Q4 2022 SJW Group Earnings Call

February 24, 2023 at 8:03 AM·32 min read

Participants

Andrew F. Walters; CFO & Treasurer; SJW Group

Bruce Hauk

Eric W. Thornburg; Chairman, President & CEO; SJW Group

Agnieszka Anna Storozynski; Research Analyst; Seaport Research Partners

Jonathan Garrett Reeder; Senior Equity Analyst; Wells Fargo Securities, LLC, Research Division

Richard Wallace Sunderland; Associate; JPMorgan Chase & Co, Research Division

Presentation

Operator

Good day, and thank you for standing by. Welcome to the SJW Group Q4 2022 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded.
I would like to now hand the conference over to your speaker today, Andrew Walters, CFO and Treasurer. Please go ahead.

Andrew F. Walters

Thank you, operator. Welcome to the fourth quarter and 2022 financial results conference call for SJW Group. I will be presenting today with Eric Thornburg, Chair of the Board, President and Chief Executive Officer; and Bruce Hauk, Chief Operating Officer. For those of you who would like to follow along while accompanying our remarks are available on our website at sjwgroup.com.
Before we begin today, 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 results as well as other factors that the company believes are appropriate under the circumstances. Many factors 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 financial results press release and our most recent Forms 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission, copies of which may be obtained on our website.
All forward-looking statements are made as of today that SJW Group disclaims any duty to update or revise such statements. You will have an opportunity to ask questions at the end of the presentation. And as a reminder, this webcast is being recorded, and an archive of the webcast will be available until April 24, 2023. You can access the press release and the webcast at our corporate website.
I will now turn the call over to Eric Thornburg. Eric?

Eric W. Thornburg

Thank you, Andrew. Welcome, everyone, and thank you for joining us. I'm Eric Thornburg, and it is my honor to serve as Chair, President and CEO of SJW Group.
2022 was a strong year for our company. We thank our employees for their passion to serve customers, communities and each other while being good stewards of the environment. And they do so in a manner that embodies our core values and honors our culture, which is essential for long-term success.
Earlier this year, Bruce Hawk became our Chief Operating Officer. He joined SJW Group in mid-2022 and brought with him 26 years of industry experience and a leadership style that aligns with our company's values. He has already proven to be an integral member of our executive leadership team, and I'm pleased to have him join us today on this call to discuss regulatory updates, 2023 capital expenditures and the growth of our Texas operation. After my initial remarks, Andrew will review the financial results of the company and our guidance for 2023.
As I mentioned earlier, 2022 was a successful year for us. Our leaders and their teams expertly navigated challenges and delivered solid results. Firstly, earnings per diluted share of $2.43 per share. These results were affected by a number of factors, including a delayed cost of capital proceeding and inflationary pressures, which the company successfully managed. Second, delivery of $219 million in infrastructure investments despite supply chain challenges. Third, a total shareholder return of 13.4% for 2022, which compares favorably to the S&P 1000 utility sector total shareholder return of negative 0.6%. And fourth, we were just 1 of 11% of Russell 3000 companies to have a gender balanced board.
One of our biggest achievements of the year was the constructive settlement agreement that was approved by the California Public Utilities Commission. It not only addressed the water supply mix challenges in California that had impacted our financial results in 2020 and '21, but also provided a benefit to customers. Given the meaningful progress achieved in our 2022 rate filings, we are pleased to provide a projected long-term growth rate of 5% to 7% based off of our 2022 diluted EPS.
Andrew will now discuss our financial results and 2023 guidance in greater detail. Andrew?

Andrew F. Walters

Thank you, Eric. Yesterday at the close of business, we released our fourth quarter and 2022 operating results. In the fourth quarter, we reported revenue of $171.4 million and net income of $33.5 million, our diluted EPS of $1.09 per share. This compares favorably to 2021 quarterly revenue of $139.7 million, reflecting a 23% increase and net income of $18 million, reflecting an 86% increase, and a diluted EPS of $0.60, reflecting an 82% increase. The significant increases were driven by the true-up of revenue for the prior period this year in the fourth quarter due to the approval of the California General Rate Case.
For 2022, we reported revenue of $620.7 million and net income of $73.8 million or a diluted EPS of $2.43. This compares favorably to 2021 annual revenue of $573.7 million, reflecting an 8% increase; net income of $60.5 million, which reflected a 22% increase or diluted EPS of $2.03, reflecting a 20% increase.
As you can see, the 20% year-over-year increase in diluted earnings per share for 2022 was primarily driven by revenue increases of $1.56 per share, which I will break down for you shortly. The increase in diluted earnings per share is also attributable to production costs that better match our actual costs in California contributing $0.21.
In fact, the recovery in owned water supply benefited customers in California, a welcome outcome for all. These increases were partially offset by an increase in water supply cost of $0.84 per share, which I also will break down shortly as well as increases in depreciation due to prior investments.
Inflation impacted the company's earnings in 2022, particularly due to investments in our employees that help drive the increase in administrative and general as well as higher interest costs due to the interest rate increases in addition to new investments in infrastructure that benefit our customers.
As promised, a breakdown of the 8% increase in revenue compared to 2021. The revenue increase was mostly driven by $38.7 million in cumulative water rate increases and $20.7 million in the true-up related to the San Jose Water Company general rate case that was approved and recognized in the fourth quarter and retroactive to January 1, 2022. It's worth noting that customer growth has become a more significant contributor to revenue, particularly in our Texas utility, adding $5.1 million in total across our utilities.
Partially offsetting the increases were decreases of $14.3 million associated with lower customer usage. As a reminder, San Jose Water Company continues to operate under a mandatory call for water conservation declared by Valley Water, our wholesale water supplier. The declaration called for a 15% reduction in 2022 water consumption as compared to 2019. During 2022, conservation by our California customers resulted in a usage decrease of 11% for residential customers and approximately 6% for business customers.
Also as promised, some detail about the water production expenses for the year. There was a modest 2% increase in total water production expenses from 2021 that was primarily driven by increases in water and energy pricing of $28.6 million.
Partially offsetting the increase in expenses was $15.3 million decrease in production-related costs to lower customer usage and increase in owned water supply in California that reduced costs by $7.3 million, an increase of $2.3 million in balancing and memorandum account cost recovery.
The 10% increase in total other operating expenses compared to the prior year was primarily driven by an increase in depreciation of $10 million. An increase in general and administrative expenses of $6.6 million, reflecting higher operating costs and labor costs. And an increase in maintenance costs of $4.7 million that included $3.7 million from the order instituting investigation. And finally, an increase in taxes other than income of $1.6 million due to increased assets in our utilities.
A $2.2 million impairment of long-lived assets in the fourth quarter of 2021 did not repeat in 2022, partially offset the increased expenses. $165 million was raised by SJW Group in 2022 through equity and debt issuances at competitive share prices and interest rates. Two of the debt issuances, Kinetic Water Company's $25 million senior notes and San Jose Water Company's $70 million senior notes were funded on December 15, 2022, and January 25, 2023.
At the end of 2022, we had $190 million available and $160 million drawn on our bank lines of credit for short-term financing of utility plant additions and operating activities. The average borrowing rate for the line of credit advances during 2022 was approximately 3.41%. The average borrowing rate for the same period in 2021 was approximately 1.32%.
Of note, the SOFR (Secured Overnight Financing Rate) was 0.05% on January 4, 2022, which compared to 4.55% on February 16, 2023. Also like to highlight that over the same period, the 30-year treasury rate nearly doubled and were more than double at times during 2022. The effective income tax rate for 2022 was 10% compared to 11% in 2021.
We are announcing our 2023 guidance of $2.40 to $2.50 per diluted share and updating our 5-year capital investment outlook to $1.4 million from $1.3 billion -- sorry, $1.4 billion from $1.3 billion. Our infrastructure investments are critical to the company's mission to reliably provide safe and high-quality water to our customers and communities.
2022 diluted earnings per share of $2.43 excluded adjustments related to the California cost of capital proceeding given the delay in the decision. While the 2022 guidance range included the cost of debt adjustment, the company included in its testimony to the CPUC.
Factors impacting the 2023 guidance includes no significant rate case decisions expected in 2023, continued inflation affecting interest cost, labor cost and other expenses as well as a constructive cost of capital ruling in California. To spend a minute on inflation, in 2022, it drove significant increases in interest cost, labor cost and chemicals expenses.
As I noted earlier, interest costs increased dramatically during 2022. We expect that 2023 will include the full impact of those increases compared to 2022, which started with historically low rates. Labor costs also increased significantly in '22 and will continue to increase into 2023. Chemical spend increased at an estimated compounded rate of 20% since year-end 2020 and 39% from last year alone. While some of the chemical cost increases reflect the changing mix of water types and acquisitions, the universal factor was inflation across the utilities.
As I've highlighted, inflation is a significant factor in the financing markets with impacts on the return requirements necessary to attract capital. The interest rate environment certainly supports a higher ROE than currently authorized and ROEs for California water utilities are lower than the national average. We made a strong case for the proposed ROE in our application to the Commission for the cost of capital proceeding and are optimistic that the Commission will consider all the supportive factors for an increased ROE when making its decision. While I can't comment further on the proceeding, we remain hopeful for a constructive outcome.
As a final note on inflation, our California Utility has inflation adjustment mechanisms in the forward rate cases that help offset some of the inflationary impacts. Our company plans to execute a number of rate cases that Bruce will discuss further that should help reduce inflationary impacts in 2024 and help with the recovery on and of investments made in our system.
The company is instituting guidance for long-term EPS growth rate. The new 5-year growth target is 5% to 7%, anchored off of 2022 diluted EPS of $2.43. Importantly, the year-over-year growth is not expected to be linear given the relative contributions of each utility and rate case timing.
With that, I turn the call over to Bruce.

Bruce Hauk

Thank you, Andrew. As was mentioned earlier in the fourth quarter, we realized the full benefit of the CPUC approved settlement agreement between San Jose Water Company and the [public advice] office for the 2021 GRC that covers 2022 through 2024, interim and outstanding revenue for 2022 of $25.1 million as well as the recovery of memorandum and balancing accounts amounting to $18.2 million.
We, along with our other fellow Class A water utilities in California, continue to await a decision in the cost of capital proceeding. While we have seen higher-than-normal precipitation and San Jose Water Company service area this rain season and Lake Elsman, our largest owned California surface water supply is at full capacity. The state of California is still in a multiyear drought. Recent rains have helped, but the drought declaration remains very much in effect.
Regulatory mechanisms remain in place to balance the need to aggressively promote water conservation while providing the company an opportunity to earn its authorized return. Furthermore, the combination of the full cost balancing account authorized in our GRC and our water conservation memorandum account afford the same benefit as with a full decoupling mechanism and should further minimize our earnings volatility and maximize the opportunity to earn our authorized ROE.
Senate Bill 1469 restored water utilities' ability to request, to establish or reestablish a decoupling mechanism in a future GRC application. We anticipate requesting decoupling any future application. Given the drought conditions, which demand a strong conservation and response, we believe pursuing decoupling will allow us to be aggressive on that front while also ensuring we can recover our fixed costs.
Our advanced metering infrastructure project is moving forward. $100 million authorized by the CPUC for this project is on top of the 3-year capital budget approved in the GRC. There will be a modest expenditure in 2023 with the bulk of spend to occur in 2024 through 2026. In Connecticut, we filed for a water infrastructure conservation adjustment increase to recover $27.8 million in completed projects. If approved by the Public Utilities Regulatory Authority, as filed, the increase would generate $3.1 million in annualized revenues and will bring the Cumulative WICA to just over 6%.
A decision is expected in the first quarter of 2023 with any authorized increase effective on April 1, 2023. Last month, the Maine Public Utilities Commission approved [general rate] case applications in 4 of our main waters operating divisions. The rate increases were all retroactive to January 1, 2023, and will generate $692,000 in annualized revenue. Step 3 of Maine water's multiyear GRC and the Biddeford-Saco Division will be filed in the first quarter of 2023. This filing will reflect the operating cost of the new Saco River drinking water resources that went online in the summer of 2022.
Our Texas subsidiary, SJWTX, filed an application for a system improvement charge at the end of 2022. Since our last general rate case in 2014, the company has invested more than $43 million in drinking water and wastewater infrastructure that is in service and providing a benefit to customers. Our system improvement charge filing request recovery of $14.8 million in improvements that were made between January 1, 2020, and September 30, 2022.
The FIC charge, as submitted, would increase the bill of the average residential customer using approximately 7,000 gallons per month by less than $5 per month or about $0.16 per day. A filing to expand our CCN with the PUCT is pending for the transfer of more than 500 acres of water service area and more than 300 acres of wastewater service area from the San Antonio Water System to SJWTX. San Antonio has already approved the service area transfer. No customers would be affected.
In January, SJWTX filed applications with the PUCT to acquire KT Water Resources and KT Water Development. KT Water Development is a water utility that serves about 560 customers in Southern Comal County with the potential to add additional customers. SJWTX's application requested fair market value and applied rate doctrine treatment to constructive regulatory mechanisms available to us in Texas.
KT Water Resources is a wholesale groundwater supplier to KT Water Development. KT Water Resources once interconnected with SJWTX water systems will significantly increase the efficiency and resiliency of our water systems, allowing us to meet projected customer growth through 2070. We anticipate PUCT decisions on these applications in the third quarter of 2023.
SJWTX now serves more than 26,000 water and wastewater connections between Austin and San Antonio. And its service areas are located in 3 of the 5 fastest-growing counties in the United States. SJWTX has quadrupled its customer base in 16 years under SJW Group, providing service to about 76,000 people today.
SJW Group has a $255 million capital expenditure budget for 2023 and plans to invest $1.4 billion through 2027. About $90 million is budgeted in 2023 for pipe replacement as part of our long-term goal to replace approximately 1% of our water [mains] every year. Approximately, 2/3 of our infrastructure investments are forward-looking or recoverable through infrastructure recovery mechanisms, which helps to minimize regulatory [lag].
There are several key projects that support growth and reinforce our position as a best-in-class water and wastewater provider. Looking across our operating regions, some of these projects include in California, the purchase of installation of 5,500 acoustic leak detection sensors to enhance our already robust leak detection program. Our current unaccounted for water at San Jose Water Company is 8.9%, which is well below the industry average; in Maine, we are currently developing 2 new source wells in Kezar Falls to address the reduction in capacity of the existing wells sources and replacing the existing groundwater treatment facility; Connecticut, we are replacing 1970s groundwater treatment facility in our largest water system; and in Texas, we are installing a number of water storage tanks to meet the needs of our rapidly growing service area. The tank pictured is going into service this month.
With that, I will turn the call back over to Eric.

Eric W. Thornburg

Thank you, Bruce. We know infrastructure investments are necessary to ensure high-quality drinking water, reliable service and a healthy environment. But investing in our people is just as critical to achieve our mission. We are fortunate to have high-quality talent that executes on our strategies and provides exceptional service to our customers and communities daily.
And we recognize our teams are affected by the same inflationary pressures impacting our business. We have a commitment to our people to be good stewards of their careers and to maintain a world-class culture. In response to the recent surge in inflation in 2022 and and 2023 to date, we also invested in our workforce through wage and benefit adjustments that exemplified our commitment to them and their families.
Last month, SJW Group published a supplement to its 2021 corporate sustainability report. The report is available at our website. Our 2022 report will be available later this year. These reports detail the work we have done and will continue to do to live up to our commitment to be exemplars of corporate social responsibility. We continue to have strong institutional shareholder services ESG ratings. Further, GRESB's infrastructure assessment places SJW Group in the top quartile of our comparison group, which includes many of our water utility peers.
In 2022, we helped secure nearly $10 million in financial assistance for customers who were in arrears on their bills through various state and federal programs. This assistance supplements already existing programs to ensure access and affordability to customers within our service areas.
In 2023, we're planning for the installation of additional solar arrays to offset our purchased electricity and we will begin the electrification of our vehicle fleet in California.
We extend a warm welcome to Commissioner Karen Douglas on her appointment to the California Public Utilities Commission and thank Commissioner Clifford Rechtschaffen for his many years of dedicated service. We also congratulate Commissioner John Reynolds on his recent reappointment and confirmation. We look forward to working with the new commissioners and their staffs to address the water-related issues facing California's regulated water utilities.
I would like to take a moment to recognize our retiring leaders and their successors. I thank Maureen Westbrook for her leadership at Connecticut Water and SJW Group. Maureen retired as President of Connecticut Water in December after a distinguished 34-year career at the company. She was a champion for investor-owned water utilities and fought for policy and legislation that protected the company and its customers.
We welcome Craig Patla, as Connecticut Water's new President. He was most recently the company's Vice President of Service Delivery. Craig has been with Connecticut Water for 32 years and has been a leader in our New England operation for nearly a decade. Craig's promotion is evidence of the high-quality talent we have at every level of the organization and the success of our talent management program. I also want to thank Wendy Avila-Walker for her leadership. Wendy is retiring next month as San Jose Water Company's Vice President of Finance, Assistant Treasurer and Controller at SJW Group. Among Wendy's considerable accomplishments over her 17-year career was the integration of accounting teams and systems following our transformational merger with Connecticut Water.
I am pleased that Rally Zerhouni will be assuming Wendy's duties. He joined us earlier this year as Senior Vice President, Principal Accounting Officer. Rally comes to us from Veolia North America Regulated Utilities, where he was the Chief Financial Officer. Rally is a consummate professional with a deep understanding of the investor-owned utility accounting and finance functions. His leadership style aligns well with our strong culture of teamwork, respect and transparency.
With that, I will turn the call back over to the operator.

Question and Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Angie Storozynski of Seaport Research Partners.