H2O America (HTO) Q1 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the SJW Corp. First Quarter 2014 Financial Results Conference Call. [Operator Instructions] As a reminder, this 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 proceed.

Thanks, operator. Welcome to the first quarter 2015 (sic) [2014] 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, we refer you to the press release and to our most recent Form 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 July 28, 2014. You can access the release and the webcast at the corporate website, www.sjwcorp.com. I will now turn the call over. Richard?

Thank you, Suzy. Welcome, everyone, and thank you for joining us. I'm Rich Roth, Chairman and CEO of SJW Corp. On the call with me today are our Chief Financial Officer, Jim Lynch; and our Senior Vice President of Regulatory Affairs, Palle Jensen. SJW's Q1 earnings reflect the long regulatory lag being experienced by San Jose Water Company in many California Public Utilities Commission-regulated utilities. San Jose Water Company's rates for their pending general rate case should have gone into effect on January 1, 2013. Today is May 1, 2014, 16 months after the date rates should have gone into effect, and we still have not yet received even a draft decision on our general rate case application for the years 2013 through 2015. Equally challenging is preparing for our next CPUC-mandated general rate case for the years 2016 through 2018, which must be filed in January of 2015. Listeners familiar with utility regulation will understand how extreme regulatory lag and the pancaking of general rate cases complicate and frustrate the whole Regulatory Compact. San Jose Water Company is keenly aware of its responsibilities to work with regulators so that economic regulation can evolve and adapt to a rapidly changing world, and we are committed to the tasks and challenges that lie ahead. Utilities and regulators have always shared responsibility and accountability for effective regulation, and we simply must find better ways to work together to achieve effective, timely and balanced solutions and outcomes. In spite of the obvious frustration, SJW continues to be fully engaged, constructive and cooperative with regulators in identifying methods by which all filings may be properly prepared, carefully reviewed and diligently processed. I will now turn the call over to Jim, who will provide a detailed review and analysis of the Q1 results and other financial commentary. Jim?

Thank you, Rich. As Rich noted, our first quarter operating results were adversely impacted by regulatory lag, as well as the ongoing drought conditions in our California service area. San Jose Water Company continues to operate under interim rates, that, except for the impact of pass-through water expenses, were essentially the same as those in effect at the end of 2012. The negative impact on first quarter earnings caused by delayed rate relief was partially offset by increased customer usage brought on by the drought conditions in California. The drought, however, has also lead to diminished surface water supply, resulting in higher water production expenses. Net income for the quarter was $906,000 or $0.04 per diluted share compared to $1.3 million or $0.07 per diluted share for the first quarter of 2013. The decrease in quarterly net income was primarily due to higher water costs in our California service area. The higher water costs were partially offset by higher customer usage, a decrease in general and administrative expenses due to cost control measures and certain onetime expenses in 2013 that did not occur in 2014. In addition, 2013 first quarter nonoperating income included a $1.1 million pretax gain on the sale of real estate investment property in Connecticut. No similar sale occurred in the first quarter of 2014. Income per share in 2014 also reflects the impact of approximately 1.4 million shares of common stock that were issued in April of the prior year. First quarter revenue in 2014 was $54.6 million, an increase of 8.9% over the first quarter in 2013. The increase was primarily due to a 7% increase in customer usage and an average 5% increase in water rates, offset by a 5% decrease due to a change in our balancing and memorandum accounts. In addition, our real estate operations contributed $486,000 in new revenue due to payments from the new Tennessee property tenant that commenced in July 2013. The customer usage increase was primarily due to persistent drought-like conditions in California. The higher water rates were primarily due to a 9% pass-through rate increase imposed by the Santa Clara Valley Water District in July 2013 and an average system-wide rate increase of 23% implemented in our Canyon Lake, Texas service area in December 2013. Water production expenses for the quarter were $23.5 million, an increase of 28% over the first quarter of 2013. In addition to the previously noted increases in customer usage and wholesale water expenses, essentially no lower-cost surface water was available for use during the quarter. This compares to the prior year first quarter when approximately 1.2 billion gallons of surface water was used. It cost approximately $2.4 million to replace each billion gallons of surface water with imported or groundwater. Operating expenses, excluding water production expenses, were $25 million in the first quarter, a decrease of 4% over the first quarter of 2013. The decrease was primarily due to an 18% reduction in general and administrative expenses, partially offset by higher depreciation and property taxes related to new utility plant assets placed in service. The decrease in general and administrative expenses was due to lower recycled water retrofit expenses, lower pension costs and payments in 2013 to secure permits for our Texas water supply project that did not recur in 2014. Updating our capital expenditures program, we added approximately $25 million in utility plant during the quarter, which represents 28% of our planned 2014 budgeted annual capital investment. In addition, we added $1.6 million in developer-funded projects. As of March 31, 2014, our gross utility plant totaled approximately $1.3 billion. With that, I'll stop and turn the call back over to Rich.

Thank you, Jim. While San Jose Water Company's performance lagged, financial results for both SJWTX, Inc. and SJW Land Company showed improvement. SJWTX continues its strong growth in connections revenue and profits. We believe 2013's regulatory headwinds are now mostly behind us. Also, 2014 will be the first year since 2009 that all of SJW Land Company's properties have been fully leased and reflected in the results for the entire year. Now let's turn our attention, once again, to regulatory affairs. As I mentioned at the outset of this call, we are still awaiting a decision on our 2012 general rate case application. Interim rates have been in effect since January 2013, and we will implement new rates retroactively to this date when a final decision is issued. On February 28, San Jose Water Company filed for reimplementation of the Mandatory Conservation Memorandum Account or MCRAM to track the revenue shortfall associated with the implementation of the expanded conservation measures. The MCRAM also tracks operational administrative costs associated with the implementation of our water conservation plan and effectively functions as a full Water Rate Adjustment Mechanism. The request was approved by the California Public Utilities Commission effective March 31. As previously reported, San Jose Water Company received approval from the California Public Utilities Commission to invest $62 million in the renovation of our Montevina Water Treatment Plant. On March 17, San Jose Water Company filed the first of what will be several future annual requests for rate base offsets for investments in the plant. The current filing seeks to recover $670,000 of projected cost occurred during -- incurred during 2013. Although the amount of the current filing is relatively small, it will hopefully establish a protocol for timely approval of more substantial future filings. The initial filing is still pending before the Commission. In Texas, activities are underway to transfer rate-making from Texas Commission on Environmental Quality to the Public Utility Commission of Texas effective September 1, 2014. The PUCT intends to initially transfer most relevant rules, regulations and procedures from the TCEQ and later, undertake formal rule-making to adapt and modify those rules. SJWTX has joined other Texas investor-owned utilities to monitor the transition process and to participate in the development of new PUCT rules. Following the driest calendar year on record in 2013 and 2 years of below average precipitation in California, Governor Brown declared a drought state of emergency on January 17 and requested all residents to voluntarily reduce usage by 20%. On February 25, the Santa Clara Valley Water District increased their 2014 conservation target from 10% to 20% of 2013 water use. On February 28, the California Public Utilities Commission ordered all water utilities to implement voluntary water conservation measures to comply with the governor's call for conservation. In response, San Jose Water Company put in effect its water conservation plan. These rules focus mostly on outdoor water use that typically accounts for 50% of an average household's usage. Fines, penalties and water allocations are not being employed at this time. A comprehensive communications campaign is currently underway to inform customers and other stakeholders of the water supply situation. San Jose Water Company is coordinating its communications with the Santa Clara Valley Water District, other retailers and municipalities in the area to ensure consistent messaging and to leverage resources. We have seen increased customer awareness and interest in how the utilities are responding to the drought. Operationally, we are preparing for peak usage months, anticipating limited supplies. Effective March 1, 2014, Santa Clara Valley Water District reduced treated water deliveries to 80% of the monthly contract allocations through December 31, 2014. Increased groundwater production should allow San Jose Water Company to meet demand. In summary, the growing regulatory and water supply challenges are requiring more of SJW and its employees. However, I am confident in our ability to meet these challenges and develop viable long-term solutions. SJW continues to make prudent investment in our water system, employee-efficient and sustainable business processes and provide exceptional customer service. Additionally, our regional business model facilitates efficient design, construction, maintenance and operation of the water systems while providing high-quality water service at reasonable rates. On behalf of everyone at SJW, I want to assure you that we remain acutely aware of and focused on our responsibility to provide excellent service to our customers and generate attractive long-term returns for our shareholders. With that, I will turn the call back to the operator for questions.

[Operator Instructions] And our first question comes from Kenneth Dorell with Janney Capital Markets.

This is Ken standing in for Ryan. My first question is around the general rate case proceedings. I heard you mention that you haven't received a draft decision yet. Once you guys receive that draft decision, should we expect, what, 30 days before you get some commission action on that? How does that work, timetable-wise?

That's a good question. Palle Jensen here, by the way. The statutory requirement is that the proposed decision has to -- cannot be posted on the commission's calendar until 30 days has elapsed. So it's a 30-day period of time between the issuance of the PD to the earliest time it may appear on the commission's calendar. And so it all depends on the set schedule of [indiscernible] meetings essentially.

Great. And then also just more of a modeling question. But -- so once that -- I guess the rate case gets approved and settled, those retroactive rates, how will they hit the P&L? Will they be recognized wholly in -- as far as, like, going back to 2013, will they be recognized wholly in that quarter or will be spread over 12 months, 24 months? How does that work?

We would not recognize anything until the final decision is reached. And then once the final decision is reached, we would ensure that whatever is in that final decision, from a revenue recognition standpoint, for those items that have been identified that meet the revenue recognition requirements, we would record those at that time. They would be recorded at that time, though, as opposed to retroactively going back and doing any sort of a restatement.

Great. And just my last question would be on SG&A. Obviously, you guys did a very nice job keeping that down in the quarter, given groundwater traction, power costs. Going forward, should we expect that to kind of creep back up to historical levels? Or was there a fundamental shift on SG&A line in 1Q that we should expect going forward? Just curious how to think about that.

There was a fundamental shift relative to pension costs. If you refer back to our 10-K, the pension costs this year compared to the prior year were about $2 million, $2.5 million lower. And so we'll expect to see that going forward as a fundamental change. The recycling retrofit is certainly a project that we are eager to continue working on and have budgeted certain amounts in the current year that will come to fruition as we move forward.

[Operator Instructions] And we have no other questions on queue at the moment. Okay, if there are no other questions, we'll turn it back to Rich Roth for any closing statements.

Well, thanks, everyone, for tuning in and listening to the call. Certainly, as matters develop over the course of the next quarter, we'll try to keep you posted. It's a very sensitive time as the rate case decision is being finalized, and we want to be very respectful of the commission and the policies and procedures around finalizing a decision. But as soon as we know something, certainly, we'll get back to you. Thanks again. Look forward to talking to you at the end of the third quarter -- second quarter. Thanks.

Thanks, everyone, for your time and your participation. You may disconnect, and enjoy the rest of your week.