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SJW (NYSE:SJW)

Q4 2013 Earnings Call

February 21, 2014 1:00 pm ET

Executives

Suzy Papazian - Secretary and Secretary of San Jose Water Company

W. Richard Roth - Chairman, Chief Executive Officer, President, Member of Real Estate Committee, Chief Executive Officer of San Jose Water Company, Chief Executive Officer of Sjw Land Company, Chief Executive Officer of Sjwtx Water Inc, President of San Jose Water Company, President of Sjw Land Company, President of Sjwtx Water Inc, Director of Sjw Land Company and Director of San Jose Water Company

James Patrick Lynch - Chief Financial Officer and Treasurer

Palle L. Jensen - Senior Vice President of Regulatory Affairs - San Jose Water Company

Analysts

Kenneth J. Dorell - Janney Montgomery Scott LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter SJW Corp. 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.

Suzy Papazian

Thanks, operator. Welcome to the full year and fourth quarter 2013 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 April 28, 2014. You can access the release and the webcast at the corporate website, www.sjwcorp.com. I will now turn the call over to Rich.

W. Richard Roth

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 Jim Lynch, Chief Financial Officer of SJW Corp.; and Palle Jensen, Senior Vice President of Regulatory Affairs.

As Jim will discuss in further detail, SJW delivered solid results for the year, despite some regulatory and water supply challenges in both our utility service areas. Further, looking back to 2013, SJW made substantial progress that I believe will lead to a better and stronger company at every level. San Jose Water Company invested nearly $83 million in utility plant during 2013, upgrading critical infrastructure, improving service levels and increasing gross utility plants in service to about $1.3 billion. These investments directly correlate to an increase in rate base, which should in turn sustain earnings for many years to come.

Since its inception in early 2006, SJWTX Inc., our Texas water and wastewater utility, doing business as Canyon Lake Water Service Company has experienced sustained demand for new services. This, coupled with our strong acquisition program, has increased customer count by nearly 50% and gross utility plant by more than 260%. With our strong portfolio of water supply as a growing wastewater business and continued additions to customer base both through organic growth and acquisitions, we continue to be optimistic about the prospects of profitably and intelligently expanding our Texas operations.

Following the completion of tenant improvements at our Knoxville, Tennessee properties, SJW Land Company's entire developed real estate portfolio is now fully leased with quality tenants, and making a substantial contribution to consolidated cash flow. Additionally, SJW Land Company was able to sell, at a gain, our Connecticut property in early 2013.

I will now turn the call over to Jim, who will review our financial results. After Jim's remarks, I will address regulatory matters and provide additional perspective on key operational and business issues. Jim?

James Patrick Lynch

Thank you, Rich. In spite of a continuing delay from the California Public Utilities Commission on a decision in our general rate case and other regulatory and water supply challenges, SJW Corp. delivered solid operating results in 2013. Net income for the quarter was $4.7 million or $0.23 per diluted share compared to $5.9 million or $0.31 per diluted share for the fourth quarter in 2012. The decrease in quarterly net income was primarily the result of the recognition of $2.1 million in certain balancing and memorandum accounts in the fourth quarter of 2012 that did not repeat in 2013.

Also recall that in 2013, we issued approximately 1.4 million shares of common stock that are included in our 2013 per share calculations. For the year, net income was $22.4 million or $1.12 per diluted share compared to $22.3 million or $1.18 per diluted share in 2012. Fourth quarter revenue in 2013 was $67.3 million or 8% over the fourth quarter in 2012. This change was primarily due to a 9% increase in customer usage and a 3% increase in water rates, offset by a 6% decrease related to balancing and memorandum accounts. For the year, revenue was $276.9 million, an increase of 6% over 2012. This change was primarily due to increases in customer usage and water rates by 2%, respectively, and increases due to new customers and the recognition of balancing and memorandum accounts by 1%, respectively.

In addition, our real estate operations contributed $1.2 million in new revenue, due to new leases in 2013 at our Tennessee office and warehouse facilities. The customer usage increase was primarily due to persistent drought-like conditions in our California service area throughout 2013. In a few minutes, Rich will give you an update on the drought and our current water supply situation in California.

The higher water rates were primarily due to pass-through of a 9% rate increase imposed by the Santa Clara Valley Water District, our wholesale water supplier in California. As a reminder, we received no margin benefit from district pass-through cost. The impact of the district rate increase was partially offset by a nominal refund in our Texas service area as a result of our Texas rate case decision.

Water production expenses for the quarter were $29.7 million, an increase of 28% over the fourth quarter of 2012. For the year, water production expenses were $120.8 million or an increase of 13% over 2012. These changes were the result of the previously noted increases in customer usage in addition to wholesale water and power expense increases in California.

Operating and expenses, excluding water production, were $26.3 million in the fourth quarter, an increase of 4% over the fourth quarter of 2012. For the year, operating expenses, excluding production, were $102.6 million, 3.6% higher than 2012. The expense increases were primarily due to higher depreciation of property taxes related to new utility plant assets placed in service. During the quarter, we continued many of the cost management strategies we initiated at the beginning of the year. As a result, we experienced only nominal synergies in administrative and general and maintenance expenses when compared to 2012.

Nonoperating income and expenses for the year included a $1.1 million gain on the sale of our Connecticut warehouse property that occurred in the first quarter of 2013. We experienced a similar $910,000 gain on the sale of our Florida warehouse in the third quarter of 2012. Income taxes for the quarter were 32% of pretax income and 39% of pretax income for the year. Income taxes include the release of a $500,000 tax contingency reserve in the fourth quarter, which upon settlement of our recent IRS audit, we determined was no longer necessary.

Updating our CapEx program. We added $26.5 million in utility plant during the fourth quarter, bringing our total utility plant additions for the year to $94.3 million, including $83 million invested by our water utilities and another $11.6 million in developer-funded projects at our water utilities. As of December 31, 2013, our utility plants in service totaled 1.3 billion. Over the next 5 years, we anticipate investing up to $527 million in new utility plant, subject to regulatory approval in both California and Texas.

Included in our planned spending is $60.5 million in additional monies that we will use to upgrade our Montevina Water Treatment Plant. We've received approval for this project from the CPUC in July of 2013. Also in 2013, we benefited from a 90 basis point increase in the discount rate used to determine the benefit obligations for our defined benefit plans and other postretirement benefits. This, combined with a 12% return on average plant assets, contributed to a $30 million reduction in our unfunded benefit obligations. The net periodic pension costs for our defined benefit plans and other postretirement benefits in 2014 will be $7.1 million compared to $10.2 million in 2013.

As I previously noted, in April 2013, we completed a follow-on public offering of 1,421,000 shares of our common stock. The sale price per share was $26.50, resulting in the gross proceeds of approximately $38 million. This included 100,000 shares issued in connection with the exercise of the underwriters' over-allotment option. Proceeds from the offering were used to finance capital expenditures, repay short-term debt and for other general corporate purposes.

In January of 2014, San Jose Water Company executed a note agreement with John Hancock Life Insurance Company and its affiliates to sell $50 million of San Jose Water Company's Series L senior notes. The notes bear interest at 5.14%, are unsecured and are due 30 years from the date of issuance. The closing date of the transaction is August 5, 2014, or such later date as mutually agreed to with John Hancock, but not later than October 3, 2014.

With that I'll stop and turn the call back over to Rich.

W. Richard Roth

Thank you, Jim. Following the driest year on record and 2 consecutive years of below average precipitation, Governor Brown declared a drought state of emergency for California on January 17, 2014. Shortly thereafter, the Department of Water Resources, the state agency responsible for managing and projecting California's water, announced there will be no deliveries from the state water project for the first time in its 54-year history. In response, the Santa Clara Valley Water District, our wholesale water supplier, established a conservation target of 10% on January 28, 2014.

While the lack of precipitation is challenging, San Jose Water Company's water supplies will be adequate owing to our diverse portfolio, which includes recycled water and ample ground water. To maintain the high service and reliability levels our customers have come to expect, we are conducting in-depth operational modeling and planning to balance availability and the cost of water supplies. San Jose Water Company and the Santa Clara Valley Water District have cooperated in preparing for an extended drought by maximizing and diversifying the region's water resources, making the counties' [ph] water supplies more drought tolerant. After the drought of 1987 through 1992, San Jose Water Company was the first utility to implement a comprehensive water conservation program to help customers use water wisely and further stretch our water supplies.

More recently, we have been working with regional stakeholders to expand the recycled water system distribution network. Recycled water has been and will continue to be a critical water resource for the region. San Jose Water Company will continue to evaluate partnership opportunities and explore expanded use of this drought-resistant supply. These efforts are now paying off, as our region is better equipped to withstand multi-year droughts, especially when compared to other parts of California.

While recent rains have marginally improved the water supply picture, the continued and frequent media coverage of the drought has intensified the public's opinion [ph]. The days of the silent service water utility are behind us and there is a greater need for proactive communication and engagement with customers and other stakeholders. Topics such as the cost and value of water, water quality and rates continue to demand a more robust communication program to inform stakeholders on the challenges facing all water systems, both public and private. By utilizing traditional approaches, leveraging new technologies and partnering with other utilities, we are working to ensure that the solutions are available, and to communicate candidly about rate impacts and what the company is doing to keep rates as reasonable as possible.

Turning our attention to regulatory affairs. SJW received final decisions on key regulatory filings in both Texas and California in 2013. Almost 3 years after filing an application seeking authorization to upgrade our Montevina Water Treatment Plant, we received a final decision and are moving forward with the $62 million project. These upgrades are critical in ensuring that the customers continue to receive high-quality and reliable water service and to maximize the use of low-cost, high-quality local surface water supply. This is especially important in light of the water supply challenges now facing the region.

SJWTX Inc.'s general rate case decision conclusively established a solid rate base upon which future rates can be based. Importantly, the decision and rate base determination removes significant uncertainty about the value and regulatory treatment of assets acquired from a water supply corporation in 2006.

There have been no new significant developments regarding our California general rate case. You will recall that San Jose Water Company's pending general rate case was filed in early January of 2012 to establish rates for the years 2013 through 2015. The completion of hearings and filing of testimony concluded in the summer of 2012, and the case was submitted to the administrative law judge. In January of 2013, prior to rendering a proposed decision, the administrative law judge reopened the general rate case for the purpose of receiving and evaluating new information regarding safety and security issues. The reopening of the general rate case further delayed the general rate case process. It is important to note that San Jose Water Company filed for and received initial approval to institute interim rates effective January 1, 2013. The approval to institute interim rates will, among other things, allow the company to implement new rates retroactively on the date when the final decision is issued.

It is not possible to determine when a proposed general rate case decision will be issued. The CPUC is and has been for some time, under constant scrutiny by the media, elected officials and the general public. This heightened scrutiny, we believe, is contributing to the significant regulatory delays experienced by CPUC-regulated utilities.

The California Public Utilities Commission's newest commissioner, Michael Picker, of Sacramento, was appointed on January 29,2014, replacing Commissioner Mark Ferron, who resigned citing health issues. Mr. Picker served as a Senior Adviser for Renewable Energy in the Office of the Governor since 2009 and was also a member of the Sacramento Municipal Utility District Board of Directors since 2012. We welcome Mr. Picker to the Commission and look forward to working with him to resolve the many water-related issues facing California's regulated water utilities.

As previously announced, Andy Walters joined San Jose Water Company in January as Chief Administrative Officer. We believe Andy's significant experience in utility and infrastructure, finance and administration will nicely complement our existing skill sets as the company continues to pursue efficient business processes and adapt to a variety of new challenges and opportunities.

Finally, in January of 2014, the SJW Board authorized an approximate 3% increase in SJW's annual dividend to $0.75 per share. In addition to demonstrating the strong commitment to our shareholders, the increase also underscores the board's confidence in the company's business plan.

In summary, the greater regulatory complexity and water supply challenges demand that SJW's operations, strategic planning and capital allocation be carried out with greater awareness and discipline. While we remain fortunate to have businesses and customers in regions with relatively strong economic fundamentals and stability, the social, political, environmental and economic changes that have occurred over the last several years continue to present challenges to SJW and require us to refine and diligently execute our business strategy.

With that, I'd like to turn the call back to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Kenneth Dorell from Janney Capital Markets.

Kenneth J. Dorell - Janney Montgomery Scott LLC, Research Division

So I'd like to shift towards the general rate case, specifically on the CapEx side. Given the unique circumstance that you guys have operated the entire year that you were supposed to be granted the new rates, on the CapEx side, since I believe you were expected to target around $92 million in CapEx and you came in around $83 million for water this year. When the CPUC looks towards establishing rates for 2013, will they still use the planned CapEx for 2013? Or will they now go to your actual spend?

Palle L. Jensen

Well -- Palle Jensen here, I'll answer your question. What we have done is that we have anticipated that the projects that were not disputed in the rate case would ultimately be authorized by the commission. So that's sort of set the bottom line for the capital budget. For rate-making purposes, once we get a decision from the commission, it will revert back to January of 2013 and authorize the projects that are allowed by the commission in this particular rate case. So in essence, the company will be made up for the investments going back to January 1, 2013, once we get the rates.

Kenneth J. Dorell - Janney Montgomery Scott LLC, Research Division

Okay, perfect. So is it safe to say that your outlook for CapEx over the next 5 years, I think it's $565 million, is that still intact?

Palle L. Jensen

Yes, that's correct. We have requested about $100 million a year in the rate case. I think it was just under $300 million for the 3-year period. And that's as far as we have -- we can request in the current rate case. When we file again for the next rate case, we will be requesting for the additional 3 years in that case. So currently, the projection for the 3-year period, that is for '12, '13, and '14, that's the review the commission does in the current rate case, is in the neighborhood of $300 million.

James Patrick Lynch

Yes, Palle, I'd just like to follow on that. For purposes of the 5-year plan right now, we're looking at something closer to $527 million.

Operator

[Operator Instructions] I would now like to turn the call back to Rich Roth.

W. Richard Roth

Okay, thank you, everyone, for listening. And really, we all appreciate your patience and forbearances. We await a long overdue and very important rate case for San Jose Water Company. As soon as we receive solid information, we'll pass that along to you. But right now, we just don't have enough to talk about. So again, thank you for your patience. And thank you for your investment in SJW. We'll see you next quarter.

Operator

Thank you very much. This concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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