H2O America (HTO) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the SJW Group Full Year and Fourth Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the call over to Suzy Papazian, General Counsel. You may begin.

Thank you, operator. Welcome to the full year and fourth quarter 2016 financial results conference call for SJW Group. 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 this presentation and related materials posted on our website may contain forward-looking statements. These statements are based on estimates and assumptions made by the company in light of its experience, historical trends, current conditions and expected future developments as well as other factors that the company believes are appropriate under the circumstances. Many factors that could cause the company’s actual results and performance to differ materially from those expressed or implied by the forward-looking statements. For a description of some of the factors that could cause actual results to be different from statements in this presentation, we refer you to the press release and to our most recent Forms 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission, copies of which may be obtained at www.sjwgroup.com. All forward-looking statements are made as of today, and SJW Group 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 is being recorded and an archive of the webcast will be available until April 24, 2017. You can access the press release and the webcast at our corporate website. I will now turn the call over to Rich.

Thank you, Suzy. Welcome, everyone, and thank you for joining us. I am Rich Roth, Chairman and CEO of SJW Group. Jim Lynch, Chief Financial Officer of SJW Group; and Palle Jensen, Senior Vice President of Regulatory Affairs at San Jose Water Company are also with us today. For those who would like to follow along, slides accompanying our remarks are available on our website at www.sjwgroup.com. SJW delivered strong financial results for the year. Looking back at 2016, several accomplishments stand out, including: the delivery of safe, high quality and reliable water service, despite continued mandated drought restriction; the addition of a record $136 million to the utility plant through our sensible and systematic infrastructure investment program; significant progress towards the completion of our Montevina Water Treatment Plant Retrofit project; further enhancements to our customer and stakeholder communications program; and another successful year of meeting drinking water and environmental regulations. I will now turn the call over to Jim, who will review our financial results. After Jim’s remarks, I will address key operational, regulatory and other business matters. Jim?

Thank you, Rich. Our fourth quarter and year-end operating results reflect the positive impact of our California General Rate Case decision, our effective water conservation revenue mechanisms in California, and our ongoing infrastructure reinvestment activities in both California and Texas. Fourth quarter revenue was $79.3 million, a 9.5% decrease over the fourth quarter of 2015. For the year, revenue was $339.7 million, and 11% increase compared to 2015. Net income for the quarter was $13.8 million or $0.67 per diluted share. This compares with $16.2 million or $0.79 per diluted share for the fourth quarter 2015. For the year, net income was $52.8 million or $2.57 per diluted share, compared to $37.9 million or $1.85 per diluted share in 2015. The net decrease of $0.12 in diluted earnings per share for the quarter was primarily attributable to $0.48 decrease in diluted earnings per share, a net revenue tracked in our Water Conservation Memorandum Account or our WCMA, and higher water production expenses of $0.13 per share. This was partially offset by rate increases of $0.23 per share and a gain on sale of real estate of $0.30 per share. Recall that in the fourth quarter of 2015 the company met the revenue recognition criteria of amounts accumulated in our California utilities WCMA account for both 2014 and 2015. This resulted in an increase in fourth quarter 2015 revenue of $20.5 million or $0.60 per diluted share. Total WCMA revenue recognized in the fourth quarter of 2016 was $4.1 million or $0.12 per share. The higher water production expenses were primarily due to cost increases by the Santa Clara Valley Water District by our wholesale water provider in California. The district instituted a 20% cost increase for purchased imported water and groundwater pump taxes in the third quarter of 2016. The rate increases were primarily the result of the decision we received in the second quarter of 2016 on our 2015 general rate case. The decision authorized an 8.6% increase in our authorized revenue requirement for 2016 effective as of January 1, 2016. In addition, rates increased due to the recovery of the district’s midyear water cost increase. The gain on sale of real estate primarily resulted from an eminent domain proceeding conducted by the Arizona Department of Transportation on our Arizona cold storage facility. In connection with the condemnation, the company recorded a pretax gain of $10 million in our 2016 fourth quarter. Turning now to the year, the $0.72 increase in diluted earnings per share was driven by many of the same factors as the quarter. The impact of customer rate increases was a $1.04 per share and the impact of the gain on sale of real estate was $0.25 per share. As in the quarter, the customer rate increases were primarily due to the 2015 general rate case decision and recovery of the district’s higher water cost. The earnings impact from the gain on sale of real estate reported for the fourth quarter was partially offset by a $1.9 million gain in real estate that occurred in the third quarter of 2015. In addition, in 2016 we sold 159,000 shares of California Water Service Group stock for an after-tax gain of $1.9 million or $0.09 per share. These increases were partially offset by higher water production cost charged by the district of $0.43 per diluted share, higher depreciation and amortization expenses of $0.11 per diluted share and lower WCMA revenue of $0.10 per share. Of note, the change due to higher water production cost was partially offset by an approximately $2.5 million saving due to an increased use of local surface water supplies. The higher depreciation and amortization cost resulted from our prior year investments in utility plant and the change in WCMA revenue was due to $3.4 million of 2014 lost revenue that we actually recognized in 2015. We continue to operate under drought restrictions in our California service area, despite the improving water supply condition. Customer conservation in 2016 resulted in a 29% decrease in usage when compared to the 2013 base year. As a result of the savings and improved water supply outlook in February of 2017, the company suspended its water allocation and drought surcharge programs. Rich will provide more information on the local area water supplies in his remarks to follow. Turning to our capital expenditure program, we added $42.3 million in company funded utility plant in the fourth quarter of 2016, bringing total company funded additions to a $136.2 million for the year. This includes approximately $29 million spent on our Montevina Treatment Plant retrofit project. We expect to spend an additional $20 million in 2017 on the Montevina project with project completion targeted for the fourth quarter of 2017. Authorized rate base increased in our California utility to $659 million in 2016 excluding the Montevina project. Turning now to liquidity, 2016 cash flows from operation increased 17.5% over 2015. Included in operating cash flows is a collection of various balancing and memorandum accounts including $15.6 million in collections from the 2012 and 2015 GRC true-ups. In addition, we collected $24 million in cash from drought surcharges. We’ve been collecting drought surcharges under our water shortage contingency plan since June of 2015. Amounts collected are initially recorded by the company as regulatory liabilities and subsequently used to offset amounts authorized by the CPUC for recovery under the WCMA. In December, the company entered into a loan agreement with California Pollution Control Financing Authority or CPCFA for $70 million. Loan proceeds were provided from the sale by CPCFA of its Series 2016 Revenue Bonds, to loan and underlying revenue bonds accrue interest at 4.75% and our due November 1 of 2046. At the end of the year, we had $130.8 million available on our bank lines of credit for short-term financing of utility plant additions and operating activities. The borrowing rate on our line of credit advances averaged 1.48% during 2016. On the final note, in January 2017, 444 West Santa Clara Street, L.P., an entity in which SJW Land Company holds 70% limited partnership interest, entered into an agreement to sell its interest in the commercial building and land the partnership owns and operates for approximately $11 million. The sale is expected to close by the end of the 2017 first quarter. With that, I will stop and turn the call back over to Rich.

Thank you, Jim. California’s water supply outlook has much improved compared to the same period of 2016. Abundant precipitation have resulted in full reservoirs in most of the states, and more importantly, the Sierra Nevada snowpack that has not been equaled in more than two decades. Roughly half of California is no longer under drought conditions according to the U.S. drought monitor. Hopefully, ground water levels in the Santa Clara Valley have rebounded to their normal range for the first time since the end of 2013. While the improved water supply outlook has allowed San Jose Water Company to remove drought surcharges from our water conservation program, [staying locally utilities] [ph] are taking a cautious approach, citing the possibility that dry weather could return. On January 31, 2017, the Santa Clara Valley Water District, our wholesale water supplier, maintained its call for 20% conservation goal for our customers. On February 8, 2017, the California State Water Resources Control Board also voted to extend the emergency drought regulations until further directions by the governor. Our California customers have done a remarkable job of conserving, helping to stretch our precise water suppliers’ response to the continued calls for conservation. Usage reductions in 2016 exceeded targets set by the State Water Resources Control Board and the Santa Clara Valley Water District when compared to the 2013 base year. Clearly, the water supply challenges and mandated drought restrictions have impacted our customers as well as San Jose Water Company. Customers are growing increasingly aware of these challenges and are demanding sufficient water supplies even in times of drought. SJW is committed to ensuring that our water supplies are reliable and drought tolerant. Accordingly, we are working with regional stakeholders to identify and evaluate solutions to meet the demands of the region’s growing economy and customer base. The increasing public awareness of water issues underscores the need for effective transparent and timely engagement with stakeholders. SJW’s efforts to ensure that a comprehensive and effective communication capability as a core competency are paying off and allowing us to initiate important albeit difficult conversations on water supply, conservation and rates with our customers. Greater engagement with all stakeholders will be needed as we address long-term structural challenges. And SJW continues to expand its broad array of communication competencies. Turning now to regulatory affairs, San Jose Water Company received new rates, effective January 1, 2017, intended to generate a revenue increase of $13 million or approximately 3.8%. The amount reflects the 2017 escalation year increase from our 2015 General Rate Case decision. Both the California and Texas public utility commissions continue to recognize the need for continued investments in water system infrastructure, and thus have enabled regulated water utilities to make those investments. It is especially noteworthy that SJW’s 2016 consolidated capital program exceeded $136 million and marked a record year for plant utility investments. Importantly, the capital program included in our Montevina Water Treatment Plant retrofit project, which when completed will allow San Jose Water Company to maximize the use of local water supply from our 6,500-acre watershed in the Santa Cruz Mountains. These approved investments are not only essential to providing safe, high quality and reliable water service, but are also the foundation for the company’s long-term earnings potential. The California Public Utility Commission also recognizes the structural water supply challenges facing investor-owned water companies and the customers they serve. To that end, regulatory mechanisms are in place to track and recover lost revenue due to mandated conservation and other drought restrictions. These mechanisms have provided a high degree of assurance that utilities will have a realistic opportunity to recover their capital investments and earn a reasonable return. Conservation will be a way of life going forward. And San Jose Water Company and SJW Group are well prepared to deal with this impact. SJWTX, Inc. or SJWTX, our Texas water and wastewater utility, is proving to be an excellent investment and an outstanding platform for growth. Since its acquisition in 2006, SJWTX has roughly doubled in size from 6,500 connections to more than 13,000 connections owing to a robust water supply portfolio and a strong regional economy along the I-35 corridor that is drawing residents, businesses and jobs. With a diversified portfolio of water supplies, a growing wastewater business and continued additions to customer base through organic growth and acquisitions, we remain optimistic about the prospects for SJWTX. Additionally, we continue to evaluate and opportunistically liquidate our real estate portfolio on SJW Land Company, which is expected to periodically augment SJW cash flow and financial performance. In January 2017, the board authorized a 7.4% increase in SJW’s annual dividend to $0.87 per share. Dividend increase demonstrates the company’s strong commitment to our shareholders and is an evidence of the board’s confidence in the company’s business plan. We would also like to extend a warm welcome to Commissioners Martha Guzman Aceves and Clifford Rechtschaffen to the California Public Utilities Commission, and express our appreciation to outgoing commissioner’s Catherine J. K. Sandoval and Michael Florio for their service. We look forward to working with the new commissioners to address the many water related issues facing California’s regulated water utilities. Finally, we would also like to welcome Greg Landis to our board. Greg brings significant experience to SJW based on his 35 plus year legal career, including over two decades in the telecommunications and energy industries as well as in regulatory and government affairs. His expertise will serve SJW well, as we look to capitalize on utility sector growth opportunities. With that, I’d like to turn the call back to the operator for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Michael Gaugler of Janney Montgomery. Your line is now open.

Hey, good morning, gentlemen.

Good morning, Michael. How are you?

Doing well. Great to see you guys were able to make it into the office and didn’t float away this morning. We…

We fairly had our share of rain over the last few weeks.

Yes. I noticed my news stories this morning with nothing but footage of flooding in San Jose. I think they…

Yeah, the good news is it’s been pretty localized and the floodwaters right now are starting to recede. So we’re all looking forward to some dryer conditions ahead.

What a difference do you make? Anyway, my question on that, did that flooding cause you guys any issues that would perhaps impact your O&M expenses for it?

We did have some groundwater wells and other infrastructure in the area. And we’re taking a look as the waters recede in terms of what has occurred in those particular areas, in terms of damage to that infrastructure. So I think it’s a little premature to estimate what potential O&M that’s going to result in. I do think that we’ve had some support from the regulatory front in that regard, and maybe I can ask Palle to kind of give an update on that.

Yes. Hi, Michael, we actually activated our catastrophic event memorandum account effective February 10. So any expenses of capital requirements resulting from any damage associated with these storm damages will be covered in that memorandum account for future rate recovery.

Okay. Also given the level of water across the state, in your area, I would guess that you’re going to use more your own supplies this year.

Yes. We’ve actually had some really good precipitation up in our Lake Elsman area in our Santa Cruz watershed. We do still have the ongoing project on our water treatment plant, our Montevina plant that will stay offline now probably into the third quarter. But once we bring that plant back online, we should have full use of what has been stored in the reservoir.

Okay. And then just one last one, and probably for you to, Jim, the $11 million sale of the property in the first quarter, and I think you mentioned now that was a joint venture type situation. How much of that $11 million would dropdown to the pretax point?

Right now, I haven’t made that calculation, Michael, because we’ve got a 70% limited partnership interest in the partnership. But what happens once the property is sold is we settle up on the partnership. That’s the only asset that’s held by the partnership. And so in addition to the sale proceeds we’ll be settling up any other accounts between the general partner and the limited partner. So we’ll have a better idea of what that is once we finalize the purchase price and go through the exercise of settling up with the other partner.

Okay. Well, that’s all I had, gentlemen. Thank you.

Okay. Thank you.

Thank you. [Operator Instructions] One moment for our question. And I’m showing no further questions at this time. I’d like to hand the call back over to Jim Lynch for any closing remarks.

Well, thank you operator. We’d like to thank all of our listeners out there for your continued interest in SJW Group and we look forward to talking with you again next quarter. Thanks and have a good day.

Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program. You may all disconnect. Everyone have a great day.