SJW Corp. Q3 2008 Earnings Call Transcript

Oct.27.08 | About: SJW Corp. (SJW)


Q3 2008 Earnings Call

October 23, 2008 1:00 pm ET


Suzy Papazian – Corporate Secretary

W. Richard Roth – President and Chief Executive Officer

David A. Green – Chief Financial Officer


Christian Bradbury – SJW Corporation

Heike Doerr – Janney Montgomery Scott


Good day, ladies and gentlemen, and welcome to the SJW third quarter financial results conference call. My name is Tawanda and I'll be your coordinator for today. (Operator Instruction) I'd now like to now turn the call over to your host for today, Ms. Suzy Papazian, Corporate Secretary.

Suzy Papazian

Welcome, everyone, to the third quarter 2008 financial results conference call for SJW Corp. Presenting today are Richard Roth, President and Chief Executive Officer, and David Green, Chief Financial Officer.

Before we begin today's presentation, I'd like to remind you that yesterday's press release and this presentation may contain forward-looking statements. We wish to caution you that these statements are just projections and that actual results and the timing of future events 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 the Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 10, 2008 and the report on Form 10-Q filed on August 1, 2008. 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 January 22, 2009. You can access the release and the webcast at the corporate website,

I will now turn the call over to Rich.

W. Richard Roth

Thank you all for joining us today. I am Richard Roth, the President and Chief Executive Officer of SJW. I am joined today by our Chief Financial Officer, David Green, and our Executive Vice President of Finance, Angela Yip. Together, we are pleased to provide you with SJW’s third quarter results for 2008.

As most of you know, SJW’s executive team now includes two top-flight financial executives, David Green, our new CFO, and Angela Yip, our Executive Vice President of Finance. David’s fresh perspective and diverse experience complements Angela’s unparalled water utility experience. Their combined skills will help SJW navigate these challenging time.

We believe that the current economic environment may result in opportunities for well-managed and financially capable water companies. The structural changes that we have made at SJW are already having an impact on our ability to analyze and assess our operations, finances, and growth opportunities and should serve us well going forward.

The last month has brought extraordinary changes to the financial markets. As such, some of my comments this morning will focus on the issues of credit and liquidity and their impacts on our operations and growth plans.

Water companies, and water utilities specifically, are very capital intensive so we must be particularly acute in our approach to changing capital costs and availability. Today we will do our best to describe SJW’s capital situation, our plans to address our capital needs, and what we see as potential impact, positive and negative, to SJW’s overall plans and strategies.

I believe SJW’s operating and financial models, strong balance sheet, and outstanding asset base position us well to deal with current market conditions. David will provide you with detailed information on SJW’s third quarter results, which were strong, so my comments on the results will be brief. I will then focus on some of the business drivers, recent regulatory developments, and where we are headed from here.

Through economic cycles and changing capital markets it is important to remember that water utilities provide a very critical and basic service. Additionally, we operate in a relatively stable, regulated environment. During SJW’s 140-year history, we have persevered in the face of financial, operational, and force majeure events to continually deliver shareholder value. Our focus will remain on financial discipline, operational excellence, and providing outstanding customer service.

To sustain and improve our financial performance, SJW will continue to operate efficiently and execute infrastructure replacement plans. Our regional model of operations is efficient, our franchise is of high quality, our reputation with regulators strong, and our balance sheet healthy. This means we are in a relatively strong and enviable position to endure economic adversity.

Clearly, access to reasonably priced capital is a key to our operations. Fortunately, the timing of our upcoming general rate case should allow us to include current estimates of the amount of capital required and the associated costs.

Based on regular conversations with lenders and others knowledgeable about capital markets, I believe that we will be able to fund our capital projects but with increased capital costs.

I also want to speak to SJW’s dividend. One of the hallmarks of SJW has been our ability to consistently maintain and increase our dividend through sound financial management and maintaining a conservative pay-out ratio. This balance, discipline, and sound dividend strategy has served the company and its shareholders well and should allow us to sustain our annual dividend while generating cash flows with which to fund infrastructure investments.

We continue to carefully assess our capital needs, evaluate funding options, and adjust to changing market conditions. We are maintaining an open dialogue with lenders, investors, and regulators. And finally, we are developing alternatives should capital and liquidity issues persist.

Turning now to third quarter results, SJW’s third quarter 2008 results were strong and demonstrate again SJW’s ability to perform consistently, even in challenging environments. In the third quarter of 2008 SJW Corp. earned $0.44 per diluted common share compared with $0.43 per share for the same quarter in 2007.

Year-to-date SJW’s earnings per diluted common share are $0.93 compared to $0.84 per share for the first nine months of 2007.

I would now like to turn the call over to David for his report.

David Green

I am very pleased to make my first presentation of the financial results for SJW Corp., particularly in a quarter that demonstrates our steady growth and profitability even as we navigate through the economic turmoil of late.

In the third quarter of 2008 total operating revenue was $69.5 million, an increase of $4.7 million, or 7.2%. This compares with $64.9 million of revenue in the third quarter of 2007.

For the quarter, net income increased 4% to $8.3 million compared to $8.0 million for the same period in 2007. Basic and fully diluted earnings per share were $0.45 and $0.44 respectively compared to $0.44 and $0.43 respectively for the same period in 2007.

Revenue growth was primarily driven by infrastructure investment that translated to rate increases, most notably in California and to a lesser extent in Texas. Together, rate increases represented $4.5 million of the incremental revenue growth.

Water production costs of $30.8 million was higher this quarter versus a year ago by only 2%, or $1.2 million, which compares to revenue growth of approximately 7%. The lower rate of growth in water production costs was attributable to greater availability of surface water in San Jose in 2008 compared to 2007 and to modest declines in California usage.

These factors were partially offset by higher unit prices for purchased water and ground water extraction charges.

Operating expenses in the third quarter, excluding water production costs, increased by $2.7 million, or 10.8% for the third quarter of 2007.

General and administrative expenses, maintenance, non-income taxes, and other operating expenses combined represented 76% of the increase in operating expense, or $2.0 million of the increase.

Some of the Q3 expense items with significant increases were salaries and wages, professional fees, permitting fees, and increase fuel and paving costs. Because asphalt is an oil-based material, higher oil prices led to increased costs for our paving activities.

To give you some additional context on expenses, we realized increases in reserves and various one-time expenses of approximately $700,000. Some areas where these expenses were realized include legal, consulting and professional service fees, and project expenses related to our growth plan.

Income tax expense increased by $338,000 in the third quarter compared to the same quarter last year, largely due to higher income.

Depreciation and amortization expense increased $298,000 in the quarter due to increases in utility plant investment versus a year ago.

Putting everything together, our third quarter 2008 operating income of $11.5 million was up $734,000, or 6.8% over the same period in 2007.

On the balance sheet, we had almost $32.0 million more debt outstanding this quarter compared to the third quarter of 2007. More than $11.0 million of the increase was attributable to short-term debt plus $20.0 million of additional long-term debt. The aggregate increase in debt was the primary driver for increased interest expense of $502,000.

Our 2008 capital spending, which is primarily focused on utility plant, drives our rate base and therefore our ability to increase earnings. We had approximately $47.0 million of new capex through September 30, 2008, including approximately $39.0 million of company-funded investment.

An increase in the market value of our investment in California Water Service Group contributed net of tax comprehensive income of $3.7 million in the quarter in addition to dividend income of $322,000.

SJW Land Company investments continue to product positive cash flow. The land company assets together with our investment in California Water Service Group contribute cash to help fund our own dividend and capital spending.

On the whole, we are pleased with our financial results for this third quarter, especially in light of the current economic challenges.

This concludes my report for the Q3 financial performance of SJW Corp. Thank you for your interest in the company. I will now turn the call back over to Rich.

W. Richard Roth

As you heard from David, SJW Corp. delivered another solid quarter of earnings and growth, investments in infrastructure, the income from our investment in California Water Service Group, and real estate, together with cumulative rate increases achieved through our regulatory compact on our regulated water utilities were important factors in achieving these results.

During the third quarter the California Public Utility Commission approved a series of advice letters providing additional revenue to offset increased operating costs and additions to utility plants. These included a revenue increase of $6.1 million to offset the increased cost of purchased water and higher pump tax charged to SJWC, that’s San Jose Water Company, by the Santa Clara Valley water district, Revenue increases of approximately $1.2 million for plant improvements placed in service by SJWC.

As far as SJWC’s general rate case for the years 2007 through 2009, the company is authorized to implement a step rate increase of approximately $4.0 million, or about 2.2%, in 2009. The precise amount of the increase will be determined when the CPUC releases its September 30, 2008, CPI forecast.

The decision also authorized additional rate recoveries to be phased in as capital projects are completed in 2009.

We are currently in the process of preparing rate filings for both our California and Texas utilities. We will file SJWC’s rate case as part of the normal 3-year general rate case cycle with the CPUC in January 2009, with new rates anticipated to become effective in January 2010.

A rate case for our Texas utility, Canyon Lake Water Service Company, will be filed with the Texas Commission on Environmental Quality on or about November 14, 2008, with rates anticipated to become effective in January 2009.

Separate from the general rate case filing, under the CPUC’s water action plan, SJWC and all large regulated water systems in California are required to implement tiered water rates. On August 21, 2008, the CPUC issued a final decision regarding SJWC’s conservation rate design, the implementation of a water revenue adjustment mechanism, including $150,000 annually for enhanced conservation efforts.

The decision requires SJWC to implement two-tiered increasing block rates in November 2008. A key outcome of our design and the decision is that SJWC did not give up upside potential of higher usage by adopting a full revenue adjustment mechanism, as some other investor-owned water companies have done in California.

On October 2, 2008, the commission issued a decision granting the authority for SJWC to sell our former main office building to Adobe Systems. We intend to close such sale by the end of 2008. In addition to approving the sale, the long-awaited decision authorized an increase of approximately $1.1 million in 2008 revenue resulting from the replacement of the old main office with a new office facility.

The decision denied SJWC’s request for authorization to reinvest the net proceeds from the sale into rate base. Rather, the decision order the net proceeds of approximately $1.5 million from the sale of the building to be allocated to the rate payers and shareholders in accordance with the gain on sale decision.

The determination of whether we will be authorized to include in rate base some or all of the costs for the purchase of the new headquarters is deferred to SJWC’s next general rate case.

Moving on to the question of water supply, we have said before that approximately 50% of the water supply of the SJWC is imported by the Santa Clara Valley Water District, our water wholesaler, from the Sacramento San Joaquin River Delta. The delta continues to be the focal point of California water policy but there have been no new mandates for water use restrictions or reductions and we are working closely with the Santa Clara Valley Water District to manage our local supplies.

Although there has been much discussion among the numerous stake holders there has been little progress on a long-term delta management solution. In 2008 the district expects to meet current contract volumes in spite of continuing ecological concerns about the delta and low snow pack in the Sierra Nevada Mountains.

As a contingency for the possibility of a third dry year in 2009, the Santa Clara Valley Water District is continuing to ask the public to voluntarily reduce water usage.

Local surface water supplies, which are a small but important part of our water portfolio, were lower during the third quarter of 2008 than the five-year averages, but higher than the third quarter of 2007. Ground water supplies remain at about 80% of capacity. As a reminder, SJWC is authorized by the California Public Utility Commission to recover any unit price increases in ground water extraction and purchased water costs through balancing accounts.

We continue to view the water supply issues facing California and Texas as both a challenge and an opportunity. As I reported during last quarter’s conference call, we continue to work with regulators and public entities to expand the use of recycled water by the extension of the Recycled Water Distribution Network in our service territory.

We recently completed a recycled water master plan and developed several key recycled water infrastructure projects for inclusion in SJWC’s upcoming general rate case filing.

In Texas we continue to successfully expand and enhance our platform, adding customers and service territory and making sensible acquisitions. During the third quarter we announced entering into agreements to acquire the water service area known as the City of Bulverde CCN, that’s a Certificate of Convenience and Necessity, and the related infrastructure adjacent to our service area in Texas, for an aggregate purchase price of approximately $4.1 million.

We are especially gratified with our success in working across municipal and agency boundaries to solve complex water supply issues and create an efficient and effective regional water system. This is a rare success for a private company and a tribute to our local management and agency partners in Texas.

The pending acquisition should allow Canyon Lake Water Service Company to provide water service to an important growth corridor north of San Antonio and adjacent to our existing service area. We continue to actively pursue opportunities for consolidation of adjacent water systems and additional regional platforms in Texas and elsewhere.

Like the rest of the economy, the commercial real estate market is experiencing change. We expect to see slowing growth in the real estate sector. In our land company, enhanced scrutiny and careful asset management are the key management imperatives. SJW land company is working closely with tenants and addressing current conditions for all of our real estate investments to preserve cash flow and keep the properties fully leased.

We continue to execute our strategy of converting non-income producing properties into income producing properties as market conditions dictate and opportunities arise. We do not expect any significant changes to our operating strategies.

In closing SJW’s strong balance sheet and quality base have enabled the company to fund significant investments in our water systems and increase the shareholder dividend without compromising the company’s overall financial well being.

SJW’s regional approach to the water utility business and disciplined expense management have resulted in efficient operations and outstanding customer service and we have been very deliberate in executing our business plan by effectively managing resources, controlling costs, and engaging our employees.

That concludes my remarks for today. I would like to open up the floor to your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Christian Bradbury – SJW Corporation.

Christian Bradbury – SJW Corporation

I don’t know if you provide this at all, but do you break out Texas revenue. I’m just wondering how much it contributed for the quarter.

W. Richard Roth

We don’t, but it’s combined under regulated services. I could give you a couple of data points that I think are important for the Texas operation and you could probably impute from these data points the relative contribution. But we have about 8,700 customers there. That’s about 11% growth over the same period a year ago. And that’s the customer count there. So I think that from that you can probably get a relative accurate idea of sort of its contribution.

Christian Bradbury – SJW Corporation

Also, the conservation base rates are going to go into effect this quarter?

W. Richard Roth

They’re in effect right now.

Christian Bradbury – SJW Corporation

That includes a modified cost balance account that allows you to pass through all the production costs?

W. Richard Roth

There are different ways in which the conservation base rates are being implemented. There are sort of two mechanisms and one includes a decoupling mechanism as well as a modified full cost balancing account.

Christian Bradbury – SJW Corporation

Right. The coupling mechanism is the RAM, right?

W. Richard Roth

Yes. And the other one is sort of a modified approach to that, that SJW has adopted, which includes a modified RAM, but not one that really decouples. We have thinner tiers to our conservation base rates and although it’s not 100% just based on usage, there is basically some decoupling but not very much. In other words, we still have basically, you know, our revenue will be driven by usage and will not be decoupled and we do not have a full cost balancing account.

Christian Bradbury – SJW Corporation

How are you weathering the foreclosures in both California and Texas. Are you seeing an increase in your uncollectable accounts?

W. Richard Roth

The foreclosure situation is, as you know, is pretty geographic specific and it’s not to say that there aren’t foreclosures in the San Francisco bay area but most of the ones you read about in California are in the Central Valley, Stockton, Sacramento and that area. We are fairly fortunate here not to see too much of that. We do see some slowing in payments and so forth.

The only time we really get exposed to uncollectable receivables is someone just ups and leaves the area. Most of the time our restriction policies and so forth allow us to work with the customer to collect all the revenue that’s been billed and only if they sort of leave town in a hurry do we have to eat it and those are very seldom.

Texas is a fairly strong, we’re watching it carefully, but Texas continues to be able to weather the storm pretty well. They didn’t probably get as over-heated as other parts of the nation, in an economic sense, and they’re not experiencing quite the downturn, although we’re watching it carefully.


Your next question comes from Heike Doerr – Janney Montgomery Scott.

Heike Doerr – Janney Montgomery Scott

Can we go back to this Adobe sale? It wasn’t clear to me, the Commission is going to get to choose how you reinvest that money? I thought it was part of your regulatory free base and so you could just automatically reinvest that into the regulated side of the business.

W. Richard Roth

We were the first company to sort of test some of the new Commission rules. And what the new Commission rules sort of bifurcate utility and non-utility property. This was a little bit of a test because it was utility property but it was going to become non-utility property when we moved out. So it was not, without blaming the Commission, some of the rules were not quite clear. And they’re becoming more clear.

But essentially what happened is we filed for an application to sell utility property because we were still in the building, knowing we would have to move out and it would become non-utility property. And so the Commission had a difficult time and I’m not saying they weren’t right but they had to take a careful look at this and try to understand it.

So in essence, what happened is they considered this to be utility property, even though subsequently once we moved out it became non-utility property and the rules guiding the sale of utility property are that most, if not all, of the gains go to the rate payers. And that’s what the decision said here. And when I say gain I mean net proceeds, net of the cost of sale.

So that’s what happened.

Heike Doerr – Janney Montgomery Scott

And what does the gain to rate pay translate into? A credit on a bill? Is that what we’re talking about.

W. Richard Roth

They say over the next year there will be a lowering of the revenue requirement or reduction in bills for our customers over the next 12 months as we rebate to them the net proceeds from the sale.

Heike Doerr – Janney Montgomery Scott

Can we have a refresher on what kind of credit line you have, who that is with, and what other options you have as far as any short-term financing needs you may have.

David Green

We have a $35.0 million unsecured credit line with one of the strongest banks out there today. We still have got quite a bit of capacity on that line. We do feel comfortable where we are with our short-term financing needs. And we’re confident that should we need to add to the facility, that that would be possible.

Heike Doerr – Janney Montgomery Scott

What is the current thinking as far as what capex is going to be next year and what kind of cash on hand do you have that this can be internally funded, with the way the balance sheet looks right now?

W. Richard Roth

I think the capital budgets for next year have been pretty much disclosed in the 10-K so you have a pretty good idea.

Heike Doerr – Janney Montgomery Scott

So there’s no change.

W. Richard Roth

I can’t say that there’s not going to be any change because I think we just don’t have good enough optics to know really what’s going to come down. We think that hopefully this thing will stabilize and we can operate as normal and there are certain capital expenditures we view as fairly non-discretionary that we have to make.

So our plan right now, and we’ve been talking closely with financiers, both long-term and short-term financiers or financing institutions, and the response we get is that capital is available but it’s at a higher cost. And depending on how much higher that cost is, we will have to evaluate.

But right now, based on what we know, and based on the regulatory compact that we have, we intend to fulfill our capex obligations as previously published to execute that.

What we have in place now is we’ll have some additional cash proceeds coming in before the end of the year from some real estate sales and other activities that are planned. And I think that we are going to have enough short-term capability to carry us on through as long as we really want into 2009, and certainly through at least six months of that.

Our plan would be in a normal year to go out and seek long-term financing in our usual unsecured 30-year debt, somewhere in the second quarter. But that again has to be evaluated. Our commercial bank and line of credit is with a triple-A rated bank, there are not many of those around these days and we have gotten strong assurances from them that if we need to extend our line we will certainly be able to do that.

Heike Doerr – Janney Montgomery Scott

Have you seen in this climate that your construction costs have actually come down as people are looking for work to keep them occupied?

W. Richard Roth

Most of our contractors have about a six-month pipeline of work. In other words, I think they’re going to be fine for about six months. When that ends then I think we are going to see sort of a recalibration of costs and we expect at that time to, you know, one part of our strategy is to make sure that our procurement are pretty hard hedged and we get as best a deal as we can. So we think in about six months as their pipeline dries up we will really begin to get some better optics on pricing.


There are not further questions.

W. Richard Roth

Thank you all for joining us today. I appreciate your continued commitment to SJW and we are doing everything we can here to deal with these difficult times and make sure that our investors and shareholders are protected. I also want to tell you that I think there are going to be opportunities. We are currently executing very well in Texas and have added a significant service area in the path of growth down there. Our customer growth remains strong there. Our franchise in San Jose is doing very well. We are very fortunate to be in the areas we are in and have the asset base we have. I think we are going to be well positioned to capitalize on the opportunities that we think are going to come to pass as well as maintain our strong operating results.

So thank you again and I look forward to seeing you next quarter.


This concludes today’s conference call.

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