H2O America (HTO) Q4 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the SJW Corp. Fourth Quarter and Full Year Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today, to Ms. Suzy Papazian, Corporate Secretary. Please proceed.

Thanks, operator. Welcome to the Full Year and Fourth Quarter 2011 Financial Results Conference Call for SJW Corp. Presenting today are Richard Roth, President and Chief Executive Officer; and James Lynch, Chief Financial Officer. Before we begin today's presentation, I would like to remind you that yesterday's press release and this presentation may contain forward-looking statements. The statements are only projections, and actual results may differ materially. For a description of factors that could cause actual results to be different from statements in the release and in this presentation, we'll refer you to the press release and to our most recent Forms 10-K and 10-Q filed with the Securities and Exchange Commission. All forward-looking statements are made as of today and SJW Corp. disclaims any duty to update or revise such statements. You will have the opportunity to ask questions at the end of the presentation. As a reminder, this webcast will be available until April 23, 2012. You can access the release and the webcast at the corporate website, www.sjwcorp.com. I will now turn the call over to Rich.

Thank you, Suzy. Welcome everyone, and thank you for joining us. I'm Rich Roth, President and CEO of SJW Corp. On the call with me today are Jim Lynch, Chief Financial Officer of SJW Corp.; and Palle Jensen, our Senior Vice President of Regulatory Affairs. We're going to slightly reorder the call agenda this quarter to focus on the results of operations for 2011. So I'm going to turn the call over to Jim now to provide you with a review and analysis of the financial results. After Jim's remarks, I'll address regulatory matters and provide perspective on key operational and business issues. Jim?

Thank you, Rich, and thank you to our listeners for joining us today on our call. Quarter-over-quarter and year-over-year, we experienced stronger operating results in 2011 when compared to 2010. Our quarterly and annual results were driven by a combination of rate increases of 8% and 6%, respectively, and increases in customer demand of 4% and 2%, respectively, at our water utilities. In addition, in December, we received authorization from the California Public Utilities Commission to recover the accumulated balance in our Mandatory Conservation Revenue Adjustment Memorandum account or MCRAM, recognizing the balance totaling $5.7 million in the fourth quarter 2011 revenue. As we have discussed on previous calls, the MCRAM account was established to track the revenue impact of mandatory conservation instituted by the Santa Clara Valley Water District in effect from August 2009 through May 2010. For the year, total revenue was $238.9 million compared to $215.6 million recognized in 2010. The increase was primarily attributable to $12.4 million in rate increases, $3.4 million in increased customer demand and recognition of the MCRAM. Note that despite the increase in customer demand, usage for the year was below amounts forecasted in our current general rate case by approximately 10%. Water production costs were $92.1 million compared to $87.3 million in 2010. The increase was primarily attributable to higher unit cost for purchased water and groundwater extraction charges from the water district. In June, the water district implemented a 9% increase in the wholesale cost of water. Operating expenses, excluding water production costs, were $92.5 million for the year compared to $90.3 million in 2010. The $2.2 million increase consisted of $2.9 million in higher depreciation, $1 million in higher property and non-income taxes related to new utility plant assets placed in service, $1 million in higher maintenance expenses related to increased water main leak repair activity, and $952,000 in higher administration and general expenses. Recall that in the fourth quarter of 2010, we recorded a $3.6 million impairment charge on a real estate investment in Tennessee. No similar charge was required in 2011. Interest paid on long-term debt for the year was $18.9 million compared to $15.9 million in 2010. The increase was primarily attributable to interest on the $50 million in senior notes we issued at the end of the second quarter of 2011 and the full year of interest on the revenue bonds we issued in June 2010. Also recall that in 2010, we sold 907,000 shares of California Water Service Group stock recognizing a pretax gain of $19 million. No similar sales of stock occurred in 2011. Our net income for the year was $20.9 million or $1.11 diluted earnings per share compared to $24.4 million or $1.30 diluted earnings per share for the year ended December 31, 2010. The trends and contributing factors impacting our fourth quarter results were consistent with our annual results. Fourth quarter revenue was $62.3 million, $11.5 million higher than the $50.8 million in revenue recognized in the fourth quarter of 2010. Fourth quarter 2011 revenue was impacted favorably by increased demand, higher rates and a recognition of the MCRAM balance. Water production costs for the quarter were $22.3 million compared to $20.9 million in the fourth quarter of 2010. The $1.4 million increase was primarily the result of the June 2011 water district rate increases for purchased water and groundwater extraction. Operating expenses, excluding water production costs, were $23.4 million for the quarter compared to $26.4 million in the fourth quarter of 2010. The difference is primarily due to an increase in depreciation on new utility plant placed in service and the 2010 fourth quarter real estate impairment charge. Fourth quarter 2010 results also included $14.5 million of pretax gain on the sale of California Water Service Group stock. Again, no similar sales of such stock occurred in 2011. Net income for the fourth quarter of 2011 was $6.6 million compared to $8.1 million in 2010, and diluted income per share was $0.35 compared to $0.43 in 2010. During the fourth quarter of 2011, we continued our focus on utility plant investment, placing $31.3 million of net additions into service. For the year, net utility plant additions placed into service were $65.3 million, bringing our gross utility plant to $1.1 billion. As discussed previously, our long-term plans call for continued investment in our core utility plant infrastructure adding up to $300 million through 2014, subject to CPUC approval. In 2012, we also plan on expending $12 million to $14 million on permitted utility plant additions in connection with the CPUC's resolution L-411-A. As you recall, L-411-A was issued by the CPUC to address the bonus depreciation impact that resulted from the 2010 Tax Act. Further, we plan on spending approximately $74 million over the next 3 to 4 years on our Montevina treatment plant retrofit project with construction anticipated to begin in the second half of 2012. However, we are still awaiting approval from the CPUC to move forward on this project. Our planned utility plant expenditures in connection with the 2010 Tax Act and our Montevina retrofit project are in addition to the $300 million we plan to spend through 2014 on core utility plant infrastructure. With that, I'd like to turn the call back over to Rich. Rich?

Thank you, Jim. SJW has several important regulatory filings pending in 2012 and I would like to provide you with an update on those filings and their key elements. In California, the appointments of Commissioners Sandoval and Florio were unanimously confirmed in January by the state senate. Commissioner Ferron is currently scheduled for his confirmation hearing in March. With all but 1 of the 5 commissioners now confirmed, we believe the commissioners will turn their full attention to regulatory issues and filings. In early January, San Jose Water Company filed its required general rate case covering rates for the years 2013 through 2015. The filing of SJWC's general rate case application marks the beginning of a year-long regulatory process that is scheduled to culminate with a commission decision in late 2012 and with rates going into effect in January 2013. In the application, San Jose Water Company is requesting a $90 million revenue increase over the 3-year period. As we have discussed on previous earnings calls, it is imperative that the redeterminations are based on realistic usage numbers and accordingly, a significant portion of the requested rate increase results from the use of more accurate and realistic usage assumptions. The requested increase also reflects increased costs due to SJWC's infrastructure replacement program and increased operating expenses. In its filing, San Jose Water Company seeks commission approval for approximately $300 million in infrastructure replacement cost. These capital outlays are needed to continue to ensure safe and reliable water service to our customers. This level of capital investment demands revenue -- stability. And accordingly, San Jose Water Company has requested a water revenue adjustment mechanism or RAM, any modified cost-balancing account in its application. San Jose Water Company has also requested a healthcare memorandum account, any memorandum account for expenses related to anticipated new water quality standards for chrome VI. In a separate application filed with the CPUC, San Jose Water Company is seeking approval to invest approximately $74 million to upgrade its Montevina Water Treatment Plant. That application was filed on September 30, 2010, and is still pending with a proposed commission decision expected in the fourth quarter of 2012. As most of you are aware, San Jose Water Company's cost of capital determination for 2012 to 2014 is still pending before the commission. In October 2011, the commission's division of rate pay advocates and the 4 utilities involved in the case reached a settlement and agreed to a return on equity of 9.99%. Additional information requested by the administrative law judge has been submitted. Any decision is expected in the second quarter of this year. In August of 2010, SJWTX, Inc. filed a GRC application with the Texas Commission on Environmental Quality. The TCEQ authorized SJWTX to implement a portion of the requested rate increase in October of 2010. The administrative law judge scheduled mediation in March of this year. If the parties are unable to reach a settlement, hearings are scheduled for the last week in March. Any commission decision is expected sometime in the second quarter of this year. SJWTX reached a milestone in 2011 when it surpassed 10,000 connections with the acquisition of adjacent service area operating assets and slightly more than 500 additional connections in Comal County and the City of Bulverde. As we have previously reported, much of our success in Texas has been the result of our ability to work cooperatively with various public agencies and regulators as we improve customer service throughout our regional water system. While much of Texas experienced severe droughts and water shortages in 2011, SJWTX was able to meet strong customer demand by virtue of its multiple robust and dependable water supplies. Water supplies in much of the western United States continue to be pressured by environmental demands, population growth and the increased demand for energy. December 2011 was one of the driest months on record for Northern California. So the state is off to a slow start with the snow pack and run-off below seasonal averages. Fortunately, last winter's heavy rains have allowed the states reservoirs to remain at or near seasonal capacity. As a result, we do not expect significant reduction in the availability of water from the state and federal water projects in 2012. I'll provide you with a more complete update on water supplies at our next conference call. Notably in January, the SJW Board authorized an approximately 3% increase in SJW's annual dividend to $0.71 per share. In addition to demonstrating a strong commitment to shareholders, the increase also underscores the board's confidence in the company's business plan. Thank you, all, for your continued interest and investment in SJW. With that, I will turn the call back to the operator for questions.

[Operator Instructions] Your first question comes from the line of Heike Doerr with Robert W. Baird.

I don't see a cash flow statement in the press release. Perhaps I missed it, Jim. Can you give us what the CapEx ended up being for 2011?

Sure. For 2011, we actually added in our statement of cash flows $62.4 million in company-funded additions to utility plant and $7.3 million in contributions in aide of construction. And that would be in both utilities.

Okay. And as we think about 2012, I know you gave us this $300 million through 2014, but would we expect the 2012 amount to be similar to what we saw this past year?

I think we're looking at probably an increase of about 9% or so over 2011 and that would not include any incremental amounts that we would have for the L-411-A or the Montevina plant.

Okay. I know we've talked about Montevina as this separate $74 million. We had also talked -- Rich, I think it was 2 calls ago, you talked about reclaimed water in that part of the next rate case. You were going to include about $25 million to go towards that. Are we including that $25 million in this $300 million or is that upside as well?

That's in the $300 million.

Okay. And a quick housekeeping item, Jim. I see that the regulatory assets has spiked this quarter compared to last quarter; it had been about $90 million, now we're looking at $120 million. Can you explain what the increase is?

Yes. A lot of that had to do with the pension -- the increase in pension liability. The other side of that, the regulatory entities is accounted for in regulatory assets. So if we take a look at our pension liability, you'll also see a similar spike there. And that's being driven principally on the reduction in the discount rate that happened in 2011.

Got it. And just for clarification, Rich, did you say we were going to get an answer on Montevina in the second half of 2012? I think I may have misheard you.

Well, we said the second half and we said the fourth quarter. And I think that the private best guess right now is sometime towards the latter part of this year. So I don't know that it would be in, say -- the third quarter, probably more likely in the fourth quarter.

So if we wouldn't get final approval until late 2012, would we still see some of that construction money being spent in 2013? Or does the entire project shift back a year?

I think it's probably delays for about the year. I mean, I don't think it's -- would be appropriate to begin construction without commission approval. And if it's late in the year, it's just hard to see us getting much done this year.

[Operator Instructions] Your next question comes from the line of Michael Roomberg with Ladenburg Thalmann.

Just first off, Jim, I know you mentioned in your commentary that consumption, despite the increase year-over-year, was still 10% below what had been authorized or used as a projection basis in your previous rate case. Can you quantify that in dollar terms?

Well, I think you're roughly looking at somewhere in the neighborhood of $20 million thereabouts. Now understand that you've also got in 2011 figures the recovery of the MCRAM, so that has to be taken into account when you're doing a comparative.

Sure. But in terms of the revenue shortfall, the $20 million is an annual figure?

Just on revenue, yes.

Okay. Okay, that's helpful. And then, Rich, I believe you mentioned -- just given, obviously, it's still early innings, you've had a very dry winter so far. You mentioned that surface water -- I'm sorry, that your purchase water would still be available going into next year. But can you kind of update us on how we should think about the surface water availability of the company's own reservoirs?

Yes, I think right now, it looks like it's going to be substantially reduced from prior years. So prior past years have been -- the prior 2 years, rather, have been significantly wet years, and we've been able to get a lot of benefit from that. So I mean we still have some winter left here but I think right now, we'd be looking at pretty significant reductions in our available surface water supply. And as you know, that impacts our production cost.

Sure. Sure, okay. Just going back to the rate case. You guys have applied for the RAM and it seems just based on the commission's sentiment that, that will go forward. I'm just wondering the other utilities that have made this transition to decoupling, they've accrued pretty sizable balances -- accrual balances. And the funding of those balances have been a bit of an issue for those guys. I'm just wondering in your discussions in your rate case, whether or not funding those balances will be something that will be discussed and how the company thinks about that in the context of the case?

That's a good question, Michael. It's Palle here. The issue with the RAM balances is really twofold. One is that the accumulation of the RAM balances are due to sales forecasts that are basically too high. So what we have done in our case, we have adjusted our sales forecast down. And if we are granted a RAM, we expect to accumulate very limited balances in our RAM account. Okay? Now the second issue is related to the recovery process for the RAM balances. At the time, the original RAMs were put in place, I don't believe they would start through the adequate recovery process for the RAM balances. What we have requested in our filing is that we have an annual true-up of the RAM balances and annual recoveries of existing balances. So there's 2 -- this is two-pronged: one is, we don't believe that we're going to accumulate large balances in a new RAM; and second of all, we hope to be able to convince the commission for an annual recovery of any existing balances.

Okay. Okay. And these balances, would they receive rate base treatment or would it be more of a 90-day commercial paper type?

The standard in California is a 90-day commercial paper rate.

Okay. Okay, that's helpful. And then just lastly, somewhat of a bigger-picture question for the company, we were surprised to read recently that the city of San Jose is facing some significant financial issues. And I guess I say, "surprised" because I know it's one of the most affluent metro areas in the country. When I think of the criteria that might make for an appealing growth opportunity for regulated water utilities, clearly municipal distress as well as favorable demographics, those 2 factors come to mind. So I guess I'm wondering in light of that, are you guys aware of kind of the local budget issues that have been facing the city? And does that open up just giving your geographic situation -- being situated geographically in that region, whether that would open up an opportunity for SJW to expand its service territory?

Well, San Jose's budget crisis has been pretty well documented and Michael Lewis in Vanity Fair and others have documented it. I think that the mayor and the council have been pretty upfront about the budget situation. I think it's probably too early to tell what's going to actually happen. There are valid measures that are being proposed. And I think that it still remains to be seen whether or not this will indeed -- the budget crisis will indeed precipitate some sort of opportunities. We're certainly very close to the city and believe that it would make a lot of sense. But I think that the politics of the situation just haven't fully matured. And right now, it would be, I think -- it would be premature to make any judgments about opportunities that may or may not arise. It would seem very logical that they would and that makes a lot of sense for private capital to find its way into the water utility systems. But I think right now it would be premature to say.

And at this time, I'd like to turn the call back over to Mr. Roth for closing remarks.

Thank you, everyone, for listening in. We look forward to seeing you next quarter. Thanks.

We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect and have a great day.