H2O America (HTO) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for your patience. You joined the SJW Group Q1 2018 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference maybe recorded. I would now like to turn the call over to your host General Counsel, Ms. Suzy Papazian. Ma’am, you may begin.

Thank you, Operator. Welcome to the first quarter 2018 financial results conference call for SJW Group. Presenting today are Eric Thornburg, Chairman of the Board, President and Chief Executive Officer; and James Lynch, Chief Financial Officer. For those who would like to follow along, slides accompanying these remarks are available on our website at www.sjwgroup.com. Before we begin today's presentation, I would like to remind you that this presentation and related materials posted on our website may contain forward-looking statements. These statements are based on estimates and assumptions made by the Company in light of its experience, historical trends, current conditions and expected future development as well as other factors that the Company believes are appropriate under the circumstances. Many factors could cause the Company's actual results and performance to differ materially from those expressed or implied by the forward-looking statement. For a description of some of the factors that could cause actual results to be different from statements in this presentation, we refer you to the press release and to our most recent Forms 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission, copies of which may be obtained at our website. All forward-looking statements are made as of today and SJW Group disclaims any duty to update or revise such statements. You'll have the opportunity to ask questions at the end of the presentation. As a reminder, this webcast is being recorded. And an archive will be available until July 23, 2018. You can access the press release and the webcast at our corporate website. I will now like to turn the call over to Eric.

Thank you, Suzy. Welcome, everyone, and thank you for joining us. I am Eric Thornburg, Chairman, President and CEO of SJW Group. I'm very pleased to be here today with Jim Lynch, our Chief Financial Officer; and Palle Jensen, the Executive Vice President of San Jose Water is here today. SJW delivered strong first quarter results relative to its recurring operations. Other key highlights for the quarter include the announcement of our merger of equals agreement with Connecticut Water Service. The startup and commissioning of San Jose Water is $62 million, Montevina Water Treatment Plant retrofit project, and a new cost of capital decision for the years 2018 through 2020 for San Jose Water. It is with deep appreciation and respect that SJW bids a farewell to Board members Rich Roth and Buddy Moss who did not seek reelection in 2018. Those on the call are very familiar with Rich, who served as Chairman, President and Chief Executive Officer and whose careers spanned 27 years with SJW. Buddy’s association with SJW spanned over 30 years, and both gentlemen have left an indelible mark through their character, dedication, and commitment to the Company, its customers, shareholders, and the communities we serve. On behalf of the Board and all of our employees, we wish them the very best. I will now turn the call over to Jim Lynch for a review and analysis of the Q1 financial results. After Jim's remarks, I will provide additional information on regulatory and other key business matters. Jim?

Thank you, Eric. Our first quarter operating results reflect the positive impact of higher customer usage and rate increases in both California and Texas, partially offset by lower revenue due to the regulatory impact of our cost of capital decision and the recently passed Tax Cuts and Jobs Act. In addition, we experienced higher water costs, as well as merger costs incurred in connection with our proposed transaction with Connecticut Water Service or CTWS. First quarter revenue was $75 million, a 9% increase over the first quarter of 2017. Net income for the quarter was $1.3 million or $0.06 diluted earnings per share. This compares with $3.7 million or $0.18 diluted earnings per share for the first quarter of 2017. The net decrease of $0.12 diluted earnings per share for the quarter was impacted by non-recurring cost of $2.7 million net of tax related to our proposed merger with CTWS or $0.13 per share. Eric will provide an update on the transaction in his remarks to follow. For the quarter customer usage increase $0.22 per share and rate increases contributed another $0.21 per share. These increases were partially offset by increased water production expenses of $0.11 per share, a $0.09 per share decrease due to the net changes in the Company's balancing and memorandum accounts which includes the impact of our cost of capital proceeding and the implementation of the Tax Act. We also experienced a $0.09 per share decrease due to lower revenues recorded in the water conservation memorandum account or our WCMA as a result of higher customer usage. Higher depreciation and other items reduce earnings per share combined by an additional $013. First quarter 2018 revenue was 9% higher than revenue recorded during the first quarter of 2017. The increase was attributed to $6.3 million in higher customer usage and $6.1 million in water rate increases. The higher usage was due primarily to the return of drier weather in our California service area during the first quarter of 2018 as compared to 2017. Regarding the rate increases San Jose Water implemented a 4.2% rate increase on January 1 of 2018 as provided for in our 2016 California general rate case. The Company also implemented a 3.5% rate increase effective July 1, 2017 to recover increased purchased water costs and groundwater pump taxes implemented by the Santa Clara Valley Water District, or the district in July of 2017. The increases were partially offset by a net $6.6 million decrease in balancing the memorandum accounts including revenue recorded under our WCMA. Recall, that in periods of higher customer usage the benefit provided by the WCMA decreases. The increased higher water production expenses we experienced were primarily due to increased customer usage in the amount of $2.5 million and $2.3 million due to the previously mentioned district water cost increases. These increases were partially offset by an increase in the use of surface water from our recently renovated Montevina Water Treatment Plant in the amount of $1.4 million. Turning to our capital expenditure program we added $29 million in Company funded utility plant during the first quarter of 2018. This represents 24% of our total 2018 planned capital expenditures. Combined the budgeted 2018 rate base for our California and Texas Utilities is $792 million. Turning to liquidity, first quarter 2018 cash flows from operations decreased 20% over the first quarter of 2017. The decrease was primarily the result of a $3.2 million reduction in net income adjusted for non-cash items a decrease in accrued water production expenses of $2.2 million and a decrease in collections of previously build and accrued receivables of $1.5 million. These decreases were partially offset by an increase in general working capital of $1.3 million. At the end of the quarter we had $106 million available on our bank lines of credit for short-term financing of utility plant additions and operating activities. The average borrowing rate on the line of credit advances during the quarter averaged 2.7%. With that, I'll stop and turn the call back over to Eric.

Thank you. Jim. As previously reported SJW entered into a definitive agreement with Connecticut Water Service in a merger of equals to create the third largest investor owned water utility in the United States. We believe this merger of equals provides both companies with the best opportunity for value creation over the long-term as well as significant benefits for our customers, for our employees and the communities we serve. Accordingly and has filed in our Form S-4 we have reaffirmed our commitment to this MoE, and remain confident that we will close during the fourth quarter of 2018. Now the proxy filing was a significant milestone towards closing the merger of equals in the fourth quarter of this year. We received very positive reception from shareholders, analysts, regulators, employees, customers, and community leaders. As you also now know, we did receive and reject an unsolicited non-binding indication of interest. Our Board following a careful and thorough review in consultation with SJW Groups management, legal and financial advisors, consistent with our fiduciary duties determined that this non-binding indication of interest neither constituted nor was reasonably likely to lead was superior proposal has defined in the existing merger agreement with Connecticut Water. We believe there are benefits you need in a merger of equals including increased scale and has financial strength and geographic diversity, anticipated higher future growth profile and associated share price appreciation, significant earnings accretion and importantly regulatory diversification and our shareholders will own 60% of the combined company. The merger of equals also provides long-term benefits for our customers, all of our employees and communities, delivering customer benefits including no rate changes, benefits of scale and best practice implementations. Honoring our commitments to all employees, we've seen no job losses or changes to compensation benefits, our union partnerships in contrast to the unsolicited offer support for employees is limited. We also see a strengthening of existing community ties, continued support of economic development and investments in growth, safety and reliability. We are building a national scale company that is locally focused. Now on other fronts, our March 22, 2018 California Public Utilities Commission decision and the proceeding to determine the cost of capital for the period 2018 to 2020 for San Jose Water. The Commission's decision provides for a reduction to San Jose Waters authorized return on equity from 9.43% to 8.90% and its overall return on rate base from 8.09% to 7.64% resulting in a $5.8 million reduction to authorized revenue requirement in 2018. The decision effective retroactively to January 1, includes the continuation of the water cost of capital mechanism, which allows for an annual adjustment to authorize return on equity between filings. New customer water rates reflecting this updated authorized rate of return became effective on March 22, 2018. San Jose Water continues to process our general rate case or GRC application with the commission. Our 45 day update was submitted on March 16, 2018 and pre-hearing conference was held on April 19, 2018 where all the parties to the proceeding reaffirmed the remaining GRC processing schedule that anticipates a final decision by December 2018 and new rate starting January 1, 2019. We continue to be very pleased with the performance of SJWTX incorporated, our Texas water and waste water utility. Customer growth continues to be driven by a booming economy and one of the fastest growing regions of the country as well as by our aggressive acquisition program that has closed on 10 water systems in the past ten years. Accordingly, I am happy to announce that SJWTX is completing the final steps to acquire the Deer Creek Ranch water system as one of our larger acquisitions that includes approximately 750 connections and will increase SJWTX's current customer count by about 5%. Importantly, it expands our service area into Western Travis and Northern Hays counties, pacing the way for future acquisition opportunities. We anticipate closing in Q3 and look forward to delivering safe, high quality and reliable water service to our new Deer Creek Ranch customers. With its increased contributions to consolidated earnings, we remain optimistic about the prospects of SJWTX. In summary SJW remains an attractive investment with a focus on designing, building and operating high quality regional water service platforms that we believe will deliver safe, high quality and reliable water service to our customers and sustain attractive long-term returns for our shareholders. We are executing our growth strategy, investing a necessary infrastructure to provide safe and reliable water services to customers and communities and then earning a return of an on that investment. Additionally we are poised to augment our growth through the acquisitions and mergers I mentioned here today, expanding our footprint and building scale. Our investments are smart and enduring and we are confident over the long haul that investments we have made will contribute to growth and profitability, earnings and dividends. With that, I'll turn the call back to the operator for questions.

Thank you, sir. [Operator Instructions] Our first question comes from the line of Ryan Connors of Boenning and Scattergood. Your line is open.

Great. Thanks for taking my question. I just want to say first off, congrats on – again on the transaction and all the interest from our perspective merger of equals and diversification, certainly compelling. But I wanted to actually start on the cost of capital decision. Obviously, it wasn't done in the worst case scenario, but it wasn't exactly ideal either. So my first question is, is there a sense that there's a baseline level now, 8.9, or is there some likelihood that directionally in the years ahead, there could be further slippage now. Well how should we be looking at this ROE level?

Hi, Ryan. This is Palle Jensen. Yes, we’re happy that this proceeding is behind us at this point. I think that it will establish a new baseline for other utilities coming in before the commission. I know the energy utilities are coming up here shortly, and the outcome of those proceedings will obviously set the tone for the future of cost of capital proceedings in the state of California.

Hey, Ryan. I’d add to that. This is Eric. We were pleased with the cost of capital adjustment mechanism remained in place, so that will allow the adjustment based on interest rates in the future. So we're pleased that that device remains in place, and we think that will likely help in the out years as well.

Okay. I know there's not too much you'll be able – at liberty to say on the other stuff, but a couple conceptual questions. I mean you mentioned regulatory diversification as one of the rationales for the merger of equals. Obviously, that doesn't come with the alternative there. Is the cost of capital decision, I mean does that play any role in that? Obviously, Connecticut has got a significantly higher return on capital in place at this point.

Ryan, it's actually one of the reasons why we sought to diversify from a single state operation essentially, going into four states that would provide additional regulatory diversification. Our current set up is we have about 92% of our earnings comes from a single state. So it just made sense to look for partners outside of California as well and not double down on that investment in a single state. So we definitely believe it's a significant advantage to our merger of equals.

Great. And then my last one also had to do with kind of the alternative transaction here. So back in March on your conference call discussing the merge of equals, initially you downplayed the issue of kind of regulatory review and regulatory delay, and yet the Board in its letter today – that was one of the things that was mentioned as a concern with the alternative transaction was a potential for a protracted regulatory review. So can you just remind us, like what are the types of things that would be looked at in that review and why would one review maybe more protracted than the other?

Yes. Thank you, Ryan. An excellent question. When we talked in March, our regulatory approval process for the merger of equals involves the states of Connecticut and Maine only because there is not an effect of changing control in California or in Texas because SJW Group would remain and retain 60% ownership of the new combined organization. Under the non-binding indication of interest from the unsolicited party that would change, and California regulatory approval would thereby be required. And when you look back on the history of such endeavors, they are typically an 18-month or up to an 18-month statutory proceeding that interjects significant additional risk, so that's the difference is the California regulatory approval process.

Got it. Well that’s clear enough. Thanks so much.

Thank you, Ryan.

Thanks, Ryan. End of Q&A

Thank you. [Operator Instructions] And there appear to be no questions in queue at this time. At this time, I would like to turn the call back over to Eric Thornburg for any closing remarks.

Well thank you, everyone. Thank you for joining our call today. We are extremely excited about the future of SJW Group. We are very pleased with our merger of equals, and we are extremely excited about moving forward, and receiving the approvals necessary, and closing that transaction by year end, and we look forward to the journey together. Thank you, everyone.

Thank you, sir. And thank you, ladies and gentlemen for your participation. This concludes today's conference. Have a wonderful day.