Good day, and welcome to the California Water Service Group Q1 2023 Earnings Call. [Operator Instructions] I'd now like to welcome Mr. Tom Scanlon, Corporate Controller, to begin the conference.

Good morning, and welcome, everyone, to the 2023 first quarter 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 information for this call can be found in our quarterly results release, which was issued earlier today. The replay will be available until June 26, 2023. 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 yesterday afternoon 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 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, 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.

Good morning, everyone, and thank you for joining us on our first quarter results call. I'm going to start on slide number five of the slide deck, which is just a table of our financial results for the first quarter. And what you'll see there is a large drop in revenue, which I'll get to in just a second. We had a decrease in operating revenue of $41.9 million or 24.2%. That lines up with a decrease in operating expenses of $15.3 million. And that's a reduction of 9.3%. The effect of those among the other things that were on during the quarter was that we had a net loss for the first quarter of 2023 of $22.2 million or $0.40 per share, and that compares to net income of $1.1 million or $0.02 per share in the similar quarter last year. I do want to highlight and we'll talk a little bit more later about the increase in capital investments of 19.7% in the quarter, that is certainly good news for the company's business plans. Turning to Slide 6. The big story for the quarter that we are describing in this document and in the press release is that we had a combination of severe weather in our main service areas in California, very wet and cold weather here in California and really what I would call a gap in our regulatory mechanisms. And this gap is temporary, and we'll talk a little bit probably a lot about where we go from here in terms of those mechanisms. On Slide 6, the big impact to revenue, both billed and unbilled revenue, again, the extremely wet winter in California, we saw a 12% decrease in our sales. And remember that sales in California are usually quite low to begin with…

It actually seems kind of odd to talk about a drought given what we've just gone through with the winter. But certainly, we want to get you up to date on kind of what's going on out on the West Coast. As Tom mentioned, it was a record winter for California especially. As of April 24, if you look at the percent of normal for the snowfall in Northern California, which is also the Northern Sierras or Trinity region, they're at 217% of normal snowfall and the Central Sierras, which is around the Lake Tahoe area, they're 251% of normal for snowfall. And in Southern California, as of April 24, they are at 322% of normal snowfall. The significance of that, I'll talk about it a little bit later as we start to talk about the potential flooding. Accordingly, given the winter results and the number of atmospheric rivers that have hit the West Coast, governor Newsom California basically issued an executive order. His emergency declaration is still in place, but issued another order that basically eased some of the drought restrictions that were in place throughout the state. If you remember in 2022, we had a fairly severe drought. And we were in Stage two and moving to Stage three of a 5-stage plan for the state, and he has eased some of those restrictions as we go into spring. The emergency regulation that was adopted by State Water Resources Control Board remains in effect and then as an exploration date of 610, so June 10th, the emergency, the declaration of the State Water Resources Control Board if they don't extend it will end at that point. We believe that the DRMA account, which is the drought response emergency memorandum account will stay into effect until the State Water…

On Slide 15, just a quick update there. Two updates to the slide. First of all, the yellow bars still indicate the projected and estimated with the California Rate Case going on $82 million year-to-date. And you'll note that this does not include any capital expenditure for PFOS treatment. There's no changes on Slide 16 that still represents the projection of the California General Rate Case, but we'll keep showing you that and hope to give you an update when we get some more certainty on the Rate Case. I'll turn it back to Marty for summary.

Well, I don't know what to say other than it's been an interesting journey going from a severe drought in 2022 to living through one of the wettest winters on record and record snow calls on record in the state of California. The winter results, coupled with the temporary absence of certain regulatory mechanism is pending our 2021 General Rate Case, which is, as you know, is delayed. It has certainly made for an interesting and confusing quarter. We anticipate that the potential of future recognition of these mechanisms, once our General Rate Case is finalized and the decision has been issued. And in the meantime, we'll continue to do our best to provide clarity and as much disclosure as possible, so you can see all these pieces fit together. I also want to point out that as long as the GRC is delayed, we anticipate that the quarterly results will remain a volatile pending resolution of these regulatory mechanisms that we've discussed here today. And again, the team now will do as much as we can to provide as much clarity as possible when we work with the California Public Utilities Commission to successfully conclude our 2021 General Rate Case and then quickly move on to our 2024 General Rate Case, which is a little over a year away. Additionally, as I mentioned, the ESG report will be available on May 16th. I highly recommend people take a look at that and all the work the company has done, especially on the greenhouse gas side, which was a focus for us in 2022. And certainly, as we wait to get these regulatory decisions out of the way, the work does not stop. As Tom mentioned, we had almost a 20% increase in capital investment during the quarter, which is…

[Operator Instructions] Our first question comes from the line of Jonathan Reeder from Wells Fargo. Jonathan, please go ahead.

Hi, good morning. Marty on, are you guys doing.

Hi.

Just a little bit of clarity on one thing. I know in the release, you said cumulatively, it's $24 million to $34 million is kind of your estimated adverse revenue impact in Q1 from the delayed GRC. Does that include, I guess, the deferred revenue component that you talked about, the $18.8 million that was offset by, I think it was like $15.4 million of deferred costs?

No, that's unrelated. What we're talking about there, Jonathan, are the DRMA account of 6.5% to 7%, the M-WRAM account of 9.5% to 11% and then the interim rate account, which is 8% to 15%. Just those three accounts is what we're summarizing there. And with respect to the deferred revenue, obviously, as time goes by, that becomes undeferred because those subcharges are in place. And so we would expect that, that would start to accumulate back to the company in future quarters. Obviously, it's not a permanent disallowance or anything like that.

I know you might not have a whole lot you can say on this matter, but any sense of what a reasonable time frame might be for getting a proposed decision in the General Rate Case? I think the ALJ at least got the PDL in Golden State Water, and that's the same ALJ that you have for this case. Do you think it's something we're going to get by year-end or certainly by year-end earnings where we can get the true-up recorded in 2023?

Jonathan, I think we're certainly hopeful of that. If you look back to our last case, we had the same judge in our 2018 General Rate Case, and we did have about a year delay there, but as far as the time that he took was about a year on that from the time that we filed in October to a proposed decision that came out in October. And so with the clearance of the case for Golden State, I would certainly hope that, that time line is reasonable, but you never can tell. And obviously, just a reminder that the Golden State case was really three issues and unrelated to revenue requirement, whereas our case has really big open issues as far as capital investments and expenses. And so it's a little bit more for him to decide in our case. And so that's the guidance that I can give you is we're hopeful, but we're not sure. Let's put it that way.

Did you say it took about one year from the point you filed the settlement in the last case to get a PD?

That's correct.

And then the black coal that is the cost of capital. Any sense what's going on there? Are we going to get a decision or if the commission is going to let it ride until the next filing?

Yes, we're going to hopefully get a decision before we have to file again for cost of capital. But I think that they gave themselves essentially the full extension that they could out to August. And I think we're hopeful that we get a PD well before then and a decision by August. But it all comes down, as you know, to what it says. And we have several issues in there, not just the normal issue of cost of equity. But the question of retroactivity and the capital structure issue is an issue for Cal water. It's both the timing and what comes out that will matter to us.

I mean has there been signs that like it's actively kind of like being worked on? Are there any discussions that you've been aware of and stuff like that? Is everyone just sitting around and waiting for the proposed decision?

The only thing that I'll say, and we haven't heard anything, Jonathan, there's nothing to discuss there. But I will say that 30 days before every commission meeting, which is when they typically publish all of their documents for the meeting, our blood pressure goes up just a little bit. And I know Greg Milleman, who you talked to on these calls before, I usually share a text message at the end of that day, saying no PD. And so I think we're as in the dark as anyone as far as that goes. But you can always look to those meetings, those meeting dates and calculate back 30 days and say, when could news possibly come out of the commission. And certainly, they do issue off-cycle proposed decisions. But generally, they're aggregating all of those on the last possible day that they can get on the agenda.

Regarding the whole drought emergency regulations that the State Water Resource Control Board has issued. I think you said they expire at the end of June or at least is it that the Board just has to come out with a decision whether to extend or let them expire, how exactly does that work?

The regulation expires on June 10th. They issued the emergency regulation. I think it was probably June 10th, the year before, it's for 12 months. It expires on June 10th, unless they do something else. They could always come back here in May and order to be expired earlier, they could extend it. I think the issues are, as you know, and as we've talked about in past quarters that there are still certain areas of the state that are impacted by water shortage, particularly Southern California with respect to the Colorado River situation. I understand we don't address it directly here with Cal Water, but I understand the Colorado River Basin has had a good winter as well. But that is an area that's in the long-term decline and a major source of water for Southern California. And so I think there's a little bit of hesitation regionally on just sort of wiping our hands of the drought because there's still a potential major impact in Los Angeles and Imperial County, et cetera. And we'll just wait and see on that. I think that we're a wash in water in Northern California for sure. And so when we look at our wholesalers and those are the ones that really drive whether we have voluntary or mandatory conservation, we see them making their orders contingent on the state boards order. For instance, the San Francisco Public Utilities Commission, which is a major wholesaler for us in San Francisco Bay Area has made their waiving of drought restrictions contingent on what happens with the State Water board. And so they're awaiting that as well.

Obviously, water has been plentiful as of recent. But yes, from a long-term perspective, I mean, is it your view that the groundwater has been like fully recharged? I know that always takes longer than just the rain and everything. Depending on the long-term view, do you still want to keep kind of these restrictions in place to set the state up to be in the best position longer term?

I think some hydrologists have estimated you need 10 winters like we had back-to-back to really recharge the basins that have been over pumped. And even with all this excess water that we've had, it still takes a long time to recharge those basins. I think my impression is because the governor eased the drought restrictions. He didn't step it all the way back and canceled it and the State Water Resources Control Board has been kind of silent and we kind of follow the State Water Resources Control Board because they are in charge of managing the water in the state. I think they're evaluating that. And my sense is we'll roll back to probably a Stage one or maybe Stage two drought, which is kind of voluntary contribution. But your point about long term, this is a long-term situation. And if you look at the point I was trying to make on going from an extreme drought in the fourth quarter of 2022 to one of the wettest winters on record. I mean, that's what people say climate changes, right? It's extremes and the intensity of the rain and the rain that we had early on in January and February, filled up the reservoirs in Northern California, and then they had to start releasing water because these other storms are coming in because we didn't have enough storage in our capacity. We're a long way from where we need to be as a state in terms of adequacy of supply, sustainability, the ability to move water transmission wise and store water. I think there's a reason why those two declarations are still there. They haven't been fully canceled out yet. And we'll just have to see how the politics of it play out here over the next six weeks with the State Water Resources Control Board. But I'm hoping to keep them in place.

You said maybe roll it back to Stage one or Stage 2. What stage are you currently at? Remind me.

We're in Stage two now. The talk would be to move it back to Stage 1. And that would include restrictions on the use of water for washing your car, wasting water restrictions, that sort of thing. I think Governor Newsom particularly called out that he'd still like to see nonfunctional turf, not be irrigated, that's in line with the potential long-term regulation in California to try to avoid ornamental plantings of lawn everywhere. You want your lawn to be used by soccer players and Frisbee or dogs or whatever, but not to put it everywhere all around. That's a long-term effort that they've had.

And in Stage 1, would you still have the availability of the DRMA?

I don't think so at that point because it's really not a voluntary restriction that we're calling our customers on. It's really Stage two. That's the one that would be qualifying for the DRMA.

Okay, alright. Thanks, thanks for answering my questions. I appreciate it. And yes. Good luck. Good luck with the weather and with the regulatory front.

Thanks, John.

Thanks, Thomas.

Our next question comes from the line of Gregg Orrill from UBS. Please go ahead.

Yes, thanks for taking my question. Good morning, Thomas.

Hi.

I know you kind of touched on this, but can you kind of like recast how you thought about the quarter with adding back those items, the DRMA and the Monterey account and if the Rate Case would have come in on time. How would you have come out really?

We would have had a profitable quarter with those three items there. And obviously, the rate case is the biggest variable because we have a wide gap between what Cal Water's presentation of the facts of the case are and what the Rate Case advocates proposal was. And so our estimate would be somewhere between breaking even and maybe a single to, I'd say, $0.09 or $0.10 profit for the quarter. This kind of depends on other things going on. But that's really speculative at this point. You can also do the math yourself and add those things in and expect them to get to a number. But it's all things that we'll be booking in the future once we get a Rate Case. It's really timing, unfortunately, at this point.

And I would just add that to what Tom said, Greg, that we always tell the street don't get too excited about Q1 because from a demand perspective, it's always the softest quarter. And then having such a hard winter this year clearly had an effect on consumption and overall customer demand. Q1 is just historically a soft quarter. Q1 tends to be an ugly quarter when you have a delayed General Rate Case because you can't book stuff. And I think, again, Tom and the team have tried to put the variables in there, so you can see if they look like, but it's really hard for us to speculate too much further than that until we get the decision and clarification from the commission.

Okay, thanks. Great.

Next question comes from the line of Davis Sunderland from Baird. Please go ahead.

Hi, good morning guys, thanks for taking my question.

Good morning.

Good morning.

I just wanted to ask, I think last time on the call, you guys had mentioned in the BD pipeline, there was some strength you were seeing or some potential opportunities in wastewater with Texas and a few other opportunities, but that it was contingent on just kind of where things were going to go this year with inflation and the macro environment. And I just wanted to ask what the current status is there and what you're thinking with the development pipeline?

In Texas, we have partnered with a company called BVRT, and they have continued to grow. You've had pretty explosive growth in Texas, where we have seen a number of companies and frankly, a number of friends and family that live around us in Silicon Valley, they've kind of followed the companies as they've migrated to Texas because it's pretty positive business environment to operate in. BVRT continues to do very, very well for us. And these are long. It's kind of early seed capital for us is a way to think about it. These are developments that are currently kind of getting underway and being planned and where we go in and become their wastewater supplier. In addition, is we announced last year, we did the Guadalupe Based River Authority project which is allowing us to partner with water wholesaler to build a pipeline into that South Austin area, which we think will be rapidly developed as well. Generally still very good. I mean clearly, the overall market has slowed down a little bit as inflation's kind of creeped up. But so far, the business environment in Texas is kind of has maintained it, it slowed down a little, but certainly still maintained kind of forward momentum as you see a lot of people and businesses move to that state and relocate to that state.

Thank you. That's helpful. And I guess just a quick follow-up to that. Have any of the delays in General Rate Case or any impacts from other parts of the business slowed down the pipeline?

Too early to tell. I mean, the hardest thing about PD is kind of sellers' expectations, what we're willing to pay. And we tend to be kind of a value slanted acquirer. Certainly, inflation starts changing those calculations. And when you run net present value calculations or future value calculations, a change in interest rate can potentially have an effect. I think the thing that's going to be more interesting to watch, frankly, is as the stricter regulations come out about PFOA and PFOS and water quality changes and these small systems don't have the adequate operating capital to make the investments to meet those standards, what do they do? And that may be a large catalyst to get some of these smaller systems to break off ultimately get acquired. I would say that it slowed down a little bit, but certainly, we're still seeing things come to the pipeline, and we've got a number of deals that we're closing and integrating. And as those come to fruition, we'll continue to disclose those on Page 14, we've been putting in the deck every quarter just to share where we are with everything. We'll continue to update those as we move forward throughout 2023.

Davis, let me add one more thing about the nexus between business development and regulatory, which I think is interesting, is that you'll see in the Q that we're preparing to file or I think have just filed a Washington Water Company General Rate Case. That is tied into the acquisition that we made a couple of years ago, the Rainier View Water Company. And so a lot of when you initially buy these systems, they need to help in terms of new capital, as Marty mentioned, improvements in water quality, et cetera. And so we're seeing the second leg of that is being able to go into the rate making process. And we've been treated very fairly by those commissions as far as the rate increases go, most of those are outside of California, and so we don't see the regulatory lag that we have. But I know we have a number of new systems to us in Hawaii that we've acquired over the last three or four years, and we're certainly starting to endeavor to go into the rate-making process there in both Hawaii, Washington, New Mexico and now even in Texas with the ratemaking process, we've seen fairly favorable results from those commissions.

That's very helpful. Thanks guys. I'll pass it on.

Thank you.

There are no further questions at this time. I'd turn the call back over to our presenters.

April, thank you. Everyone, thank you for taking time to be here today. As I mentioned, there's a lot of moving parts here. If you have any questions, please feel free to reach out to us, and Tom and I will be available to answer any questions that you want to ask. Until then, be safe, and we look forward to seeing everyone at the end of July on our second quarter conference call. Thank you very much.

Today's conference call, you may now disconnect.