H2O America (HTO) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the SJW Corp. Second Quarter 2012 Financial Results Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Suzy Papazian, Corporate Secretary. Please go ahead.

Thanks, operator. Welcome to the Second Quarter 2012 Financial Results Conference Call for SJW Corp. Presenting today are Richard Roth, Chairman of the Board, 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, I refer you to this 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 October 22, 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. 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. As Jim will discuss in greater detail, SJW delivered solid results in the second quarter, as water usage rebounded somewhat in response to the relatively warmer and drier weather in California this year. Additionally, the quarter was an eventful one from a regulatory perspective, as we continued the prosecutions of our California and Texas general rate cases, had positive new developments in our application for the proposed improvements to our Montevina Water Treatment Plant and received, what we consider to be, a favorable cost of capital decision. We were also acutely focus on our capital program for 2012, completing nearly 1/2 of our budget capital projects, right in line with our calendar target, as Jim will detail. In both our California and Texas operations, we are entering the summer months with adequate water supplies in spite below-average rainfall in California and the continuing drought in Texas. I will now turn the call over to over to Jim to provide you with a detailed review and analysis of the Q2 results and other financial commentary. After Jim's remarks, I will provide additional information on our regulatory filings, water supplies and other key operational and business matters. Jim?

Thank you, Rich, and thank you, to our listeners for joining us today on our call. Our 2012 second quarter and year-to-date results reflect an increase in revenue due to an overall increase in customer demand and higher rate as compared to 2011. The increase in customer demand was attributable to warmer, drier weather in our California service area. This demand increase was partially offset by lower demand in our Texas service area as seasonal rains brought some relief to ongoing drought conditions in the region. Revenue also includes the impact of a rate increase in California from higher water costs imposed by the Santa Clara Valley Water District, our wholesale water supplier. As you recall, in July 2011, the water district implemented a 9% increase in the wholesale cost of water. Wholesale water cost increases are passed on to our customers through higher rates on a cost recovery basis. Approximately 40% of the revenue increase from higher rates this quarter was due to recovery of these costs. Our second quarter and year-to-date results were also significantly impacted by a lower supply of local surface water in California. Through the first 6 months of 2012, local surface water production was 1.2 billion gallons versus 3 billion gallons during the first 6 months of 2011. At the end of the quarter, our available stored surface water supply stood at approximately 800 million gallons compared to approximately 1.8 billion gallons at June 30, 2011. As a result of our diminished local surface water supply, we expect to experience higher costs for water production through the remainder of the year. However, with existing surface water, committed water from wholesalers in both California and Texas, and available groundwater, we will have adequate supplies to meet anticipated customer demand as we head into the warmer months of summer. Revenue for the quarter was $65.6 million compared to $59 million during the second quarter of 2011. The $6.6 million increase included $1.2 million due to higher customer demand, $4.9 million due to rate increases and $495,000 related to new customers and new lease revenue from real estate operations. Water production costs for the quarter were $27.4 million, an increase of $5.2 million over the second quarter of 2011. The increase was primarily attributable to increased demands and higher unit cost for purchased water and groundwater charges by the Santa Clara Valley Water District in California. The change also reflects the lower use of company-owned surface water, which resulted in an increase of approximately $2.5 million in water production cost. Operating expenses, excluding water production costs, were $24.6 million in the quarter compared to $23 million in the second quarter of 2011. The $1.6 million increase consisted of $1.1 million due to higher payroll and benefit expenses and recycled water retrofit expenses, $534,000 in higher depreciation and $296,000 in higher property and non-income taxes related to new utility plant assets placed in service. These cost increases were partially offset by $343,000 in lower maintenance expenses. Nonoperating expenses included interest paid on long-term and mortgage debt, during the first quarter, of $5.1 million compared to $4.7 million in 2011, reflecting our higher outstanding debt balance. Net income for the quarter was $5.2 million or $0.28 per diluted earnings per share compared to $5.5 million or $0.29 diluted earnings per share for the second quarter of 2011. Turning now to year-to-date results, operating revenue increased to $116.7 million in 2012 from $102.7 million in the first half of 2011. The $14 million increase included $5.9 million due to higher customer demand, cumulative rate increases of $7.3 million and $820,000 from new customers and new lease revenue from real estate operations. Water production costs in the first 6 months were $47.5 million, an increase of $9.8 million over the first 6 months of 2011. The increase was due to lower availability of surface water, increased demand and higher unit costs for purchased and groundwater. Operating expenses, excluding water production cost, were $48.9 million year-to-date compared to $45.6 million in the first half of 2011. The $3.3 million increase consisted of higher payroll and benefits expenses and recycled water retrofit expenses, higher depreciation and property and non-income taxes related to new utility plant assets placed in service. The expense increases were partially offset by $402,000 in lower maintenance expenses. Non-operating expenses included interest paid on long-term and mortgage debt during the first half of 2012 of $10.1 million compared to $9.4 million in 2011, reflecting a higher outstanding debt balance for the period. Net income year-to-date was $6.3 million or $0.34 diluted earnings per share compared to $6.1 million or $0.32 diluted earnings per share for the first half of 2011. As we discussed last quarter, our capital expenditure plan for the year includes investments of $98 million for infrastructure replacement. Through the first 6 months of 2012, we completed approximately $43 million of the plan and construction is in progress on another $26 million. Total utility plant in operation at the end of the second quarter was $1.16 billion compared with $1.11 billion at the end of the first quarter of 2012. Switching to our Land Company operations, in July, we negotiated an agreement to lease the remainder of our Tennessee office building and a portion of the adjacent warehouse. The lease commences on or about July 1, 2013, and is a modified, full-service lease with an initial 15-year term and 4, 5-year option periods. In addition, we have entered into a purchase-and-sale agreement for the sale of our Florida warehouse property. The sale is expected to close during the third quarter of 2012. And with that, I'd like to turn the call back over to Rich.

Thanks, Jim. I'd now like to turn our attention to regulatory matters, where there were several important developments during the second quarter. Evidentiary hearings have been completed in our general rate cases in California and Texas and we are now in the process of preparing and filing the legal briefs in closing arguments that officially conclude the evidentiary portion of the proceedings. We are hoping for decisions in both general rate cases sometime during the fourth quarter of 2012. As I mentioned on our last call, San Jose Water Company's pending general rate case covering years 2013 through 2015 request a $90 million rate increase over the 3-year period. The most important, we think, perhaps most misunderstood factor driving the requested rate increase is declining customer usage. Over the last several years, San Jose Water Company customers have responded positively to numerous calls and mandates for multiple state and local agencies for increased water conservation. Not unexpectedly, customer usage has declined significantly by about approximately 12% between the years 2008 and 2011. While there are marginal savings from reduced variable cost to production, the bulk of San Jose Water Company's costs are fixed and unavoidable due to the maintenance and renewal of our infrastructure to meet water quality standards and public health and safety requirements. The resulting math is simple, but unattractive, spreading fixed costs over lower unit sales equals rate increases for our customers. The situation is compounded because usage assumptions authorized in San Jose Water Company's last general rate case were unrealistically high, resulting in a need for even larger rate adjustments in the current general rate case than would otherwise be necessary to address rising costs alone. A further compounding factor, as Jim mentioned, is that San Jose Water Company's wholesale water provider also instituted large rate increases to reflect decreased usage and rising fixed costs at that agency, which are ultimately passed through to our customers. There is an unfortunate irony to all of this. Customers expect, understandably, that if they use less water, they will pay less. This is a struggle for all involved, customers, regulators and utilities. The blame game has already begun all across the country where water systems and customers must fund the replacement of aging infrastructure, while simultaneously reducing water usage. In my view, the factors driving conservation, which is water availability and reliability, and the impacts to reduced usage will ultimately have on customers' bills, have not been adequately portrayed in the public discourse. San Jose Water Company is demonstrably working with regulators, customers and stakeholders to communicate the reasons for higher rates as clearly as we can. We are also looking closely at our cost structure, capital budgets and business processes to ensure we are operating as efficiently as possible. I would like to give you a brief update on the status of San Jose Water Company's current general rate case. In previous rate cases, we have been able to reach settlement on at least some aspects of the general rate case, thus avoiding extensive hearings and associated filings. However, in the current general rate case settlement process, we were unable to reach agreement with the Commission's Division of Ratepayer Advocates on any issues, and as a result, it was necessary to subject all aspects of the general rate case to the evidentiary hearings process. We are confident that we have submitted a robust case, have diligently adhered to the required protocol and hope for a final commission decision in late November, with new rates effective on January 1, 2013. In a separate application pending before the California Public Utilities Commission, San Jose Water Company is seeking approval to invest approximately $74 million to upgrade our Montevina Water Treatment Plant. That application was filed on September 30, 2010, with evidentiary hearings completed in April 2011, followed by submission of legal briefs. On July 16, 2012, the commission reopened the case seeking additional testimonies substantiating the benefits of the upgrades and updating project cost estimates. We believe this is a positive signal from the commission and welcome this action because it allows San Jose Water Company to update critical water quality, water supply and other cost information that may have become stale since the original application was filed almost 2 years ago. Despite of the lengthy regulatory process, we believe the improvements to our Montevina Water Treatment Plant will ultimately be authorized by the commission. As most of you know, on July 12, the California Public Utility Commission issued a cost of capital decision that preserves, in whole, the negotiated settlement between the Division of Ratepayer Advocates and the 4 water utilities involved in the proceeding, including San Jose Water Company. The adopted settlement agreement accomplishes a number of important things. First, it establishes the cost of capital for both debt and equity. It establishes capital structures. The decision establishes the rates of return on rate-based or ROR. It eliminates the temporary interest rate balancing accounts that were previously authorized for Cal American Water, California Water Service Group and Golden State Water. Finally, it maintains the water cost of capital adjustment mechanism that allows for annual adjustments to the return on equity based upon movements in the interest rate. The result for San Jose Water Company is a return on equity of 9.99%, a cost of debt of 6.68%, a debt-to-equity ratio of 48.65% debt to 51.35% equity, which when combined, result in an 8.38% return on rate base. The cost of capital parameters are retroactive to January 1, 2012, and will remain in effect until December 31, 2014. In May, San Jose Water Company filed an advice letter with the commission requesting authorization to increase revenues by $559,000 for utility plant additions related to the replacement of 2 wells at our Needles groundwater production station. The increase became effective June 14. Also in May, the company filed another advice letter with the commission requesting authorization to increase revenues by approximately $7.4 million or about 3%. This increase is intended to recover higher cost for purchased water and groundwater extraction charges imposed by the Santa Clara Valley Water District. The requested rate increase became effective on July 1, 2012. In Texas, SJWTX Inc. filed a rate increase application with the Texas Commission on environmental quality on August 27, 2010, seeking a 71% rate increase. In March 2011, SJWTX agreed to an interim rate order that provided for a 38% rate increase that would remain in effect, subject to refund until a final order is issued. A hearing on the merits of the case was held in late March and early April of 2012 and closing arguments are currently being developed. A final decision is expected in Q4 of this year. Turning to other matters, our existing surface and groundwater supplies in Texas have helped us grow and provide reliable water service to many smaller water-strapped utilities in and around our Canyon Lake service area. In late 2011, SJWTX surpassed the 10,000-connection level and we're continuing to sensibly grow our presence in Texas, with the acquisition of contiguous water systems that can be efficiently integrated into our established regional platform. In July, SJWTX filed an amendment to our certificate of convenience and necessity, or CCN, to extend our wastewater service area to include a 30-acre expansion in Bulverde and the addition of a nearby 500-acre residential track. The primary reason for the Bulverde expansion is to incorporate new commercial development, but it will also enable us to service school in the area and other tracks that we believe, will ultimately develop. Moving now to water supplies. Following one of the driest weathers on record in California, a relatively wet March boosted this year in Nevada snowpack, but only marginally improved local service supplies. Seasonal rainfall in our Santa Cruz Mountains watershed was only 70% of normal and storage in San Jose Water Company's primary surface water reservoir never exceeded 60% of capacity through the end of June. As such, local surface water supplies will be below normal for the remainder of 2012, as Jim has discussed. San Jose Water Company's overall water supply outlook for 2012 is still good due to our diverse sources of supply. The Santa Clara Groundwater Basin, which is replenished by natural and artificial recharge, remains near capacity and allocations of imported water from the state and federal water projects largely based on stored water are currently at 65% and 75% of requested amounts, respectively, which is more than enough to meet the region's demands. As always, California water supplies remain susceptible to multiple consecutive dry years, which is why it is imperative that we develop alternative drought-proof sources of supply, while Bay-Delta stakeholders to address the complex social economic and environmental problems associated with this key water resource. In Texas, the state water supply picture has improved over last summer but last year's record drought is still having an impact. According to the U.S. drought monitor, nearly 70% of the state remains in at least a cool [ph] of moderate drought. Fortunately, the water supply in serving SJWTX customers are robust and represent a key asset and competitive advantage that is essential to our continued growth. Regarding SJW Land Company, we are pleased with the progress that Jim has outlined. These recent transactions demonstrate the strategy that we have always maintained for our real estate holdings, which is to efficiently utilize our assets to generate cash. In summary, SJW continues to make significant progress towards improving our financial performance. SJW is doing relatively well in the last year of what has become a difficult per year rate case cycle. However, we have received a generally constructive cost of capital decision. And with new rates poised to go on to effect in 2013 for both San Jose Water Company and SJWTX, we believe that the investments San Jose Water Company made in our water systems are intelligent, well-planned and enduring. Over the long haul, these investments should contribute to sustained growth and profitability earnings and dividends for our shareholders. 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] Our first question is from the line of Michael Gaugler from Brean Murray.

I just wanted to kind of take it back to the Real Estate business for a moment. Certainly good news to hear that this is Memphis facility -- sorry, the Knoxville facility, is filling up. I know that you had some extra property there as well that was undeveloped. Any thoughts now that the property is being filled in terms of future development there?

Not really, Michael. I mean, I think that the first step is to get to both the office facility, which is office building, which is now fully leased, and DC, or the distribution center, which is partially leased built and sort of take it from there because it's still a bit, sort of a hesitant market out there although we're seeing a lot more interest than we have in the past.

[Operator Instructions] At this time, we have no other questions. I'd like to turn the call back over to Mr. Roth for your closing remarks.

Thank you, everyone for listening and we look forward to seeing you at the end of the third quarter.

And ladies and gentlemen, this concludes your presentation. You may now disconnect and have a good day.