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California Water Service Group’s (CWT) CEO Martin Kropelnicki on Q4 2015 Results – Earnings Call Transcript

Operator Welcome to the California Water Service Group Fourth Quarter and Year-End 2015 Earnings Results Teleconference. Today’s conference is being recorded. I would now like to turn the meeting over to Shannon Dean, Vice President, Corporate Communications. Please go ahead. Shannon Dean Thank you, Nova. Welcome everyone to the fourth quarter and year-end earnings results call for California Water Service Group. With me today is Martin Kropelnicki, our President and CEO, and Tom Smegal. A replay of today’s proceedings will be available beginning today, February 25, 2016 through April 25th, 2016 at 1-888-203-1112 or at 1-719-457-0820 with a replay pass code of 4899398. As a reminder before we begin today the company has developed a slide deck to accompany the earnings call this quarter. The slide deck was furnished with an 8K this morning and is also available at the company’s website at www.calwatergroup.com/docks/earningsslidesfebruary2016.pdf Before looking at this quarter’s results, we would like to take a few moments to cover forward-looking statements. During the course of the call, the company may make certain forward-looking statements. Because these statements deal with future events, they are subject to various risks and uncertainties and actual results could differ materially from the company’s current expectations. Because of this, the company strongly advises all current shareholders and interested parties to carefully read and understand the company’s disclosures on risks and uncertainties found in our Form 10-K, Form 10-Q and other reports filed with the Securities and Exchange Commission. Now let’s look at the 2015 results. I will pass it over Tom. Tom Smegal Thanks, Shannon. Good morning everyone. Martin and I will be going through our presentation today a little bit differently than in the past and we will be walking through the slide deck that we distributed. So we’ll refer to page numbers as we go through to follow along on where we are on the slides and I will be and just to summarize we’ll talk about the financial highlights for the year. We’ll talk about the drought of course. Our regulatory update whether California GRC, some slides that we’ve developed relating to our adopted rate base and return on equity and lastly to talk about what we expect some of the things we expect for 2016. So very briefly turning to slide 5, our financial results, our operating revenue was down just a little bit that has to do with the unbilled revenue that we will discuss in a moment. Our operations expense was relatively flat, that is lower purchase water cost offset by higher costs in other areas particularly pension costs. All of those things are subject to balancing account protection in California, our main service area. I will highlight that our net income is down 11.7 million or 20.7% and the EPS is down $0.25 of that same 20.7%. Turning to slide 6 for a little bit of explanation and just as a reminder we talked about this for a number of calls in a row here but our unbilled revenue has been a factor for us all year and just to give an update on the accounting, unbilled revenue is excluded from our revenue decoupling mechanisms. The WRAM and the MCBA track, the actual bills that are sent out to customers and so as a water utility that does billing on an everyday, every workday cycle. We will have a period of time at the end of every accounting period where there are customers who have used water and are owing us money but have not been billed for that yet. So that’s excluded from the ramp. We just show how that’s calculated and the variance there really has to do with customer demand, rate design, weather and the number of days since the number of days left in the year from the end of the billing cycle. So it can vary from year to year and we did have a dramatic variance for 2015 versus 2014. In 2014 we had a revenue increase of 6.8 million that is comparing December of 2014’s accrual to December 2013’s accrual. The effect there is warm dry December 2014 as well as higher service charges that were adopted in the 2014 GRC decision. In 2015 we saw a revenue decrease by 0.5 million due to a cool wet December of 2015. The net difference there is 7.3 million when you take the tax effect of that, that’s the 4.9 million difference in net income. Our tax benefit we talked about in the third quarter 4.8 million received in 2014 that did not recur in 2015. Our incremental drought expenses for the year ended at 4.4 million and that reduces net income by 2.8 million. Again that expense is tracked in a memorandum account. We don’t get immediate recovery but we have to apply for recovery at the commission and once we do that we can book — we can collect that revenue. Finally the last item is maintenance costs and those increased 1.6 million for the year, again pretty much drought related we believe has to do with mains and service repairers, a lot of overtime was spent this year working weeks that we wanted to fix the day that they were discovered. That’s a policy change that we made in the drought to make sure that we’re doing the right thing and we’re out there in front of any water wasting that goes on. On slide 7 it’s just a graphical representation of what I mention that shows you the bridge from a $1.19 in 2014 down to the $0.94 in 2015. I won’t go over that in any detail. On page 8, I will highlight some important positive developments from a financial standpoint and this we’re really proud of the first item is that we spend a 177 million on capital improvements this year. If you recall I think our target was 125 million to 145 million. We’re anticipating the ramp up as we go into the 2015 general rate case cycle and if you’ll recall the 693 million of capital that we’ve asked for there, our engineering group did a really excellent job in our districts putting in all the capital improvements this year really exceeded our budget expectation really dramatically. That’s going to drive our rate base growth in the future and the rate base growth as we’ll talk about later does drive earnings growth in the future. The other big item which is important for us is that our WRAM decoupling balance which has been a problem issue for us really since the beginning of the decoupling era in 2008 that actually as a result of the drought surcharges that declined to 40.6 million. So the receivable balance is 40.6 million. It was in the range of 45 million at the end of last year that is a really positive development considering all of the drought savings that we had. As you also know we completed a successful debt offering in the fourth quarter and that was a 100 million debt offering long term debt and as well as 50 million that we expect to receive as a delayed draw in March of 2016 and we also re-upped our line of credit so we have 450 million on the credit lines we did that earlier in the year. So company is on very good footing financially, lots of liquidity the ability to do the CapEx that we’re going to discuss in the deck. And we did just get a reaffirmation from S&P of our A plus stable, AA minus for our first mortgage bonds. The next thing I wanted to point out is of a little bit of a difference in how we look at return on equity versus how you would look at it just from a from 10k and income statement balance sheet review. Our California adopted return on equity which is the bulk of our business remember 94% of our businesses in California. The adopted return on equity is 9/43% and just as an addendum there we did get a delay in the cost of capital proceedings so that will be our adopted return on equity for 2016 as well for the entire year. Our GAAP ROE if you calculated from the 10-K that will be filed later today is 7.1%. In California we are not including construction work in progress actually none of the states we include construction work in progress in our rate base. So by deducting the equity equip we value our return on equity really at this 8.45%. Now that’s not at the adopted level and so we’re certainly not jumping up and down over that but we wanted to make you aware that there is a difference between what you see straight from the balance sheet and what we’re allowed to earn based on the regulation. Right now with the regulation we’re booking the interest during construction or the AFUDC, on all of our planned projects into the ending values of the plant. So we do collect that money over time later but we don’t have a return on construction work in progress. The last item on that table, is just a demonstration of what would the ROE under this scenario have been if we didn’t have the drought cost and that’s almost 9% really relatively close to the authorized ROE. Now I’m going to turn it over to Marty. Martin Kropelnicki Thanks, Tom. Good morning everyone I want to give everyone a update on what’s happening in California with the drought. Starting off talking about kind of where we are and what it shaping up to be for ’16 and then on slide 11 I’ll talk about some of our results of our efforts for 2015 to save water. First and foremost California is entering potentially the 5th straight year of a record drought. So far we have had good — our precipitation up and down the state but it has warmed up pretty quick from a water supply standpoint if you look at the major reservoirs where they are today versus where they were a year ago. They’re mostly about the same, there hasn’t been a big change in reservoir conditions year over year. The thing that has changed is the snow back and act as earlier this week as of 23rd February our snow pack for the state was 93% of normal. If you go back to the end of January, the snow pack was 124% normal and that will give you an idea how much it’s warmed up over the last 30 days in the state. So it’s good to see the snow pack is at 93% that’s certainly better than last year, but we like to see that snow pack a little higher and not have the warm weather that we’ve been having throughout the state. So the snow pack is good but really what’s going to happen they’ll do a snow pack measurement in April and that will determine kind of our next steps with the drought. Having said that the state has extended the drought emergency through October 31 as I mentioned the final allocations and targets will be set at the snowpack reading later this spring. In the updated provisions that the State Water Resources Control Board has published, it’s basically the same kind of program but they did add three provisions to the calculations. One there’s a provision for growth. So when you look at a city like Visalia for us for example, Visalia growth 3% or 4% a year. So when you locked in the drought targets based on the 2013 consumption there was no modification of those targets for growth and population connections and so that’s very difficult to deal when you have a growing city to try to hit those targets. They have added a provision for the growth modifier. They added a climate adjustment modifier. So you if you think about the drought in the state of California whether if you were coastal, you had an allocation that was potentially the same as someone who is inland where it’s much harder. So they’ve added a climate adjustment mechanism and then they added a third piece a modifier which is a drought what they call a drought resilient supply modifier. Though as you bring in recycled water projects or desalinization that will allow you to adjust your targets within a given geographical area. So as of right now applying these provisions looking at what the potential targets might be for 2016. We anticipate approximately a 2% to 4% adjustment in many of our districts depending on whether located throughout the state to be finalized after that final snow pack reading in the spring. So the drought is going to continue, it’s going to continue to be a challenge for us. We will keep our drought team fully intact. We will be making some modifications as we move forward as those rules are finalized with the State Water Resources Control Board. Having said that we do believe we have positioned well and manage well during 2015, if you go to slide 11 our customers achieved a net reduction of 28.6% exceeding the state’s requirement of reduction target of 25%. To just put that into perspective of how much water that is that 68,000 acre feet or 22 billion gallons of water say by Cal Water customers to take it one step farther that’s 46,000 gallons per connection and that’s enough water to provide everyone in California 580 gallons of water. So that’s a real big savings and we were very, very happy with the results of our drought outreach and our drought team that has done a fantastic job. Having said that to give an idea what it took to achieve those targets I just pulled some statistics from the team throughout the seven month drought period in 2015 we ran over a 1000 radio ads. We designed and we ran 23,000 plus cable TV ads, we designed and we ran in movie theaters over 73,000 radio ads. We distributed and helped install over 10,000 low flow toilets. We had processed over 50,000 of rebates for water efficient appliances and we processed and issued over 190,000 rebates for turf replacement projects. So when we talk about our drought cost you could see where a lot of the money was spent it was clearly spent on outreach and trying to work with the customer with our customer first approach to help all of our customers set their targets. As Tom mentioned that the decoupling mechanism we believe worked well and we believe it’s the right rate design, if you think about the way the rate design is working. There were a few analysts reports that were published that was worried about that the WRAM account ballooning. The way we designed the rate design was for people who were hitting their targets. They had no change in their rates. But people who went above their targets when they hit first unit above their budgeted amount was two times their highest rate. And any drought surcharge that the company received was then used to offset the WRAM balance. So people who are abusers of water were panned on the WRAM balance to the people who were doing the right thing. So we continue to believe that it’s the right rate design and we believe it’s worked well. The incremental cost associated with the drought as Tom mentioned that’s a $0.06 impact for the year that was recorded in an incremental cost memorandum account, those costs are everything I just talked about in terms of the outreach we have a full time team of 39 employees that have been working on the drought nonstop. We believe those costs are recoverable and we will have them — we will be filing for recovery later this spring and they are subject to a prudent sea review and [indiscernible] review by the CPU but we do believe they will be fully recovered. On the customer surcharges in the WRAM balances, it gave us an extra cash flow of $36.9 million and ultimately when we apply that and the changes to revenue that go through the WRAM when it all nets out we had a net reduction in our WRAM balance of 4.6 million or 10.2%. So very happy with the rate design, very happy with how the WRAM has worked in 2015 with the drought. In addition as you may recall we recently adopted a sales reconciliation mechanism and due to the conservation and the significant drop in consumption the sales reconciliation mechanism will be filed and most of our districts will have a reset on the rates that we will file for here shortly as well. So that’s another mechanism that will keep the WRAM balance from growing and keep the adopted numbers closer to what actual [indiscernible]. So it’s a nice tool to have to keep the WRAM balances minimal and keeping rates close to what the actual costs are. Moving ahead to the next slide, as Tom talked about you know we had a great year in engineering. We got a lot of capital done as you may recall we spent a good part of 2015 reorganizing our engineering division, our engineering department including a new Vice President that we hired from outside the company. We did that because of what we were anticipating in the rate case, we did file the rate case in early July seeking about $95 million in 2017 and then 23 million in steps for ’18 and ’19, 80% of that rate increase of that 95 million is capital related and so in addition we made a commitment its rate case to keep expense headcount flat. So where we really been focused on capital, what’s embedded in the rate case is a proposed capital budget of $693 million over three years. So we’re well into the process now, we are scheduled to get the advocates or the ORA report next week. We will have about 30 days to respond to it and then we move into the next phase of the GRC process which is a settlement process. So there will be more to come and more to talk about on the first quarter earnings call. Looking at one of the big drivers of capital for us on page 13, as we’ve talked about and we’ve had in our investor slides we own and operate over 600,000 miles of main and I always like to tell people that’s equivalent from flying to San Francisco to New York J.F.K and then fly back and add 500, 600 miles and you will get that’s the amount of mains that we operate. We were on a 300 year main replacement cycle which is too long and with the drought as Tom mentioned we’ve put a program in place to fix leaks same day. So it’s 24/7 if we had a leak we wanted to fix it but ultimately those main should be should be changed out every 100, 150 years and if you look at the American Water Works Association they recommend a 100 year main replacement cycle. So in this rate case we have proposed going from a 300 years cycle to a 200 year cycle. Most of our peer companies in the state of California are already at a 100 to 150 year replacement cycle. So we think we’re on the right approach with the main replacement program and look forward to working through that with the commission. In addition we have in the rate case we’re very focused on water supply reliability, more tanks, more wells doing a brackish desalinization study for here in the Bay Area. So there is a lot of capital projects, there’s one large project but most of these projects are kind of the routine kind of capital maintenance capital improvement and it’s what’s going to drive our rate base growth going forward. In addition, we had one policy change, Tom do you want to take them to the policy change we applied for? Tom Smegal Thanks, Marty. This is an item I talked earlier about the construction work in progress and it’s exclusion from rate base. We did have comments in the last rate case cycle from the rate advocate actually suggesting that it would be better for us from their perspective to move to construction work in progress instead of accumulating interest in construction into project costs. So we did make that request in the rate case. We think it will be adopted based upon the earlier motivation of or [indiscernible] and just remember that there would have an immediate effect on our adopted rate base in the rate case we’ve asked for 80 million which represents a long term average of construction work in progress and 80 million would be added to rate base on an annual basis and that roughly translates to 4 million of net income or $0.08 on a per share basis if that is adopted. Turning to slide 14, just to give you a graphical representation of our CapEx and how well we did this last year. What you can see with the yellow bars is that we have increased over the last eight years from a capital expense of 76 million, 100 million moving up, 177 million. The blue bars for ’16, ’17 and ’18 represents what we filed for in the general rate case the 205s that I showed there in 2016 that represents what we filed in California plus what we expect to spend in the other states. And we have given a range in our 10-K that we expect to spend between 180 million and 210 million in 2016. So we will forward already working on the CapEx for this year as you would expect and we look forward to that level of CapEx continuing into the future based upon the main replacement program moving to a more normal level of a 200 year cycle. Flipping to page 15, again this is a graphic representation of the company’s authorized rate base. If it’s application in California were adopted as proposed. So a lot of caution particularly on ’17 and ’18. These are the numbers we proposed to the commission there’s always changes to the rate case process but just to give you an idea that our authorized rate base in California and all the other subsidiaries about 977 million in 2014, 1 billion of [indiscernible] in 2015 and a little bit more in ’16 so there’s not much incremental rate base in ’16 but a tremendous increment in ’17 and ’18 based on the rate case CapEx as well as the inclusion of the construction work in progress. And again just to reiterate these are projections that are based upon the regulatory filing and certainly will change based upon the outcome of that proceeding. Flipping to slide 16, just to get everyone in the mind set of what that means for the company and for its earnings potential. As we’ve talked throughout the call and over the quarters since 2008 we have adopted a decoupling of revenue from earnings and that means that there’s a very — it’s very unlikely for us in our regulated arena to earn more than our authorized rate of return. So the table on slide 16 shows that based on the rate base that we have authorized and the capital equity structure that we have with the debt equity ratio there’s a maximum allowable regulated earnings and you see that for ’14, ’15 and ’16. Remember that that does not include such things as regulatory lag, any cost that we’re not recovering through the process. Other income and expense is outside the regulation area and regulatory tax differences. The point of this slide is to get us in the ballpark of where we would expect our earnings to be in ’14, ’15 and ’16 and then for ’17 and ’18 it’s really going to be dependent and the earnings of the company are really dependent upon the rate base that’s authorized particularly in California as well as by the other state regulators and the numbers that are reflected on the right hand side of the table again are the rate basis for ’17 and ’18 assuming that the application in California were granted in full and we do know that that isn’t typically the case. So now I’m going to turn it back to Marty for slide 17. Martin Kropelnicki Great. So let’s talk about 2016 and what to expect. First and foremost as I mentioned earlier, continued drought conditions and mandatory restrictions in the State of California. We don’t see that going away now until the end of October and this will be a standing kind of agenda item that will update everyone on the quarterly calls. Based on current conditions we expect drought expenses to reduce earnings per share between $0.05 and $0.10 a share and again those costs will even though they are expensed in the period they will be recorded in a drought memorandum account that’s already been authorized and we apply or recovery of that at a later date. It’s the third year of rate case cycle. So you we know limited rate relief, we had $5 million in escalation plus a miscellaneous advice letter filings. It’s the greatest period of regulatory lag. One of the questions people ask me is well you have a year round balance in account which covers your revenue, you got your production costs balancing account you’ve got a health care balancing account, you’ve got a pension balance account, well what else is there well? Well there’s labor and as Tom mentioned with the leaks we told our team across the state you fix leaks 24/7, you don’t let water run. Any incremental costs like that are going to hit the labor line. You’ve chemicals, you have filters, as water conditions change throughout the state change. It can become more challenging from a water quality perspective. So those cost of treating water are not covered by any type of balancing account, those are forecasted into the rate case and any significant changes in water supply that we have to change treatment we have to absorb those cost and try to get them back in the next rate case. So it’s the greatest period of regulatory lag. So we’ll be very, very tight with our operating budgets this year. We did put in the slide deck here the 2015 tax rate which is 36% and we anticipate a tax rate of 38% in 2016. We did noticed and some of the questions we got from our investors is that they were missing some of the tax estimates or they would take a one-time tax adjustment and take it out in perpetuity. And when you have things like the maintenance repairs, deduction and currently congress is extended bonus depreciation that will cause the tax rate to move around but for us in terms of 2016 we’re anticipating a 38% tax rate. In addition we have a capital range which is a new all-time high for the company of $180 million to $210 million subject to the adjustments of the pending rate case that’s a big capital program for us and that’s why the reengineering or engineering was really important to us. So we did reorganize the department to focus on expedited capital delivery and getting all the projects done on scope, on schedule, on budget. A couple things to mention as well to keep on everyone’s radar screen we do have two commissioners in the State of California that will term out at the end of 2016 so we’ll be watching that and see who will become two of the commissioners, one of them is Commissioner Sandoval who has been our water commissioner. So that will be worth watching in the state to see how that plays out. In addition we announced in the fourth quarter we have a new board member that I believe is very significant. We hired Greg Aliff we invited him to join our Board, Greg has 38 years with Deloitte & Touche. He has a CPA. He recently retired as Vice Chairman and Senior Partner of Deloitte and Head of their U.S. Energy and Natural Resources. In his career he’s done a lot of things most of it’s centered around utilities including heading their sustainability practice. He also served on the Board of the Deloitte U.S. practice. So Greg truly is a utility expert and another financial expert. He’s our third financial expert that we have on the Board that really has a grasp of the regulatory mechanisms and processes and how they work and so are very, very honored to have Greg on our Board and look forward to working with them. So what are our focal points for 2016? First and foremost the drought, continue what we’ve been doing to help our customers hit their mandatory conservation targets. We don’t see that changing anytime soon. Second thing is the GRC, the GRC is a big deal. A lot of resources get burnt up and used up in the process but it’s going to be a focal point of the company and our goal is to try to drive up the GRC to conclusion before the end of the year on schedule. And the third thing is one of the capital program. Make sure that we are getting that capital on the ground, that we’re getting it closed and that we’re getting it embedded in rates and that will be our 2016 which will be a blink of an eye and I’ll be a year later we will be here talking about what we achieved in 2016. So with that operator we would like to open it up for questions please. Question-and-Answer Session Operator [Operator Instructions]. And we will take our first question from Spencer Joyce with Hilliard Lyons. Spencer Joyce Just a couple of quick ones from me, first off I know you mentioned the drought memoranda account had grown to about 4.4 million and I was hoping you could refresh us on the time table for making a recovery filing. I guess correct me if I’m wrong, at some point we will work that even as somewhat of an addition to the general rate case. Is that correct? Martin Kropelnicki Well it’ll be incremental to the rate case so essentially we will file an advice letter later most like an advice letter later this spring and then once that’s approved we will book that revenue. It used to be before we decoupled when we had memoranda accounts we would book the revenue as it was billed. So as that account balances worked out it was incorporated in rates and that’s when we recognized the revenue. Now that we have decoupled the balance in accounts it will happen as once the commission completes it’s prudency review and they authorize the collection of that memorandum account we will book all that revenue at once as it’s collectible. Spencer Joyce Okay. So if we file this spring would — is it correct to assume that we would only be filing for amounts accrued to that point so say if we file May 1st, we may go kind of May 1 through December and not accrue that additional expense? Martin Kropelnicki Yes. That’s right there’s going to be a delay for the 2016 expenses because the memorandum account deals with incremental expenses, there’s a proving to the commission that these expenses are actually incremental that you know we backfill the positions that we’re assigned to this drought task and all that. So we’re really looking at the 2015 costs and the small amount that was in 2014. Those costs are what we would file for in 2016. Any costs that are incurred in 2016 are likely to be filed in 2017. Spencer Joyce So those costs that we file for in 2016 that would likely be a net income benefit at some point in 2017? Well it depends on the length of time of the commission review. This is an informal review not a application filing. So I would anticipate that the review would take 90 to 120 days. So we’re talking about most likely what would that be? Probably a third quarter type event but it could be early or it could be later. I would hope that we would get recovery of that within 2016. Operator [Operator Instructions]. We will take our next question from Jonathan Reeder with Wells Fargo. Jonathan Reeder So I might have missed it in your remarks Marty, the 2% to 4% adjustment you said in the conservation goals kind of across the district that you expect this spring. Is that like allow more usage or would it just increase the level that they have to conserve? I miss which direction it’s going? Martin Kropelnicki It would allow for more usage. So essentially if you look at the comments of the State Board right now they’re anticipating — we had a 25% kind of total target for the state last year in 2015, they are talking about an approximate 20% target for ’16 but again that’s subject to the final snow pack reading here in April. So it’ll allow customers to use a little bit more water essentially and it’ll vary by region by region which is nice. The other thing I’ll tell you from a rate design perspective that we’re looking 70% to 80% of our customers are doing a great job and hitting their targets and we have that 20% that are going over their numbers. We’re looking at trying to incorporate in our rate design to call the dead band, you know that’s not a technical rate making term. But for example if Tom has a water budget of 10 units and he uses 11, on that 11th unit Tom will pay two times the highest rate and if you assume Tom hit his target all year [indiscernible] pretty mad when he gets that one unit at the super high rate. So a dead band essentially would put a little bit of a buffer in there before the surcharges kick in and again we have been very happy with our customer responses across the Board and we serve a very diverse slice of California from low income areas to very, very high income areas and overall just 70% to 80% of our customers have just done a fantastic job at hitting those targets. Jonathan Reeder Okay. So if you implement that dead band and that might I guess impact how quickly you I guess recover — under recovered WRAM balance, is that right how you made some headway there because of the surcharges? Martin Kropelnicki That would reduce the surcharges, remember also that Marty mentioned the sales reconciliation mechanism. So the extent that we had a 28% drop in our sales in ’15. We’ve adjusted our sales targets within the rate design by 10% to 15% across the Board. So they were actually collecting more cash throughout the year in base rates. So that is going to have the opposite effect and hopefully the combination that you won’t change the pace of recovery of the WRAM balance. Tom Smegal I think the other thing too, Jonathan again the surcharges are being paid by 20% to 25% of our customers who go well above their targets, their authorized water budget. So that dead band will basically give the customers who are been doing the right thing a little bit of breathing room. But the ones who really you know basically where we have collected the majority of the surcharges, I think they’re going to continue to go away over their budgets and those are people who tend to be less price sensitive and they just continue to write the check. So it’ll be interesting to see a year from now how that plays out. Jonathan Reeder Okay. So that’s good there and then I guess the other part the you mentioned the higher usage. If it does move to 20% that should hopefully help the unbilled revenue issue in ’16 where that’s actually may be a tailwind turnings, is that accurate? Martin Kropelnicki Again it’s very hard to say because it’s so dependent upon really the usage in December and so month the month it may have an impact really comes down for the annual basis it really comes down to December of ’15 versus December of ’16. And remember we’re incorporating – we’re as good as we are based upon the surcharges because we’re incorporating the unbilled surcharges as well, the drought surcharges into that number. If we get to October and that drops off we could still have a problem of unbilled in ’16 and expected to normalize later. Tom Smegal Yes I think Jonathan , a lot of times I think people get — the unbilled can be complicated but it’s just a revenue accrual at the end of the quarter. So if consumption is going down your revenue accrual is going to go down, if consumption starts going up at the end of the accounting period your revenue accrual is going to go up. So it’ll follow that and then it’s just subject to you know weather conditions and where we have seen more of the violent swings in the unbilled balance or the revenue accruals is been where we’ve had significant shifts in weather. So as Tom mentioned a warm dry December it was a $6 million pick up and now this year we had a really a wet December, a lot of rain in December and it ram back the other way. Jonathan Reeder Unfortunately unbilled not going through WRAM and just been kind of a timing issue, it creates a noises for the quarter, for the year and for the investors that maybe aren’t paying as close of attention. Martin Kropelnicki Right. And really that’s kind of why we’re pointing in those last few slides of the deck to sort of what’s the core earnings potential of the company just to get focused on that. It is noise related to that unbilled issue and it does float up and down and try to kind of pass through that and say what should we really expect this company to earn. Jonathan Reeder Right. So turning to the rate base forecast. What you showed does that included the 80 million pick up from the [indiscernible] or would that be incremental to your forecast? Martin Kropelnicki That does include that. The 1.3 billion – 4 billion estimate for ’17 is California GRC as filed which includes [indiscernible]. Jonathan Reeder Okay. And then why wasn’t there much of an increment to rate base in 2016 given you know the high level of CapEx in ’15? Martin Kropelnicki Remember this is the authorized, this is not the actual rate base that we went in and calculated what’s there on the balance sheet as far as the rate base goes. This is what ended up being additional authorized rate base. Two things drive that, one is that if you look at our CapEx, the 177 million about 60 million of that, 65 million of that is still in SEWIP and so it’s not earning a regulated return. There was an increase to the SEWIP balance from ’14 to ’15. So that’s part of it. There’s also timing issues associated with the rate case, they’re looking at an weighted average plant and a lot of our CapEx was at the end of the year so we’re looking at 177 million through the end of the year. A lot of it is necessarily going to get incorporated into ’15 whereas it would get incorporated for the following year. Jonathan Reeder Okay. And so the projections you’re showing are they average rate base or are they year end balances? Martin Kropelnicki Those are average rate base, so that is the weighted average rate base that we’ve applied for with the commission for ’17 and ’18 plus what we in the other states. Jonathan Reeder Okay. So that’s the total company rate base not just California? Martin Kropelnicki That’s right. That’s the total company rate, yes. Jonathan Reeder And then I guess last question and then I will let some other people get in there but the higher level of CapEx that you’re doing so does require that advice letter recovery for the portion that was above the authorized amount in the last GRC and I guess there is like a little bit of a lag involved there, is that how to kind of think about those higher amounts? Martin Kropelnicki Yes. I think there’s two things, remember in the GRC process. The last year GRC was filed in mid-2012 and so to forecast out what we’re going to spend and what we’re authorized to spend in 2015 is a little bit of a stretch from that vantage point from the vantage point of when you initially file. So part of the CapEx for ’15 is anticipating the recovery in the 2017 test year. So we do have potentially a lag between what the actual rate base and what’s the adopted rate base for ’16. That kind of what you’re talking about there. Some of these projects are advice letter projects and we will be filing for recovery of some of the advice letter projects throughout the year. The difficulty in predicting those into our earnings for ’16 is really the timing of the commission’s authorization for recovery as we go through the year as you get later, later in the year you get less and less of a recovery within the year. So we do have a number of advice letter capital projects that we expect to file but that the amount of revenue that we can expect from that is fairly limited based upon when we think we’re able to file that during the year. Jonathan Reeder So last thing to understand, you were talking about kind of the headwinds against achieving that maximum regulate earnings should we also think I guess [indiscernible] on SEWIP is I guess offsetting a portion of that? Martin Kropelnicki Well I mean those are it’s really timing differences, so when we say the AFUDC on the SEWIP what we’re talking about is including those costs and we have for the last 15 years included those costs in our rate base figures as the products are completed and recognized in rate base and so that adds whatever it adds 2% to 5% of the project cost based upon how much interest happened during the period that the project was under construction. So what you’ll see is an initial bump based on the SEWIP and the trend will be that for each project going forward there will be no capitalized interest included in the project cost of the trajectory of CapEx would decline somewhat over what it would have been including interest during construction. Jonathan Reeder Right, but until that potential change like for 2016 when we look at what you said the maximum allowable regulated earnings I guess why you’re still accruing AFUDC that potentially offset some of the cost recovery and regulatory lag those kind of headwinds. Martin Kropelnicki It does but you don’t see it right away, I think that’s what I’m getting at. That gets capitalized and incorporated into the plant that’s built in 2016. Operator [Operator Instructions]. It appears we have no further questions in the queue at this time. Martin Kropelnicki Okay. Well thanks everybody for joining us and we look forward to discussing our first quarter results at the end of April. Thanks very much. Tom Smegal Thanks everyone. Operator And that does conclude today’s conference. Thank you for your participation. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. 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ITC Holdings (ITC) Joseph L. Welch on Q4 2015 Results – Earnings Call Transcript

Operator Good day, ladies and gentlemen, and welcome to ITC Holdings Corporation Fourth Quarter Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will have a question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded. I would now like to turn the call over to your host for today’s conference, Ms. Stephanie Amaimo. Ma’am, you may begin. Stephanie Amaimo – Director-Investor Relations Thank you. Good morning, everyone, and thank you for joining us for ITC’s 2015 fourth quarter and year-end earnings conference call. Joining me on today’s call are Joseph Welch, Chairman, President, and CEO of ITC; and Rejji Hayes, our Senior Vice President and CFO. This morning, we issued a press release summarizing our results for the fourth quarter and for the year ended December 31, 2015. We expect to file our Form 10-K with the Securities and Exchange Commission today. Before we begin, I would like to make everyone aware of the cautionary language contained in the Safe Harbor statement. Certain statements made during today’s call that are not historical facts such as those regarding our future plans, objectives, and expected performance reflect forward-looking statements under federal securities laws. While we believe these statements are reasonable, they are subject to various risks and uncertainties. And actual results may differ materially from our projections and expectations. These risks and uncertainties are discussed in our reports filed with the SEC such as our periodic reports on Forms 10-K and 10-Q and our other SEC filings. You should consider these risk factors when evaluating our forward-looking statements. Our forward-looking statements represent our outlook only as of today. And we disclaim any obligation to update these statements, except as may be required by law. A reconciliation of the non-GAAP financial measures discussed on today’s call is available on the Investor Relations page of our website. I will now turn the call over to Joe Welch. Joseph L. Welch – Chairman, President & Chief Executive Officer Thank you, Stephanie, and good morning, everyone. I’m pleased to report another year of strong operational and financial performance at ITC, which adds to our remarkable track record of consistently delivering on our commitments to customers and investors. On the operational side, our systems continue to perform at top tier levels. Our METC system had the lowest outage count in its history, while both ITCTransmission and ITC Midwest had the second lowest outage counts in their respective histories. This stellar operational performance shows that the longer ITC owns a system and implements its best-in-class operations and maintenance plans, the better the systems perform. It’s also worth noting that we executed our operational maintenance program under budget to the benefit of customers without compromising quality of service or safety as evidence by another solid safety record, 2015. Since ITC’s inception, we have invested over $5.8 billion in our operating systems to modernize the grid. In 2015, these capital investments totaled $771 million. Most notably, in 2015, we placed the Thumb Loop project at ITCTransmission in-service during the first half of 2015. As mentioned on our second quarter 2015 call, the Thumb Loop is the largest project in ITC’s history and services the backbone of the system of design to meet the maximum energy potential of Michigan’s Thumb region. It’s a prime example of the effectiveness of ITC’s planning process which identify the transmission needs to facilitate Michigan’s renewable energy goals while also strengthening the regional transmission grid. This project increases transmission system capacity and reliability, while providing more efficient transmission of renewable energy. With an estimated direct impact of $366 million to the Michigan economy, the Thumb Loop project created jobs and will continue to have a meaningful near-term and long-term impact on the economy of the region and the entire state. Similar to the Thumb Loop project, our Multi-Value Projects or MVPs at ITC Midwest, which remain on track, highlight the value of forward thinking and collaborative planning between the state, the region and key stakeholders, while concurrently positioning ITC for future success. From a financial perspective, we had another strong year with 2015 operating earnings of $2.08 per diluted share which was well within our guidance range and marks the ninth consecutive year of double-digit annual operating earnings growth. To that end, we continue to see double-digit earnings growth in the years to come as evidenced by our revised capital investment forecast through 2018 at our regulated operating companies which Rejji will elaborate on in his prepared remarks. On the value return front, we continue to honor our commitments to shareholders by increasing the dividend by approximately 15% in August of 2015 and including our $115 million accelerated share repurchase program in November, effectively using the remaining capacity of board authorized share repurchases. Together, these efforts highlight the operational and financial strength of the business which we believe will continue to yield long-term benefits for our customers and investors. Turning to regulatory matters. In the initial MISO base ROE complaint, the administrative law judge issued an initial decision in late December 2015. The ALJ recommended a base ROE of 10.32% with the high end of the zone of reasonableness of 11.35%. While we view this outcome as constructive, a final order isn’t expected from FERC until later this year. In the second ROE complaint, the MISO transmission owners filed their initial testimony on January 29. And we do not expect an initial decision from the ALJ until late June. As we have said in the past, we remain confident that FERC will continue to support their historic policies given the significant investment requirements necessary to modernize the electrical infrastructure of the United States. With respect to development activities, we continue to advance Lake Erie Connector project. In late January, we filed a joint permit application with the Pennsylvania Department of Environmental Protection and the U.S. Army Corps of Engineers in support of the project. Additionally, we continued to negotiate transmission service agreements with prospective shippers. As we’ve discussed in the past, upon executing transmission service agreements under acceptable terms and conditions, we would then anticipate receiving federal, state and provincial permits by the second quarter of 2017, commencing construction around that time with commercial operation expected in 2019. Lastly, in late November, ITC’s board of directors announced a review of strategic alternatives which concluded with our announcement of Fortis acquisition of ITC on February 9. I’ll let Rejji go through the transaction details. But, needless to say, we’re excited about this outcome for our shareholders, customers and employees. We view Fortis as an ideal partner that will enable ITC to continue our objectives of long-term investments in the electrical infrastructure in North America. Overall, we are pleased with the fourth quarter and full year 2015 results and look forward to working with Fortis to close the transaction to become a diversified infrastructure company with a stronger platform going forward. Since ITC’s inception, we have been focused on creating meaningful value for our stakeholders by becoming the leading electric transmission company in the United States. Fortis is an outstanding company with a proven track record of successfully acquiring and managing U.S.-based utilities in a decentralized manner. This transaction accomplishes our objectives by better positioning the company to have a higher level of focus on pursuing our long-term strategy of investing in transmission opportunities to improve reliability, expand access to power markets and allow new generating resources to interconnect to transmission systems and lower the overall cost of delivered energy for our customers. I am forever grateful for the hard work of the ITC employees in building this great company and look forward to a bright future of continued operational excellence supported by the Fortis platform. We also very much appreciate the longstanding support of our investors who will receive an attractive premium for their investment and will also benefit from the opportunity to participate in the upside of the ITC joining with Fortis, including future value creation and a growing dividend program. I will now turn the call over to Rejji to elaborate on our 2015 financial results and the Fortis transaction. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Thank you, Joe, and good morning, everyone. For the fourth quarter of 2015, we reported operating earnings of $87.6 million or $0.57 per diluted share, an increase of approximately 19% or $0.09 per diluted share over the same period in 2014. Reported net income for the quarter was $37.4 million or $0.24 per diluted share, a decrease of $9.4 million or $0.06 per diluted share compared to the fourth quarter in 2014. For the year ended December 31, 2015, we reported operating earnings of $323.8 million or $2.08 per diluted share, an increase of 12% or $0.23 per diluted share over the same period in 2014. As highlighted in our prior calls, absent the Kansas V-Plan Project bonus payment expenses booked in the first quarter 2015, our year-over-year growth would have been approximately 15%. Reported net income for the year ended December 31, 2015, was $242.4 million or $1.56 per diluted share, resulting in a decrease of $1.7 million for reported net income, an increase of $0.02 per diluted share compared to the same period in 2014. Operating earnings are reported on a basis consistent with how we have provided our guidance for the year and exclude the following items. First, they exclude regulatory charges of approximately $0.6 million for the fourth quarter 2015. These expenses totaled $7.3 million or $0.04 per diluted share for the year ended December 31, 2015, and $0.1 million for the year ended December 31, 2014. 2015 charges relate to management’s decision to write-off abandoned costs associated with the project at ITCTransmission and a refund liability attributable to contributions in aid of construction. A 2014 charge relates to certain acquisition accounting adjustments for ITC Midwest, ITCTransmission, and METC, resulting from the FERC audit order on ITC Midwest issued in May of 2012. Second, operating earnings exclude after-tax expenses associated with the cash tender offer and consent solicitation transaction for select bonds at ITC Holdings that we completed in the second quarter of 2014. The impact of this item totaled $0.2 million for the fourth quarter of 2014 and $18.2 million or $0.12 per diluted share for the year ended December 31, 2014. Third, operating earnings exclude the estimated refund liability associated with the MISO base ROE, which totaled $48.6 million or $0.32 per diluted share for the fourth quarter 2015 and $73.2 million or $0.47 per diluted share for the year ended December 31, 2015. Of the $48.6 million estimated refund liability charge in the fourth quarter 2015, $36.8 million or $0.24 per diluted common share relates to revisions to the estimated liability for the periods prior to October 1, 2015, and of the $73.2 million estimated refund liability charge for the year ended December 31, 2015, $28.4 million or $0.18 per diluted common share. And those relate to revisions to the estimated liability for the periods prior to January 1, 2015. ROE refund liability expenses totaled $28.9 million or $0.18 per diluted share for the fourth quarter year ended December 31, 2014. It is possible that upon the ultimate resolution of this matter, we may be required to pay refunds beyond what has been recorded to-date. We will continue to assess this matter and we’ll provide updates as necessary. Lastly, to exclude after-tax expenses associated with the 2015 review of strategic alternatives of approximately $1 million or a $0.01 per diluted share for the fourth quarter and year ended December 31, 2015, as well as Entergy transaction expenses of approximately $0.1 million and $0.7 million or a $0.01 per diluted share for the fourth quarter and year ended December 31, 2014. For the year ended December 31, 2015, we reported total capital investments of $771.4 million which was in excess of our revised capital guidance levels in Q3 of 2015 of $715 million to $765 million. Our 2015 capital investments included $189.6 million at ITCTransmission, $174.8 million at METC, $388.4 million at ITC Midwest, $14.4 million at ITC Great Plains and $4.2 million of development related investments in the New Covert project. As Joe highlighted, ITC’s commitment to long-term infrastructure investment continues as evidenced by the fact that we’re revising our regulated operating company capital investment forecast upward for the period of 2016 to 2018 to reflect approximately $2.1 billion of aggregate capital investments over this period which compares favorably to our prior plan estimates of $1.9 billion. The capital included in this forecast is comprised of highly probable capital investments in our current footprint which are not subject to competition or future energy policies. The resulting capital investment plan is projected to increase ITC’s average rate base plus construction work in progress balances from approximately $5.3 billion in 2015 to approximately $6.6 billion in 2018. These investment levels are expected to drive a compound annual growth in operating earnings per share greater than 10% which also compares favorably to our prior plan estimates of approximately 10%. With respect to balance sheet related activities, in December, we completed the accelerated share repurchase program or ASR that we initiated on September 30, 2015. Under the ASR, ITC received an initial delivery of 2.8 million shares on October 1, 2015, with a fair market value of $92 million. The ASR was settled on November 5, 2015, and ITC received an additional 0.8 million shares as determined by the volume weighted average share price during the term of the ASR less an agreed upon discount and adjustment for the initial share delivery. In total, we repurchased approximately 3.6 million shares at a volume weighted average price of $32.57 per share which is inclusive of any agreed upon discounts. This last trade concludes our board-authorized share repurchase program which we initiated in June of 2014. All-in, ITC successfully repurchased $245 million worth of shares or 7.2 million shares from 2014 to 2015 in aggregate at a volume weighted average price of $34.57, which compares favorably to ITC’s recent stock performance. From a liquidity perspective, as of December 31, 2015, we had total liquidity position of approximately $694 million, which consists of approximately $14 million of cash-on-hand and approximately $680 million of net undrawn revolver capacity. For the year ended December 31, 2015, we reported operating cash flows of approximately $556 million, which represented an increase of approximately $54 million or 11% year-over-year. Shifting gears to the Fortis acquisition of ITC, the transaction translated into an offer price of $44.90 in U.S. dollars per common share at announcement on February 9. The offer price consists of US$22.57 in cash per share and 0.752 of a Fortis common share, which equates to an equity purchase price all-in of US$6.9 billion or US$11.3 billion in enterprise value, including assumed indebted announcement. Upon closing, approximately 27% of Fortis common shares will be held by ITC’s investors. As Joe mentioned, the transaction enables ITC to continue to make needed investments in the grid, while maintaining operational excellence with no expected impact to transmission rates. We expect that the transaction will close in late 2016 upon receiving the required regulatory approvals, including FERC, the Department of Justice, the Committee on Foreign Investment in the U.S. or CFIUS and the state of Illinois, Kansas, Missouri, Oklahoma and Wisconsin. In closing, 2015 was another successful year which demonstrates our commitment to investing in necessary transmission infrastructure for the benefit of customers while also providing an attractive total shareholder return to our investors. Moreover, we managed to meet our operational and financial objectives while concurrently conducting the strategic review and sale process for the better part of 2015 which again speaks volumes to the focus and dedication of our employees. At this time, we’d like to open up the call to answer questions from the investment community. Question-and-Answer Session Operator Thank you. Our first question is from Charles Fishman with Morningstar. Your line is open. Charles Fishman – Morningstar Research I just have one question. Rejji, the 7.5% CAGR on your base rate – rate base growth, that is now your methodology as well as that number is consistent with Fortis. Am I correct? Rejji P. Hayes – Chief Financial Officer & Senior Vice President Yes. That aligns with the materials that were shared by Fortis and ITC jointly when we announced the transaction on February 9. And so, again, that’s average rate base from 2015 to 2018. And, as highlighted in our comments, that will yield over 10% operating EPS growth over that timeframe. Charles Fishman – Morningstar Research Got it. That was my only question. Thank you. Joseph L. Welch – Chairman, President & Chief Executive Officer Okay. Operator Thank you. Our next question is from Jay Dobson with Wunderlich. Your line is open. Jay L. Dobson – Wunderlich Securities, Inc. Hey. Good morning, Joe. I was hoping if you could just give a little inside into what the capital budget changes were, about 10% or $200 million. Does that sort of fit ratably across the franchises or was there a particular area that that sort of was associated with? Rejji P. Hayes – Chief Financial Officer & Senior Vice President Jay, hi. It’s Rejji. I can take that. Yeah. We should look at that in a couple of ways. So if you recall when we had our prior plan that extended from 2014 to 2018, we talked a lot about the $3.4 billion of regulated opco spend. And within that mix, about two-thirds of that was base capital spend and about a third of that was regional projects that were already awarded to ITC. The spend mix has evolved in this latest vintage and I’d say quite favorably where of the $2.1 billion that we’re offering from 2016 to 2018 which again overlaps with the prior public plan, three-quarters of that is base capital spend. And that’s, again, spend on our existing systems. So you’ve got asset renewals, system capacity, performance upgrades, reliability standard type spend. And so all stuff which is clearly things we have a strong track record of getting done on-time and on-budget and also you’re not replying upon co-constructors like we are for some of the regional projects. And so the mix is about 75% base capital spend, about 25% regional spend. And then within the opcos, the mix there is – it’s more weighted towards the Michigan entities. Again, if you compare this current plan relative to the prior public plans, you’ve got a little pick up in spend of the Michigan entities related to reliability type spend and again things of that nature. And you’ve got a little bit of decrease in expected spend at Midwest and Great Plains. Is that helpful? Jay L. Dobson – Wunderlich Securities, Inc. Very, very helpful. I definitely appreciate that. And then on the ROE, I’m sure you don’t want to get into specifically what you’re assuming there. But I assume it’s fair to assume you’re in line with where the ALJ came out and that drove the sort of incremental reserve? Rejji P. Hayes – Chief Financial Officer & Senior Vice President Jay, happy to take that. This is Rejji again. So, as we’ve highlighted in the past, every quarter, we’re going to evaluate the latest data points that have been publicized. And, clearly, there was an ALJ decision in late December. We also had testimony filed from our experts. And we also are clearly mindful of what the trial staff provided – I believe October. And so we’ve looked at all of that and we’ve taken into account again those data points. And I’d say we’re directionally aligned with where the ALJ has come out, but I will not say that we’re precisely on top of the ALJ. I think we have a different perspective on where FERC will end up, but it’s directionally not too far afield from where the ALJ came out. Jay L. Dobson – Wunderlich Securities, Inc. Perfect. And then, lastly, on Lake Erie, just sort of an update on sort of when we’ll have a thumbs-up or thumbs-down. Understand that you continue to pursue permits, so you must feel good about it, but when we’ll have sort of a go, no-go decision based on sort of customer response? Rejji P. Hayes – Chief Financial Officer & Senior Vice President Right. So the development team continues to work very hard on executing transmission service agreements with prospective shippers. So, initially, we thought we may have visibility on that by mid-year. We haven’t written that off yet. But at this point, we think it could be either mid-year 2016 or in the back half of 2016. So we continue to work on that. We obviously had a filing a few weeks ago in Pennsylvania that Joe noted in his opening remarks. And so we continue to push along the regulatory process as well as the negotiation with the prospective shippers. So I suspect back half of this year we’ll have visibility on that. Jay L. Dobson – Wunderlich Securities, Inc. That’s great. Thanks so much. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Thank you. Joseph L. Welch – Chairman, President & Chief Executive Officer Thank you. Operator Thank you. Our next question is from Caroline Bone with Deutsche Bank. Your line is open. Caroline V. Bone – Deutsche Bank Securities, Inc. Hey, guys, I was just wondering if you guys could provide some updated thoughts on when you might be able to start making the necessary regulatory approval filings related to the Fortis deal? Joseph L. Welch – Chairman, President & Chief Executive Officer We’ve planned to do that in the not-too-distant future. The process that we use is, of course, I’m sure you understand is that once you make a filing, you’re no longer able to talk to any of the regulators or meet with any of the people associated with the case. So our first objective is to have those meetings that are necessary, so that our regulators get a good chance to meet the Fortis team and also get a good chance to delve into, if you will, the intricacies of the transaction, with the Fortis team there in present. And then once we complete that process, I believe, we’re scheduled in about a month to make those filings. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Yeah. That’s exactly right. Caroline, this is Rejji. The only thing I would add is that, clearly, I think, the Fortis team is quite focused on identifying and structuring a deal with a third-party equity investor who would take a direct stake in ITC. And I think they’ll want to know and have visibility on that third-party before we file. So that’s, I’d say, one gating item. But we’re working hard with the Fortis team to get that done. And I think they’ve been forecasting for some time that they’d try to get that done within the next 90 days or so. Caroline V. Bone – Deutsche Bank Securities, Inc. Okay. Thanks very much on that. And then just one last one on just kind of the standalone outlook. I was wondering if you could quantify the level of parent company debt you’d expect to see through 2018, assuming this new plan. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Yeah. So, historically, Caroline, we haven’t offered that level of granularity around projected debt. I think where we sit at this point, the holding company represents about 50% of the consolidated debt portfolio which, as announced on February 9 and when we announced the transaction, was just under $4.5 billion. So I think what you can assume, if nothing else, is that as we continue to fund capital investments, we’ll continue to do so in a manner comparable with how we’ve done in the past where we’ll fund a portion of the capital requirements with debt issued at the holding company at ITC. And so we’ll probably try to have credit metrics on a consolidated basis at ITC that are in line with where we’ve been historically. Caroline V. Bone – Deutsche Bank Securities, Inc. All right. Thanks, guys. That’s it from me. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Thank you. Operator Our next question is from Greg Gordon with Evercore ISI. Your line is open. Greg Gordon – Evercore ISI Thanks. Good morning. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Good morning. Greg Gordon – Evercore ISI I just wanted to be clear on the operating EPS, CAGR, the greater than 10%. That’s all things equal stable ROE, right? So if we normalize for the ROE through the planning period whether it’s at the ultimate level of the refund or whether it’s stable at the current level, you would be growing at that rate. But any change that happen to the ROE impacts the growth rate in actuality over that period. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Yeah, Greg. This is Rejji. Let me take a stab at that. I think, first and foremost, we actually have layered in a level of ROE degradation into the forecast. And that’s something that we did provide to prospective buyers as part of the sale process. So these forecasts we’re giving you in the greater than 10% CAGR for operating EPS from 2015 to 2018 does presuppose some level of degradation. But what I think is important to note is, clearly, there is some uncertainty as to where the ROE will be, to say the least. Is that because of the nature of the refund, which essentially will be established at some point by FERC either in the end of 2016 or at some point in 2017, its retrospective, as you know. So it goes all the way back to November of 2013 when the complaint was initially filed. So 2015, the base year of your growth, will be fully exposed to the ROE degradation in which case I would submit that you have to adjust your base year 2015 and then that should be consistent with all of your subsequent years. And so no matter what ROE you utilize in 2015, whether you think it’s going to be 12%, 11%, 10%, 9%, whatever your expectation is, you’ll see that the capital investment over that timeframe drives the growth. And so whatever ROE you presuppose, you’re going to still see double-digit growth. Greg Gordon – Evercore ISI That’s exactly what I thought. I just wanted to be clear. Thanks. I still owe you that picture with the Patriots jersey. I’ll get that to you soon (28:59). Joseph L. Welch – Chairman, President & Chief Executive Officer Looking forward to it. Greg Gordon – Evercore ISI Bye, bye. Joseph L. Welch – Chairman, President & Chief Executive Officer Bye. Operator Our next question is from Julien Dumoulin-Smith with UBS. Your line is open. Julien Dumoulin-Smith – UBS Securities LLC Hey. Good morning, everyone. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Morning. Joseph L. Welch – Chairman, President & Chief Executive Officer Morning, Julien. Julien Dumoulin-Smith – UBS Securities LLC So, just as far as quick clarification, what’s the assumption on bonus deprecation of late in the forecast? Just wanted to be clear about that. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Julien, this is Rejji. As you know, we’ve not elected bonus depreciation for some time and we’re currently not assuming any election of bonus depreciation over the forecasted period. Julien Dumoulin-Smith – UBS Securities LLC Great. Excellent. And then I know you were just talking about the Lake Erie project. How are the conversations going? And I suppose specifically here directionality, given the nuclear extensions in Canada, is this more of a conversation of imports into the U.S.? Just kind of curious how are you thinking about the project at this point and potential counterparties, et cetera? Joseph L. Welch – Chairman, President & Chief Executive Officer Actually, I think that if you look at the project that there is a capacity value that’s associated with the line, as you aptly pointed out that there is the nuclear power plants in Canada. But, however, they will be shut – they won’t be shut down but they will be retrofitted and refueled. That causes flows to go in the other direction. We’ve seen interest pretty much in both directions depending on how you see certain things playing out with the now in limbo Clean Power Plan. And so what’s really starting to happen is you’re seeing people who want to hedge on both sides of the border with this line because there is no – it shouldn’t shock anyone a lot of uncertainty in the ability to plan your power plant expansion and which power plants are going to be on. I think the uncertainty is just driving the market and everyone crazy. So simple answers, both bidirectional. Julien Dumoulin-Smith – UBS Securities LLC Got it. And perhaps just on the margin, I’d be curios. The puts and takes here on the outlook, given CPP stay as you kind of kind of alluded to already with that Lake Erie project, but more broadly in terms of the planning processes at OSVP (31:28) and your own as well as any implications from the latest PTC extension. Are you seeing any kind of incremental generator connects or wider projects that could come out of that that may or may not be reflected in your current outlook? Rejji P. Hayes – Chief Financial Officer & Senior Vice President Yeah. Julien, certainly, I think, first and foremost, to your very last comment, the forecast and the updated capital investment forecast that we provided from 2015 to 2018 or 2016 to 2018 rather does not presuppose, what I’ll call, any sort of third-party-driven spend. So energy policies that may serve as the catalyst for incremental spend are forecasted, solely predicated on the stuff that we can view as quite concrete and tangible, so base spend and regional projects already awarded to us, none of which is subject to competition. So we certainly at some point will – we at least would assume that there will be incremental transmission investment opportunities attributable to whether it’s the Clean Power Plan or some derivation thereof. Certainly, there’ll be opportunities there. We’ve already talked about in the past the fact that there probably will be opportunities related to physical and potentially cyber security standards promulgated by NERC over time. And then on our last call, in Q3, we also mentioned the fact that we foresee increased spend in the distribution system in Michigan from DTE and CMS which has positive spiller effects for transmission owners. So all of those things as we see it are catalysts that could drive incremental growth above and beyond this plan, but we’re not at this stage ready to say that equates to X to Y billion dollars or whatever it may be. Julien Dumoulin-Smith – UBS Securities LLC Got it. And then, lastly, FERC 1000 talk about reform at kind of at the FERC level, et cetera. Just be curious to get your perspectives on how that ultimately manifest itself. What you all would be keen to see if that was indeed the case? Joseph L. Welch – Chairman, President & Chief Executive Officer Oh. With regards to Order 1000, I think, that internal to FERC is that they have this belief that they need to tune Order 1000 up. I don’t think that it’s safe to say that they are getting the results that they had expected. And so I think that they are going to start to hold technical conferences to try to figure out what they could tune up to make it work a little bit better. But, honestly, I don’t think that – this is my personal opinion – that Order 1000 needs a tune up. It needs to be taken off the books. It’s not working. It’s just fundamentally not working and it’s put more hindrances in expanding the transmission grid, something that it wasn’t intended or designed to do. But I think that we’ll go incrementally to try to fix it long before we get to the point where we say it’s just not working. Julien Dumoulin-Smith – UBS Securities LLC Great. Thanks for the clarity, guys. Congrats again, Rejji P. Hayes – Chief Financial Officer & Senior Vice President Thank you. Operator Thank you. And our next question is from Praful Mehta with Citigroup. Your line is open. Praful Mehta – Citigroup Global Markets, Inc. (Broker) Hi. Thanks, guys. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Thank you. Praful Mehta – Citigroup Global Markets, Inc. (Broker) Hi. Sorry. My question is on the sale, the 15% to 19% sale. And, clearly, given that impacts the Fortis stock, it is important for you guys because ultimately ITC shareholders become Fortis shareholders. So I guess it really comes back to trying to understand how you see that they are going. What you see your role in it? And, finally, given most of the buyers would probably have already participated in the auction, how do you expect the value outcome of that given the fact that they’ve already participated in the auction and Fortis kind of came out on top? So would love to get some color on that. Thank you. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Yeah. Praful, it’s a very good question. This is Rejji. I think I’d point you to the Fortis team and Barry and Karl for their perspective on their expectations around what they would like to structure for that third-party equity sale. But I can tell you that we’ve been involved in the process certainly in marketing the ITC story. And we’re working hand in hand with the Fortis team to help them raise that capital. I’ve heard Barry say this in several discussions and I said it publicly in the February 9 call, but I suspect he’ll want to have a partner who is willing to come in at a value that’s comparable to the price at which Fortis is entering ITC stock and they’ll look to do something comparable of that. So that the economics – or it doesn’t impact materially their EPS accretion estimates. And I suspect they’ll want a party that also is patient, is liquid and is amenable to exit mechanisms. But, again, I would suggest that you should talk to Barry, Karl and team about that, because it’s clearly driven by them. Joseph L. Welch – Chairman, President & Chief Executive Officer And I think what I’d like to add to what Rejji had to say which is exactly correct is that a lot of the people which you would hypothesize were in the transaction would be the same people that are looking at this. That may be true, but actually this transaction was quite large. And a lot of people who would like to tap a piece of ITC weren’t large enough to buy ITC. And so they’ve had just an immense amount of interest and again Barry has said this publicly. They have had an immense amount of interest in the people who would like to participate in having a partial ownership of ITC, hand in hand with Fortis. Praful Mehta – Citigroup Global Markets, Inc. (Broker) Got you. That’s good color. And I do appreciate this smaller acquisition fees in this case, so that makes sense. And the second thought, I guess, from a timing perspective, would these more safe, I guess, infrastructure type buyers be looking for clarity post a FERC decision to come in or do you expect this transaction to take place before a FERC final decision? Rejji P. Hayes – Chief Financial Officer & Senior Vice President Yeah. The Fortis team has been quite transparent about the fact that ideally they’d like to have this wrapped up within the next – I think they said a couple weeks ago 90 days is in a perfect world you’ll want to have the buyer in its full form presented to regulators as part of the filing. So I think if there is an unforeseen party who is still out there that regulator is unaware of that probably impacts your filing process. So I think they want to have that wrapped up first before we commence the filing. Praful Mehta – Citigroup Global Markets, Inc. (Broker) Fair enough. Thanks a lot for the color. Rejji P. Hayes – Chief Financial Officer & Senior Vice President Thank you. Operator I’m not showing any further questions in the queue. So I’ll turn the call back over to Stephanie Amaimo for closing remarks. Stephanie Amaimo – Director-Investor Relations Thank you. This concludes our call. Anyone wishing to hear the conference call replay available through March 1 can access it by dialing 855-859-2056 toll-free or 404-537-3406, pass code 35330470. The webcast of this event will also be archived on the ITC website at itc-holdings.com. Thank you, everyone, and have a great day. Operator Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. 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American Water Works’ (AWK) CEO Susan Story on Q4 2015 Results – Earnings Conference Call Transcript

Operator Good morning and welcome to American Water’s Fourth Quarter and Year End 2015 Earnings Conference Call. As a reminder, this call is being recorded and is also being webcast with an accompanying slide presentation through the company’s Investor Relations website. Following the earnings conference call, an audio archive of the call will be available through March 3, 2016 by dialoging 412-317-0088 for U.S. and international callers. The access code for replay is 10079115. The online archive of the webcast will be available through March 25, 2016 by accessing the Investor Relations page of the company’s website located at www.amwater.com. [Operator Instructions] I would now like to introduce your host for today’s call, Greg Panagos, Vice President of Investor Relations. Mr. Panagos, please go ahead. Gregory Panagos Thank you, Kerry. Good morning, everyone. And thank you for joining us for today’s call. We will keep the call to about an hour. At the end of our prepared remarks, we will open the call up for your questions. During the course of this conference call, in both our prepared remarks and in answer to your questions, we may make forward-looking statements to represent our expectations regarding our future performance or other future events. These statements are predictions based upon our current expectations, estimates and assumptions. However, since these statements deal with future events, they are subject to numerous known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from the results indicated or implied by such statements. Additional information regarding these risks, uncertainties and factors is provided in the earnings release and in our 2015 Form 10-K each as filed with the SEC. I encourage you to read our Form 10-K for a more detailed analysis of our financials and other important information. Also reconciliation tables for non-GAAP financial information discussed on this conference call including adjusted EPS and our O&M efficiency ratio can be found in the appendix of the slide deck for this call which is located at the investor relations page of the company website as well as our earnings release. We will be happy to answer any questions or provide further clarification if needed during our question-and-answer session. All statements in this call related to earnings and earnings per share refer to diluted earnings per share from continuing operations. Before I turn the call over to Susan, I would like to take this opportunity to introduce you all to Melissa Schwarzell. Our new Director of Investor Relations. Melissa has been a member of American Water’s finance team in Lexington, Kentucky since 2009. Her experience includes supporting rate cases, infrastructure filings and other regulatory matters in seven of American Waters regulated states. She has worked on most of the company’s cost components and she has tackled challenging recovery issues. She’s also provided rates related financing – excuse me, financial planning support throughout the American Water footprint. I know you will all find Melissa to be very helpful and a pleasure to work with. And now, I will turn the call over to American Water’s President and CEO, Susan Story. Susan Story Thanks, Greg. Good morning, everyone and thanks for joining us. With me today are Linda Sullivan, our CFO, who will go over the fourth quarter and full year financial results; and Walter Lynch, our COO, who will give key updates on our regulated business. On January, the 1st, Walter assumed additional responsibility for operational and safety best practices across our AWE market-based businesses. So periodically, he will give you an update on those efforts as well. The employees of American Water delivered strong results in 2015 for both the fourth quarter and the full year. We invested significant capital into needed upgrade for our system to provide reliable and safe water and wastewater services. We continued our focus on managing costs and deploying technology so that our services remain affordable for our customers and we treated and delivered water that consistently met and surpassed EPA drinking water standards. This includes the lead and copper rule, which has generated a lot of news recently, due to the crisis in Flint, Michigan. American Water samples for lead on a routine basis and our water systems continue to be incompliance with that rule. We expanded our regulated customer base in 2015 by nearly 42,000 metered customers; about 9,000 customers resulted from organic growth in our existing footprint. 24,000 customers joined our system from acquisitions that closed during the year, and additional 9,000 are from acquisitions, where we have written agreements in place and are just awaiting regulatory approval. We also continue to grow our market-based businesses through new contracts and new customers. As you can see on slide seven, we reported operating revenues of $783 million, a 7% increase above fourth quarter 2014. For the full year, operating revenues were nearly $3.2 billion, an increase of about 5% over 2014. Earnings from continuing operations were $0.55 per share for the fourth quarter, a 5.8% increase above fourth quarter 2014. Annual earnings were $2.64 per share, up 8.6% over 2014 adjusted EPS. The fourth quarter includes a $5 million contribution to the American Water Foundation whose work I will discuss briefly before our Q&A session. Turning now to slide eight; you can see that we delivered on our strategies in both the regulated and market-based businesses in 2015. We made about $1.4 billion in total annual investment, the highest in our company’s history. We invested $1.2 billion in our regulated system, which improved our long-term service reliability and water quality for our customers. We’re able to increase our investment at this level because of the expertise of our hardworking employees and our continuous improvement in both O&M and capital deployment efficiency. We’re proud of our ability to deliver on our growth goals and effectively manage every dollar to deliver excellent customer service while we keep our customer bills affordable. Even more importantly, we know that our customers need to be able to trust that the water we provide is clean and safe. So while consistently meeting and surpassing all EPA requirements in 2015, we continued our focus on further strengthening our critical assets. Let me give you a couple of examples. We upgraded two of our company’s largest water treatment plants, which serve over 300,000 customers in St. Louis County, Missouri. In Champaign, Illinois, we upgraded chemical treatment facilities nearing the end of their useful life with improvements that included replacing gas coring facilities with safer technology. In addition to these regulated system investments in 2015, we also grew our customer base organically and through regulated acquisitions. Our market-based businesses continue to grow as well. In December, our Contract Services Group was awarded a 10-year O&M contract in Camden, New Jersey with revenue of approximately $125 million. Our Military Services Group expanded to 12 bases with a successful 50-year contract bid for Vandenberg Air Force Base with revenue of approximately $300 million. Our Homeowner Services Group expanded to 1.6 million service warranty contracts and we grew our utility partnerships by adding Rialto, California and the Orlando Utilities Commission. As you know, we expanded our business through the acquisition of Keystone Clearwater Solutions. So, in summary, we produced excellent results for the year through our ongoing customer growth, highest annual capital investment in our history, and we continued our O&M and capital efficiency. This continues our progress toward achieving our goal of 7% to 10% EPS growth through 2020. Based on our performance, our board declared a cash dividend of $0.34 per share during the fourth quarter, and we are affirming our 2016 earnings guidance range of $2.75 per share to $2.85 per share. And with that, Walter will now give you his update. Walter Lynch Thanks Susan. Good morning, everyone. As Susan mentioned, our regulated businesses had a strong year all around with historic capital investment, smart and strategic acquisitions and continued O&M efficiency gains while balancing customer bill impacts. As you can see on slide 10, 2015 was a good year for growth. Through acquisitions and organic growth, we added in our pending regulatory approval, nearly 42,000 customers in our regulated businesses. In 2015, we completed 14 acquisitions adding nearly 24,000 customers to our existing footprint. Seven of these transactions closed in the fourth quarter including our purchase of the municipal wastewater system in Fairview Township, Pennsylvania. This newly acquired system provides wastewater service to approximately 4,000 customers including more than 200 businesses in commercial accounts, and it’s a perfect fit and as Pennsylvania American Water already owns the water system. This acquisition provides a long-term wastewater solution and a financial relief for the local community. According to the Township’s board of supervisors because of the sale, Township residential received a 50% reduction in real estate taxes in 2016. The proceeds of this sale will also help payoff approximately $21 million in sewer debt and avoid an anticipated $14 million in additional debt that would have been required to complete planned projects. Again this is a great example of how we can bring solution to municipalities struggling to finance the water and wastewater improvements while improving their service and keeping rates affordable for our customers. At the end of 2015, we have 12 pending acquisition agreements that were signed and waiting for regulatory approval. These acquisitions would add approximately 9,000 customers to our customer base if approved and completed. In 2016, we completed a purchase of four of these acquisitions, one of which was Environmental Disposal Corporation in New Jersey. This investor-owned wastewater utility provides service to more than 5,300 customers as well as bulk wastewater treatment services for several nearby communities. Additionally in December, Pennsylvania American Water signed a memorandum of understanding for the potential acquisition of the wastewater assets of the Scranton authority, which serves approximately 31,000 customers. This MOU commits the parties to negotiate in good faith toward executing a final purchase agreement. On the regulatory front, you can see a snapshot of our current activity on slide 11. Our Illinois and Kentucky subsidiaries fought rate request in the first month of 2016. In both space, we’re seeking to recover a significant amount of needed capital investment, offset by reduced or flat O&M expenses. In Illinois, we requested $40 million in additional revenues based on a projected total of $342 million of capital investment between October 2013, and the end of 2017. Our team in Illinois reduced their O&M expenses by about 3% since the last rate case in 2012, continuing the great work by our employees to keep those affordable for our customers. In Kentucky, we request $13.5 million in additional revenues, primarily driven by $79 million of capital investment while keeping operating expenses flat since 2012. Again, this focus on expenses allows us to make critical infrastructure investment continuing the trend of keeping bills affordable for our customers. In Missouri, our case is moving along to the process, and we expect the decision sometime before mid-year. In West Virginia, we have not yet received the rate order, so it will stay at a high level and base my comments from the press release sent out last night by the West Virginia Public Service Commission. The order provides an increase of $18.17 million in water rates and $151,000 in sewer rates. The Commission recognizes that the company reduced its O&M expenses from its last rate case, and the adjustment to base rate is driven primarily by the increased investment we made to ensure reliable water service for our customers. And consistent with our normal process, West Virginia American water will show a press release, once they’ve had a chance to review the order. Moving to California, on February 1st, we received approval from the California Public Utility Commission to extend our cost of capital filing by one year. This will keep our authorized return on equity at 9.99% through 2017 for our California subsidiary. Meanwhile, despite some rainfall from the effects of El Niño, the drought continues in California. Our team continues to demonstrate leadership in dealing with the drought and we’re certainly proud of all other efforts to help our customers during this time. We also continue to make progress on the Monterey Peninsula Water Supply Project. Our test plant well is operational and the results are positive. The project is undergoing environmental and regulatory review by the California Public Utility Commission, and this review is scheduled to be completed by the end of the year. Moving to slide 12; we ended the year with a 35.9% O&M efficiency ratio and we’re on track to meet our 34% target by 2020. I know, we’ve talked a lot about this, most recently, at our Investor Day in December, but I think it’s worth repeating, we’ve really made tremendous progress here. As you can see, the progress is evident by the amount of revenue requirement attributed to capital expenditures versus operating expenses. For the general rate cases, we filed last year, we reduced our O&M expenses by $10 million or 17%. This reduction allowed us to invest approximately $65 million into needed infrastructure upgrades without affecting our customers’ bills. Our employees are doing a great job in this area through leveraging best practices, improved efficiencies, technology and innovation, and this produces results for our customers as well as our company. So, with that, I’ll turn the call over to Linda for more detail on our financial performance. Linda Sullivan Thank you, Walter, and good morning, everyone. In the fourth quarter and for the full year of 2015, American Water continued to deliver strong financial results. As shown on slide 14, earnings per share from continuing operations for the fourth quarter was $0.55, up $0.03 or 5.8% over the same period last year. This slide shows the contribution by business line to our quarterly and annual results. Let me walk through the numbers then I’ll discuss the drivers of the key variances on the next few pages. For the quarter, the regulated businesses contributed $0.54 up $0.01, the market-based businesses contributed $0.06 flat to the fourth quarter of last year and the parent which is primarily interest expense on parent debt was $0.02 better than the fourth quarter of last year. For the full year 2015, earnings per share from continuing operations was $2.64 per share, an increase of $0.21 or 8.6% increase compared to adjusted 2014. The contribution from our regulated businesses was $2.63 per share, up $0.18 or 7.3% over adjusted 2014. The market-based businesses contribution was $0.24, up $0.02 or about 9% over last year. And the parent improved $0.01 per share. These annual increases are consistent with our long-term growth triangle. Turning to slide 15, let me walk through the components of our quarter-over-quarter increase in earnings per share. The primary driver was higher regulated revenue of $0.09 per share from infrastructure surcharges and other rate increases to support our regulated system investments. This was partially offset by higher O&M expense of $0.03 mainly from the timing of maintenance-related work as well as higher claims and pension-related costs. Depreciation, taxes and other increased $0.05 per share driven mainly by our investment growth. The improvement at the parent of $0.02 per share was mainly due to lower taxes from state tax proportionate benefit, partially offset by the $5 million contribution to the American Water Foundation that Susan mentioned. Also, please note that the market-based businesses were flat for the quarter as higher growth in our Military and Homeowner Services Groups was offset by a 2014 tax benefit. Turning to slide 16, let me walk through to the elements of our $0.21 increase in year-over-year adjusted earnings per share from continuing operations. The regulated businesses benefited from higher revenue of $0.18 per share from authorized rate increases to support investment growth as well as increases from acquisitions and organic growth. In addition, there was a $0.05 increase due to mild weather during 2014 and an improvement in O&M costs of $0.02 per share offsetting these improvements, with higher depreciation and taxes of $0.07 per share, driven by our investment growth. Overall, the regulated businesses increased $0.18 year-over-year. The market-based businesses were up $0.02, mainly due to additional construction projects under our military contracts and the addition of Hill Air Force Base and the Picatinny Arsenal in 2014, as well as geographic expansion and Homeowner Services. Parent and other was $0.01 better than 2014, due mainly the lower taxes from state tax proportionate benefits, partially offset by the Foundation donation. Now, let me cover the regulatory highlights on slide 17. As Walter mentioned, we should receive the rate order from the West Virginia rate case soon. And as such, we currently have four general rate cases in process: Missouri, Virginia, Illinois, and Kentucky for a combined annualized rate request of $87.4 million. For rates effective from January 1, 2015 through today and including the $18.3 million for West Virginia we received a total of $98.6 million in additional annualized revenue from general rate cases and infrastructure charges. We encourage you to review the footnotes in the appendix of this slide deck for more information. Slide 18 highlights our improved financial performance across the board. During the fourth quarter of 2015, we made total investments of $386 million primarily for regulated system investments. For the year, we invested a total of $1.4 billion. This includes $1.2 billion for regulated system investments, $64 million for regulated acquisitions and $133 million for the acquisition of Keystone. Excluding the Keystone acquisition, capital investment increased about 27% from 2014. Going forward, we expect to invest $6.4 billion over the next five years of which about $5.5 billion will be to improve water and wastewater systems for our customers, $600 million for regulated acquisitions and $280 million for strategic capital. For the full year, cash flow from operations increased $82 million or 7% to about $1.2 billion mainly due to the increase in net income and our adjusted return on equity for the past 12 months was 9.43%, an increase of 57 basis points compared to last year from continued execution of our strategies. We also announced in the fourth quarter of 2015, a $0.34 common stock cash dividend payable on March 1, 2016. On slide 19, as many of you will recall, during our Investor Day in New York, we gave 2016 earnings guidance of $2.75 to $2.85 per share. Today, we affirm that guidance range. There are certain important factors that could impact our 2016 results. And as we have done in the past, slide 19 outlines those factors that we have included in our earnings guidance range. Swings outside of these ranges could cause results to differ from guidance. Weather is generally the largest variable impacting our earnings. Our range of plus or minus $0.07 represents what we consider to be normal weather variation that we have included in our earnings guidance range. For our regulated businesses, we see variations of plus or minus $0.03 primarily from the timing and outcome of rate cases, the timing of completion of capital projects as well as variations in O&M and production costs. American Water Enterprises variability is driven mostly from the timing of future capital upgrades in Military Services and realization of our expected growth as well as claims costs in Homeowner Services. Variability for Keystone is primarily driven by natural gas prices and drilling activity in the Marcellus and Utica. I would also like to mention that our 2016 earnings guidance range includes estimated legal defense costs of about $0.03 per share related to the 2014 Freedom Industries’ chemical spill in West Virginia. As you may recall, we included $0.02 per share of legal costs in 2015. And lastly, I would like to address the expected impact from the five-year extension of bonus deprecation. From a cash perspective, we are in a federal tax net operating loss position. So, we do not receive a current cash benefit from bonus depreciation. We look at electing bonus depreciation on a state by state basis. In those cases, we’re adopting bonus depreciation would be in our customers’ best interest and where we expect to be able to utilize our NOL, we will do so. Assuming, we elect bonus depreciation in our regulated states, this would increase our NOLs and push out the expected timing of when we would become a cash tax payer by about one year to 2021. From an earnings perspective, while this would be expected to reduce rate base and earnings, we do not see a significant impact to our 2016 earnings guidance range, nor do we see a significant impact to our 7% to 10% compounded annual EPS growth rate for 2016 through 2020 because the rate base impact is largely offset by lower financing needs in 2020. We also have flexibility to mitigate some of the rate base impacts by redirecting a portion of our strategic capital already included in our five-year plan to our regulated businesses, as well as accelerating certain investments that continue to strengthen our critical assets for our customers. And with that, I’ll turn it back over to Susan. Susan Story Thanks, Linda. Before taking your questions, let’s review the American Water investment thesis we shared with you at our Investor Day and briefly discuss the American Water Foundation. On growth, we affirm our EPS growth goal of 7% to 10% for the next five years. We talked about our unprecedented 2015 capital investments, our continued O&M and capital efficiency and our plans for 2016. We know that reputation, operational excellence, reliability, and dependable water quality are critical to our growth. Where and how we expanded our customer base in 2015 leverages these strengths, growing through tuck-in, adding wastewater customers where we are ready to serve water and growing our market-based businesses. Our people have deep utility expertise and diversified experience and they are our biggest competitive advantage. They also care deeply about our customers in the communities in which they live and serve. This was clearly demonstrated about what our employees dealt with in both Missouri and Illinois during the last week in 2015. Record rainfall of up to 12-inches fell during a powerful three day storm across the Midwest, hitting the St. Louis area hard and causing record flooding. Homes and businesses were submerged, highways closed and water and sewer utilities faced extraordinary challenges. Missouri American has two plants on the Merrimack River, supplying water to about 20% of our customers in the St. Louis County area. Thanks to early planning and the construction of a system of temporary pipes and pumps. Our customers never loss service and we maintained excellent water quality throughout the event. Our wastewater teams also worked around the clock during the heavy rain to remove pumps and motors that otherwise would have been lost to flooding. But it’s not just what our Missouri team did for our own customers; it’s what they did for the surrounding communities in need. A local public water district had a flooded plant and lost the ability to serve its 20,000 customers. By opening a connection between the systems, Missouri American was able to help the district, serve many of those without water. Additionally, they worked with the National Guard to fill more than 500 tanker trucks that delivered our water outside of our service area, which brings me to the American Water Foundation funded by American Water’s parent company which keeps the communities we serve and have a better quality of life. One key Foundation partnership is with the Union Sportsmen Alliance, where we have worked with local union members to build walking trails, public access areas and fishing facilities for communities, including projects for special needs kids. The Foundation also has a partnership with a National Recreation and Parks Association in support of building better communities. Here, we focus on building or enhancing nature-based playgrounds for children and educating people on water and environmental stewardship practices. The Foundation also matches employee donations to qualified charitable organizations up to $1,000 per year per employee. Earlier this month, the Foundation made a $50,000 donation to the Flint Child Health & Development Fund to help the children of Flint, Michigan, get the resources they need to deal with the lead exposure many have experienced. These examples of doing good as we do well, demonstrate the dedication, expertise, strong character and the work ethic of the 6,700 people I get the privilege of working with every day. Certainly, our employees’ commitment translates into our strong financial performance, but it also let you know as our investors that we are a company, whose people believe not just in what we do, clean water for life, but also in how we do it. And we believe that it is critical for a company, who wants to be as successful in the coming decades as we are today. So, with that, we’re happy to take your questions. Question-and-Answer Session Operator We will begin the question-and-answer session. [Operator Instructions] Our first question comes from Richard Verdi of Ladenburg. Please go ahead. Richard Verdi Good morning, everyone, very nice quarter and thank you for taking my call here. Just a couple quick and easy questions; first, I guess Susan can you please speak to the strategy for capital raises the next few years to fund your program and how you think about raising the dividend versus buying back stock versus issuing equity? Susan Story Sure, Rich, and thanks for the question. I will start, and then Linda may want to jump in. So, when we look at all of the different uses of our capital in terms of growth, in terms of raising our dividend, in terms of regulated investment, all of those different things, we look at a balance in optimizing those and also where we get the biggest value from every dollar that we spend. So, we look at growth and the returns we get there. We look at regulated investment and let me be clear that in our investment plan, the first thing we do, is we invest whatever is needed in every one of our state to ensure that we provide safe clean water that meets all EPA standards. So, then beyond that is what we refer to as discretionary. But there is a base amount which is significant well over half of our capital that we spend to ensure that we provide those services. Then beyond that, we look at our dividend growth, which is, we have said, we want to keep consistent with our EPS growth. So, we want those to be correlated, so that’s the guidance we’ve given and we have a 50% to 60% payout ratio and currently we’re at the lower end of that range. So, there is room there. When we look at things like debt and I’ll let Linda talk about this more, the question we ask is what is best for our customers and our shareholders with the next dollar that we invest or whether we pay down debt or whether we’re able to provide dividend. So, as you know, to have a – to be in a strong financial position as we are, we have a lot of optionality and we’re always looking at how we optimize that optionality. Linda Sullivan And Rich, I would add to that that as we look and as we outlined in our Investor Day, when we look at the capital structure over the next five years, we continue to look at about 45%-55% equity to debt capital structure. Richard Verdi Okay, excellent. Thank you. And next on the O&M and efficiency ratio, clearly, this has been a great part of the story very successful, excuse me, couple of years back the stretch target was 35% for 2018, now the stretch target is 34% for 2020. Its 100 basis points lower in three years. I know a portion of these stretch targets were based on the ERP program a while back. Now they are predicated upon automation technology such as the Badger Meter contract recently announced. Without holding you to it, just trying to get a grasp on what lies beyond 2020, how possible is it that American reduces the O&M efficiency ratio by another 100 basis points by 2022 to 33%. And would automation and technology be the driver of that reaction or is there something underneath the American umbrella that could drive the third phase of O&M efficiency reduction? Walter Lynch Hey, Rich; Walter. I’ll take that question. Thanks for it. We’re not going to forecast beyond 2020 and a 34%, but I can tell you our teams are geared towards continuous improvement and that’s what’s driving this, and technology is going to be a big part of it. As you know, we are about 90% implemented with AMR. We’re also looking at AMI and the technology that we’re buying now is easily transitioned into AMI. So it’s a long-term solution. But I’d tell you looking at the people in our business understand the why and why we are reducing expenses. So we can invest in our infrastructure and provide excellent customer service. So it’s really throughout the business sharing best practices, leveraging our supply chain and reverse auctions and power and chemicals, so it’s a mindset and it’s a commitment by our employees that we’re going to get to where we need to go and they understand the why, and I think that is the key to this whole things, and that’s been the foundation for our success. Richard Verdi Okay. Great, thank you very much, and I appreciate it. And that’s it for me, I’m going to jump in queue, but I just want to say thank you very much for slide 36 and that’s very helpful. Susan Story Thanks, Rich. Operator [Operator Instructions] Seeing no further questions, this concludes our question-and-answer session. I would now like to turn the conference back over to Susan Story for any closing remarks. Susan Story Well, thank you, Kerry. And thank you all for participating in our call today. If you’ve got any questions, please call Greg and Melissa and they will be happy to help. I’d like to remind everyone that our 2016 first quarter earnings call will be on May, the 4, and our Annual Stockholders Meeting would take place on Friday, May, the 13. Thanks again for listening and we’ll talk to you in May if not before then. Thanks. Operator The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines. Have a great day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) 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