Good morning, and welcome to the California Water Service Group Quarter two 2022 earnings release call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press the star one again. For operator assistance throughout the call, please press star zero. Finally, I would like to advise all participants that this call is being recorded. Thank you. I'd now like to welcome David B. Healey, Vice President and Corporate Controller , to begin the conference. Over to you.
Thank you, Paul. Welcome everyone to the 2022 second quarter earnings call for California Water Service Group. With me today is Marty Kropelnicki, our President and CEO, and Tom Smegal, our Vice President, Chief Financial Officer. Replay dial-in information for this call can be found in our second quarter earnings release, which was issued earlier today. As a reminder, before we begin, the company has a slide deck to accompany the earnings call this quarter. The slide deck was furnished with an 8-K this morning and is also available at the company's website at www.calwatergroup.com. Before looking at this quarter's results, we'd like to take a few moments to cover forward-looking statements. During the course of the call, the company may make certain forward-looking statements.
Because these statements deal with future events, they are subject to various 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 risk and uncertainty 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 gonna pass it over to Tom to begin.
Thank you, Dave, and good morning, everyone. Welcome to the second quarter earnings release call. I wanna start talking about the financial summary on slide five, and I'll get into some of the details in just a moment. Just to give everybody the top line, our net income attributable to the group is $19.5 million or $0.36 per share, and that's down considerably from $38.2 million and $0.75 per share in the second quarter of 2021. For the year-to-date period, that is a relatively similar result in that our net income is $20.6 million or $0.38 per share, as compared to $35.2 million or $0.69 per share in the comparable year-to-date period in 2021.
Flipping to slide seven, we'll get into some of the details of this. The primary focus of the change in earnings has to do with our unbilled revenue accrual. I've been with the company now 25 years, and I've been in management talking about financials, I think, for about 12 years with you all. We often talk about our unbilled revenue accrual. The thing to remember is that this is the calculation that we do of the value of water that has been used by our customers, but is not yet billed and is therefore outside of our regulatory mechanisms. This has some fluctuation within the year, and we talk about it in every quarter.
If you've been with us for a little bit, in the second quarter of 2021, there was a substantial increase in our unbilled revenue accrual, and however, that came down to a normal range at the end of the year. This year, in kind of in reflection of the large increase last year, we have a large decrease in our unbilled revenue accrual. That was $15.2 million change in revenue associated with that, and a big impact on the earnings per share as well for the quarter.
Just as a reminder, the company's unbilled revenue accrual at the end of the year is very stable, and management believes that we are very likely to see a result for the unbilled revenue accrual at year-end, which is within ±$2 million of the year before. While it's a big swing here in the quarter and definitely a big swing from last year, I do wanna emphasize that by year-end, we expect that all of that volatility will go away, and we'll have a relatively normal unbilled revenue accrual. The other thing that's impacting the quarter that is outside of our control is that we had a change in the measured valuation of our non-qualified plan assets.
That's just due to market conditions and the value of those assets decreased $6.2 million relative to the second quarter of 2021. Our general rate increases, this is the step rate increase in California and changes in rates in other states, added $6.9 million, so that's a very positive element for the year. That is partially offset by changes in wages, depreciation, interest, and other operating and maintenance expenses that we would normally expect given the passage of time and inflation. Our CapEx for the quarter and year -to -date are both to plan and a little bit higher than in the prior period.
I will skip over the bar charts because they largely talk about what I just mentioned, the unbilled being the primary driver, along with the mark-to-market. Now I'm gonna turn it over to Marty to talk about the California general rate case.
Great. Thanks, Tom. Good morning, everyone. Thanks for joining us here today for the second quarter results discussion. The general rate case, the 2021 California general rate case, California being our largest operating entity, has continued. We have concluded on our hearings and briefs have been filed with the administrative law judge. We still anticipate that the GRC to have an effective date of January 1st, 2023. There's been no change in the contested items among the party. Having said that, there is still no major disagreement between the parties over sales and water water mix production that was included in the general rate case. Accordingly, we've alerted the administrative law judge that a partial settlement may be filed sometime in August. Tom, do you want to cover the cost of capital?
I think you're a little closer to that one.
Sure. Thanks. Thanks, Marty. Very similar story procedurally with respect to our cost of capital proceeding in California. The hearings have concluded, the briefs have been filed, and the ALJ has the cost of capital case under consideration. I wanted to remind the investing public that, in our filing for cost of capital, we requested a lower cost of debt than had last been adopted in the last case. If that were adopted, along with no other changes to cost of capital, we would expect to see a $11 million reduction to our revenue coming out of California, as a result of the lower cost of debt.
That's our financing and refinancing program that brought our cost of debt down from 5.51% in the last case to 4.23% on a weighted average basis in this case. We have not taken a reserve for that amount in part because we don't know the timing on effective date of the cost of capital case, and in part because there's two other elements to the cost of capital case that are unknown at this time. Those elements are the cost of equity, return on equity, and also the capital structure for the company. Investors should be aware that that's out there, and the commission could make that retroactive, but we have not yet booked that into our results here in 2022.
Marty, I'll turn it back to you for a drought update.
Great. A couple things going on with the drought. First and foremost, the drought continues. I think, as we've seen the heat wave, not just in the U.S., but really around the world, it highlights the continued need to focus on supply resiliency and sustainability. California, as we mentioned last quarter that the California State Water Project deliveries were cut to 5%, that was impacting some of the regions who solely rely on the water from the state. For us, customer usage is down 5% in the second quarter compared to 2021, but I think the broader trend is the most important. If you look at the water savings number or conservation number, year -to -date it's 2%.
It's 5% for the quarter, but if you look at just the month of June, it was over 11%. That's a good sign that our drought programs and our messaging to our customers is starting to take hold, and I'd expect that number to grow as we go into the drier summer months, July, August, and September. In terms of drought spending, if you remember, all the state is on a Stage Two drought alert for the state of California. We're at about $400,000 during the quarter that's recorded in a memorandum account, which is incremental cost that has been used to respond to the drought, for recovery at a future date.
The total balance of that balancing account now since 2021, which is when the governor declared the drought, is about $1.2 million. Drought messaging is starting to take hold going into the dry summer months, and we wanna push that number up as high and as close to that 20% target that we have as of this date as possible. Couple other items to watch in the second half of the year. One is capital spending. As Tom mentioned, our capital spending was up 6% year-over-year, and while we're very, very happy with that, I wanna make sure we're very clear about this. As supply chain issues have continued around the globe, we're not immune from those supply chain issues.
Our team internally has done an excellent job at mitigating those risks that threaten our ability to get capital in the ground. The longer those risks continue to go on, the greater the probability of an effect on Cal Water. There's some uncertainty as we go to the second half of the year on our ability to get all the capital in the ground if we hit any supply chain issues. As I mentioned, the team has done an excellent job at mitigating those issues, but obviously it gets harder as these delays in supply chain, our procured items that we need to get the capital in the ground go on. In addition to that, with the rate case, we don't have regulatory approval on some stuff yet.
If you recall the rate case, the way our rate case cycle works. It includes the 2022 capital program. As we go through this GRC cycle, we're making some assumptions and we're prioritizing the high-risk capital or things that we think we need to get done as a company that are top of the list in terms of critical. We don't have assurance of those until the commission actually approves the 2021 general rate case. The other thing I'd like to point out is that our bad debt reserves remain high at about $6.7 million, primarily driven by California now. In the other states, we have started the collection process coming out of the COVID pandemic. In California, we are just starting that process now. It's a 90-day process to start shutting off people for non-payment.
Our first notices actually went out this week to start the process. Prior to this week, collection activities have been zero as we waited for a commission approval to start the process. Customer response will be critical. What we've seen in the other states that we operate in, once we started the collection process, customers started to pay their accounts. That'll be something to watch in the second half of the year. Going on to the next page, slide 13, just a quick update on business development. The business development pipeline remains strong as we go into the second half of the year. On this page, this is the highlight of projects we've closed, projects that the commissions have recently approved, and projects we've announced during 2022.
In total, there's over 3,600 water connections that are in process, as well as over 4,000 wastewater connections. As we go into the second half of the year, the BD team is very busy, and we expect that activity to continue as we move into 2023. Tom, you wanna cover the capital and depreciation?
Sure. Just as a reminder for slide 14 and 15. Excuse me. We've made no changes to these slides, and we wouldn't expect to make changes until we had a significant event coming out of California regulatory or any new project that we announced. You'll see slide 14, the capital spending targets shown there. Those are relative to the California general rate case request. No changes except for the update on the year-to-date figure, and the same with the rate base. That rate base is relative to the California general rate case request, plus the rate base in our other states. Marty, I'll turn it over to you for a summary.
Great. Thanks, Tom. Where are we? In summary, as Tom mentioned, the change in the unbilled for the quarter was a major item. Market volatility that we've all seen and lived with throughout 2021 has lowered the unrealized valuation of certain retirement plan assets in our non-qualified plans, and those will float up and down based on market condition changes and volatility. The core business remains strong as we await regulatory outcomes in California. For those of you that have been with us a long time, as you know, it's the third year of the rate case process for us. It's always the hardest time of the three-year cycle for Cal Water, the California entity, as we wait for regulatory approval of our general rate case.
We have the most amount of regulatory lag at this time. As we wait, all eyes are on the commission as we try to resolve the cost of capital and the 2021 general rate case. Management remains focused on the drought. That's a big deal in California. We're going into the peak summer months, August, September and October for fire season, and obviously mitigating supply chain issues and of course the collection now of past-due receivables for customers who haven't paid their water bill in a while. Between that and focusing on the general rate case, it's gonna be a very busy second half of 2022 for the company.
Of course, in closing out, I'd just like to say that the growth opportunities that the BD team have worked on have remained strong, and I expect that to continue as we go into the second half of the year. With that, Paul, we will open it up to questions. Paul, are you there?
Sorry. Apologies.
No problem.
At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from the line of Ben Kallo, analyst from Baird. Your line is now open.
Hey, gentlemen.
Good morning, Ben.
How are you?
Good. How are you?
Good. Maybe just on, Tom, just, you know, back to, you know, how you started with, the unbilled revenue and, you know, estimates. You know, if I look at slide 15, and maybe my first question is, you know, have you guys thought about giving annual guidance at all in a range maybe to kind of rope us all in, just because the intricacies of working in California?
We have discussed that internally. We've not come to any conclusions on giving annual guidance. The reminder is, of course, with slide 15, that we are a company whose profits are relative to its rate base.
Right.
What we're showing there is the, you know, the estimated regulated rate base of the corporation in total, including California and the other states. The opportunity to earn a return on investment is what drives a company like ours.
Right.
Generally speaking, over time, we would hope to earn the authorized return on the investment in rate base, and that's generally what's shown on slide 15.
That would be the $95 for 2022?
I'm sorry, that $1.95 billion, that's $1.95 billion of rate base.
Oh, right. Okay, I understand. Sorry, I was reading that incorrectly. And then, Marty, just on, you know, your CapEx deployment. You noted that you guys are on schedule for the year, but, you know, obviously all the risks out there. Could you just maybe talk through kind of, you know, how it's changed since last quarter? I think maybe I asked the same question then, but, you know, if it's gotten better in supply chain or stayed the same or gotten worse.
Sure. I would say, Ben, in a lot of ways it's gotten worse. It's just the lead times that we're seeing to order. I call them capital inputs, but, you know, it's pipes, it's valves, it's fittings. We just finished a study internally, and as we were pulling the report together over the last two weeks, the lead time for ductile iron went from 8-12 weeks to 26 weeks.
Wow.
If you think about the number of capital projects that we do on an annual basis and the timeline to do design, permitting, and then procurement, that procurement piece, with pre-ordering going out that far out now, it has the real potential to slow us down a little bit. Now, when I say slow us down, it just means that capital will take longer to get into the ground, right? Especially in California, where we have a prospective test year. The capital's approved as part of the rate case, then our job is to get it into the ground. We're not a historical state, we're a prospective state in California. We're just seeing those timelines taking longer to order stuff.
Some of the things the team's been doing, they've been putting stuff out to bid earlier. They've been expanding the supplier base. We have loaded up on items we can get now that we may not have a need for right now, but we know we're gonna need them in the next six months to 12 months. The team really has done an excellent job at keeping us on track. But again, it's a global supply chain issue, and it's just taking longer to get stuff in, especially water main. Our goal is to have zero effect, but I think the probability of that is very low because the supply chain is getting more constrained at this point in time. Does that make sense?
It does. You know, back to the cost of capital, obviously, you know, interest rates have changed since you filed. Does that have any bearing on the decision, or is there a way for you guys to go revisit that or no?
Ben, there's a little bit of an interesting question from a regulatory process standpoint, and I don't mean to be vague about it. The data that was supplied in the initial case was really 2020 data, going back to the end of that year as far as what was put into the input models from the analysts. We did have hearings, and we did have briefs in the case where I'm certain, and this is public documents, you could go read them. We tried to draw the commission's attention to the fact that since those data points had been drawn, actually the interest rate environment and the market environment had changed really dramatically.
It's up to the commission, the administrative law judge and the five commissioners to recognize that and make a decision that incorporates that newer data. They're not necessarily obligated to. One of the things, though, that the parties agreed to, and we've had as a mechanism in California for many years, is a water cost of capital adjustment mechanism. In looking at a baseline period of the Moody's Aa utility bond curve, if there's a change of more than 100 basis points upward or downward, it triggers a change in the return on equity of 50% of that. A 100 basis point change in the Moody's Aa curve would change the cost of equity by 50 basis points. That's the collar, however.
If you get to 99 basis points, it doesn't change. It's something that's out there for extreme events. When we look at the data now compared to the baseline, Moody's double A and what's out there in the market right now, it appears that we're close to triggering for 2023. If the commission were to just leave the data alone and just react with the cost of capital adjustment mechanism, there is a possibility that we would get a bump from their authorized amount to a 50, you know, 50 basis points higher amount for return on equity. However, it's a 12-month weighted average, and it's very dependent actually on what's happening with interest rates over the entire period. It's not a point in time.
We don't know if that would trigger in 2023. It seems more likely that it would trigger in 2024, given that the rates, the instantaneous rate is now much higher than the trigger point, but you'd need those many months of higher rates to trigger the weighted average. All of that being said, we're hopeful that the commission can do the right thing, look at the data that's come out lately and make sure that the companies have a fair return on equity that is reasonable in the current environment.
Great. Thank you. To my last question, just with, you know, energy utilities increasing rates. You know, I don't know if across all of your service areas, but, you know, we read about a lot of that. How does that impact, you know, you, from, I guess, you know, your rate case? I mean, does that factor in at all when, you know, commissioners say that, "Well, you know, we can't raise rates here because they're being raised over there." Also, you know, your, you know, how does it impact, you know, ratepayers, you know, fighting your rate case as well? Thank you.
Let me try to address it just from a mechanical standpoint first. As a reminder that California, since the 1970s, has allowed the water utility companies a tracker mechanism for power costs, purchase water cost and pump tax costs as well. There's no material financial impact on the company when electric power rates change. That's essentially a pass-through. From the psychology of the commission standpoint, I think that we're really kind of in a little bit of a whipsaw situation, which is interesting.
I've read the brief from the ratepayer advocate in our rate case, and they initially, back when they filed their testimony back in January, February, they were talking about how awful the economy was and how everything was very, you know, everyone was jobless and they were reacting to the pandemic. Their later statements have to do with inflation and have to do with the impact of the very hot economy on our customer base and the people in California. You know, it's obviously there's a populism factor when you talk to any appointed or elected official, anyone that's representing the public. In total, the electric power cost is not the biggest impact to the company.
It's probably our fifth or sixth biggest cost, compared to you know, purchase water and employee wages and that sort of thing. Certainly a factor, we think, when the commission evaluates our rate cases, but we're hopeful that it's a little bit more mechanistic. Marty, I don't know if you have anything.
Yeah, I was trying to think back, Tom, at my time here with Cal Water, with you. I mean, I've never had a commission not consider an input cost of production. Ben, to your broader point of, well, if they're raising rates, you can't raise your rates. I've never heard that argument raised by the commission. It's always been an input cost into our production. The other thing I would say in terms of just affordability in general, if you look on page four, where we have kind of our corporate strategic map, the first thing you see is affordability. We try to stay very focused on affordability, what it means to our customers, encompassing everything that we do, including those power input costs.
When we do our rate case planning and look at where we're driving to for the next three, six, nine, 12 years, we try to take affordability under advisement. I think that's really kinda paid off for us because with the last part of your question was you talking about customers who might be intervening in our rate case. We have a couple intervening parties in this current rate case. They're two cities and they've always kind of been involved, but they've been pretty silent the last couple rate cases. We don't have a lot of interveners kind of hitting us on that side about affordability.
I think it's because we've done a pretty good job at trying to balance that with the needs of growing the rate base and the capital needs of the company to and the needs to protect and promote water health and conservation within the state.
Thank you guys very much. Appreciate it.
All right, Ben, have a good day.
As a reminder, if you would like to ask a question, please press star then the number one on your telephone keypad, and we'll pause for any final questions. There are no further questions at this time. I turn the call back over to Marty Kropelnicki.
All right, Paul. Thank you. Everyone, thanks for joining us today. As mentioned, all eyes on the California regulatory activities and fire season and the startup of the collection process in the state of California. We'll look forward to giving everyone an update when we end Q3. I guess that will be, Tom, the end of October will be.
End of October, yeah.
The next earnings call that we'll update everyone. Thanks for joining us. Be safe. Have a great day, and we'll talk to you soon. Thank you.
This concludes today's conference call. You may now disconnect.