as expense in the period that we incur them. But we record them as a, in a memorandum account for later recovery from the commission. So in 2015 we incurred about $4.3 million. And the commission allowed us to recover in rates $2.9 million of that. That recovery is ongoing as we speak, because the commission approved that recovery late last year. The 2016 cost that we incurred, about another $4.3 million, we're currently going through those numbers, reviewing them, making sure that they're correct, and we will make a filing with the commission later on this year, probably this summer, yes, probably early summer, to recover those costs. We're likely to see recovery of our approved drought memorandum costs beginning in January of next year. So there's a one-year lag between the incurring of those expenses, and the recovery of them.

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Tyler Frank, Robert W. Baird & Company - Analyst [10]

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Okay, right. So is the $1.4 million difference between the $2.9 million approved, and the $4.3 million of actual costs, is that $1.4 million, are you not going to be able to recover that, or is that still a possibility?

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Paul Townsley, California Water Service Group - VP, Rates and Regulatory Matters [11]

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That will not be recovered as a part of the memorandum account. The reason is primarily that those costs were reflective of costs already that were included in customer rates. We charged them to the memorandum account, but then after later review we determined this they were not incremental costs, but they were costs that were already included in rates.

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Tyler Frank, Robert W. Baird & Company - Analyst [12]

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Okay, got it. Excellent. And then the last question for me, then I'll get back in queue, the advice letter projects, how good is your visibility these will get completed? Should we be assuming they will be done in our estimates?

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Tom Smegal, California Water Service Group - VP, CFO [13]

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So we have a project team that's focused from engineering and accounting and rates, and other departments, that is looking at these I think biweekly. Not just monthly, but actually every other week. We'll do the best we can with these projects. One of the reasons, or a couple of the reasons that advice letter projects are noted in rate cases is because there is some uncertainty as to the timing, whether it be permitting or design aspect, or some property aspect, of a particularly large project. So typically we have not been able to complete 100% of our advice letter projects. I would like to say we'll do better this year, and in this rate case cycle, because we're really focused on it more, but you're always going to have those projects where for some reason you aren't able to get the permit to begin construction, and there's a six-month delay. We'll have to wait and see on that. The big amount of the advice letter projects really comes in the third year. It has to do with our Palos Verdes pipeline project that we've discussed on these calls before. It's a $70 million project to increase the reliability of the water system for the Palos Verdes system in Los Angeles. That's the one that is a very critical timeline to make sure that gets completed in 2019.

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Tyler Frank, Robert W. Baird & Company - Analyst [14]

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Got it. Okay. Thank you.

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Marty Kropelnicki, California Water Service Group - President, CEO [15]

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Thank you.

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Operator [16]

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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 - Analyst [17]

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Hey, good morning, gentlemen. Tom, appreciates the comments on tax reform. The one that you didn't touch on, and I'm curious about, would be the potential media expensing of capital additions, and if that's included, that would obviously impact kind of rate-based growth. Do you think that the commission would respond favorably and allow you to further bump up the CapEx? I know there's a lot more work that you'd like to get done to get back to closer to the 100-year replacement cycle. Just wondering what your comments are around that.

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Tom Smegal, California Water Service Group - VP, CFO [18]

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Yes. Maybe I would turn that maybe more to Paul. Obviously rate cases are a give-and-take as far as the rate advocate on the impact side, among other things. Paul, do you want to --

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Paul Townsley, California Water Service Group - VP, Rates and Regulatory Matters [19]

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Yes. Thank you, Tom. First of all, as Tom mentioned earlier, there's all kinds of speculation out there in terms of what the tax treatment may be. I really don't want to go too far in terms of hypothesizing what may happen. If we were to begin to expense capital in the year it was incurred, I can see that the rate impact to customers would be quite high. So I would anticipate that the commission would have a lot of concern about that, and would have, would provide guidance to us as to what to extent that may affect us. Really what I'm saying is that I'd like to wait and see what the commission comes out with before we go too far down that road.

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Marty Kropelnicki, California Water Service Group - President, CEO [20]

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Yes. Keep in mind Jon, this is Marty. You have your GAAP books, we have our regulatory books, and we have our tax books. And the commission will be keenly focused on not doing things that skyrocket customer rates. The other thing I would say, a week and a half ago, I was at a lunch with Kevin McCarthy, who is the Majority Leader in the House, he is the elected representative for Bakersfield, which is our biggest district. We had a good discussion with Representative McCarthy about the infrastructure bill, and not forgetting about the investor owns, he made a comment to us about keeping close to him, and make sure we contact him with any concerns that we have with these bills involved. Not that there's any one source can have any input on it, but obviously I think that the water industry has gotten smarter about dealing with evolving changes in accounting regulations, evolving issues on the tax side. Between NAWC, AWWA, CWA, and our member companies, I think we'll be keenly focused on these tax bills and the construction bills, as they make their way through Congress in the US.

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Jonathan Reeder, Wells Fargo Securities - Analyst [21]

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But then, I guess, from an earnings impact standpoint, I guess it's fair to say, based on your experience with the way the CPUC works, and everything, you would expect whatever may or may not be enacted, you'd kind of be held harmless, overall fairly neutral from an earnings impact standpoint?

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Marty Kropelnicki, California Water Service Group - President, CEO [22]

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That's right.

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Jonathan Reeder, Wells Fargo Securities - Analyst [23]

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Okay. And then if you could, just remind us, are the rate-based amounts on slide 16, are they averages for the year or year-end?

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Tom Smegal, California Water Service Group - VP, CFO [24]

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That is our average for the year.

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Jonathan Reeder, Wells Fargo Securities - Analyst [25]

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Okay. And then going to the cost of capital, is there any specific timeline for receiving a response from the CPUC, regarding the extension requests that the four water utilities made?

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Paul Townsley, California Water Service Group - VP, Rates and Regulatory Matters [26]

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So let me address that. First of all, the extension request that we applied for was not approved by the commission. So we are proceeding with our cost of capital filing, which we will be making at the end of March. So we are on schedule. That was always the schedule. So we're staying with that schedule. And the anticipated decision on the cost of capital matter would be in late 2017, later this year, with the new cost of capital going into effect January of 2018.

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Jonathan Reeder, Wells Fargo Securities - Analyst [27]

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Okay. So at this point we should consider any potential for I guess a settlement with ORA, or the other parties, to either extend the request, or make some adjustments, without going through the proceeding, kind of like the electrics had, that's off the table at this juncture. So now I guess you're definitely making those filings, and then maybe settlement talks may arise once the parties positions are publicly made? Is that the way you're thinking about it?

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Paul Townsley, California Water Service Group - VP, Rates and Regulatory Matters [28]

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Yes, that is the way to think about it.

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Jonathan Reeder, Wells Fargo Securities - Analyst [29]

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Okay. Looking forward to seeing those filings. Thank you for the additional time today, guys.

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Marty Kropelnicki, California Water Service Group - President, CEO [30]

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Thanks, Jonathan.

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Operator [31]

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We'll go next to Jim von Riesemann with Mizuho.

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Jim von Riesemann, Mizuho Securities USA - Analyst [32]

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Hi, gentlemen. Since I'm new to the water industry, can you refresh my memory as to what the existing cost of capital or parameters are, and what the allowed ROE and equity thresholds are, and what is included and not included in the denominator?

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Tom Smegal, California Water Service Group - VP, CFO [33]

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Sure. So we have a 9.43% ROE, and based on a 53.6% equity to equity ratio. As I indicated earlier, the construction work in progress is not included in the rate base. So that's what the percentages are based upon.

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Jim von Riesemann, Mizuho Securities USA - Analyst [34]

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Okay. And then on the debt component, do they include customer deposits in all that as part of the capital?

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Tom Smegal, California Water Service Group - VP, CFO [35]

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No.

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Jim von Riesemann, Mizuho Securities USA - Analyst [36]

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Okay. Great. Thank you. That's all I had.

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Marty Kropelnicki, California Water Service Group - President, CEO [37]

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Okay. Thanks, Jim. If you have questions about the water industry, feel free to give us a call.

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Jim von Riesemann, Mizuho Securities USA - Analyst [38]

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Will do.

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Operator [39]

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

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Spencer Joyce, Hilliard Lyons - Analyst [40]

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Good morning, guys. Thanks for taking my question. I know that we're getting a little long today.

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Tom Smegal, California Water Service Group - VP, CFO [41]

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Good morning, Spencer.

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Marty Kropelnicki, California Water Service Group - President, CEO [42]

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Good morning. No worries. Take your time.

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Spencer Joyce, Hilliard Lyons - Analyst [43]

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You all just have a lot going on out there. A couple of pseudo housekeeping questions here. Tom, the litigation proceeds, the $1.6 million of net impact, was that all in the fourth quarter?

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Tom Smegal, California Water Service Group - VP, CFO [44]

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That was booked as of the result of the rate case. It was a settlement item in the rate case. We did book it in the fourth quarter, yes.

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Spencer Joyce, Hilliard Lyons - Analyst [45]

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Okay, perfect. And similarly, the balancing and memoranda account item, I would assume that was all booked into the fourth quarter as well, but my question is, is that indicative of a sustained bump or step function higher in earnings, or is that almost a one-time item that shouldn't repeat kind of across 2017?

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Tom Smegal, California Water Service Group - VP, CFO [46]

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Yes. I think generally our view is those are one-time kind of cleanup items. For instance, one of the big memorandum account items was the recovery of the return on a piece of property that we had been excluded from rates in the prior rate case, and then was allowed sort of three years' worth of revenue requirement from one piece of property was in there. And so that's going to be included in the rates on a going-forward basis, and not that issue. If you're looking for the go-forward, I think we often say, look at the rate base of the Company, the authorized rate of return, the capital structure, and that gives you a better guide about where we're going on future years.

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Spencer Joyce, Hilliard Lyons - Analyst [47]

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Yes, yes. Okay. Perfect, perfect. And as far as the CapEx goes, it looks like a really nice quarter of spend here in Q4. Has that been kind of parlayed, if you will, into a pretty good pace of projects here in the first quarter? I know it's still early to say if you'll hit the full year target or not, but has some of that momentum carried over?

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Marty Kropelnicki, California Water Service Group - President, CEO [48]

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Well, keep in mind we had a lot of dry weather the last couple years, an wet weather certainly slows down construction work. So no, it has been a very, very wet winter, as I mentioned one of the wettest winters on record, and that affects our ability to move capital and get it in the ground quickly, especially when you have things happening like all of the flooding that you are seeing right now, that things just come to a halt. I think that the clip during the first quarter is going to slow down probably substantially over the first quarter of last year, just due to the change in weather conditions, and then you will see a lot more capital deployed and put in the ground during the warm summer months.

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Spencer Joyce, Hilliard Lyons - Analyst [49]

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Okay. That makes sense. And a final item here, just so I'm clear, the drought specific, or at least the drought expenses tracked in the memoranda, were essentially equal in 2016 to 2015. Is that correct? Right around the $4.3 million to $4.4 million amount?

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Marty Kropelnicki, California Water Service Group - President, CEO [50]

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That's right. By the way, purely coincidence it worked out that way. Not by any great planning on our part. As the conservation program changes, and you put these programs in place, they have a tail. Some customers pick up on what we offer and some don't. So it was just a coincidence this year they were the same two years in a row. I think as Paul pointed out earlier, we learned a lot going through that first filing with the commission, and reviewing it with them. I think the accuracy of the numbers for 2016 are higher, will I know that they are higher than they were the first time through it.

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Spencer Joyce, Hilliard Lyons - Analyst [51]

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Perfect. That was my follow-up question. That is all I have. Congratulations on a pretty interesting and pretty strong year. Thanks guys.

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Marty Kropelnicki, California Water Service Group - President, CEO [52]

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Thank you, Spencer.

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Tom Smegal, California Water Service Group - VP, CFO [53]

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Thanks, Spencer.

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Operator [54]

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There are currently no questions in the queue. (Operator Instructions). Apparently we have no more questions. At this time I will turn the call back to Martin Kropelnicki for any final remarks.

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Marty Kropelnicki, California Water Service Group - President, CEO [55]

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Great. Thanks Don. Well, actually Spencer's parting comment there was a great way to end the call. 2016 was the third year of the rate case cycle for us, which is always the most challenging year, and that coupled with things like the Erskine Fire, and the drought, made it certainly we had a lot of things to work on throughout the year, but even despite some of the roadblocks that we had to work around, 2016 turned out to be a very good year for the Company, with the amount of capital that was deployed, and invested in the ground, the rate case coming in on schedule, and I think this is the first rate case in a decade for any utility in the state to come in on time, and everything that we got done.

There's a whole list of projects the Company got done, including putting in a new billing system. There's just, winning the JD Power award, voted fifth year in a row Top Area Workplace. So the Company is really firing on all cylinders right now. So we believe what is the most challenging third year of the cycle into 2017, which is off to a really good start, albeit wet, but a very good start. So we have new budgets, new targets, a lot of enthusiasm, and a lot of momentum leaving 2016 going into 2017. We appreciate everyone's support of Cal Water. We are around if anyone has any questions, and we look forward to talking to everyone at the end of the first quarter. With that done, I think we are all wrapped up.

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Operator [56]

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That does conclude today's conference. Thank you for your participation. You may now disconnect.