H2O America (HTO) Q1 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the SJW Group First Quarter 2019 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Suzy Papazian, General Counsel. Ma'am you may begin.

Thank you, operator. Welcome to the first quarter 2019 financial results conference call for SJW Group. Presenting today are Eric Thornburg, Chairman of the Board, President and Chief Executive Officer; James Lynch, Chief Financial Officer; and Andrew Gere, President and Chief Operating Officer of San Jose Water. 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 developments as well as other factors that the company believes are appropriate under the circumstances. Many factors could cause the company's actual results and performance to differ materially from those expressed or implied by the forward-looking statements. For a description of some of the factors that could cause actual results to be different from statements in this presentation, we refer you to the press release and our most recent Forms 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission, copies of which may be obtained 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 will have the opportunity to ask questions at the end of the presentation. As a reminder, this webcast is being recorded and an archive of the webcast will be available until July 22, 2019. You can access the press release and the webcast on 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'm Eric Thornburg, Chairman, President And CEO of SJW Group. Along with Suzy I'm very pleased to be with Jim Lynch, Chief Financial Officer of SJW Group, Andy Gere, President and Chief Operating Officer of San Jose Water and Palle Jensen, Executive Vice President of San Jose Water. SJW delivered solid first quarter results that reflect our strong fundamentals, constructive regulatory environments and sound management, our emphasis remains on key tactical and strategic aspects of our business. The most important of those being our ability to enhance system reliability, improve customer service and deliver growth in rate base, as we make infrastructure investments pursuant to a carefully designed and prudently administered capital investment program. As previously reported, SJW Group and Connecticut Water filed a new merger approval application with the Connecticut Public Utilities Regulatory Authority or PURA on April 3, 2019. The new jointly filed application offers a set of commitments and additional supporting evidence that we believe are responsive to PURA’s previous concerns and demonstrate that our combination is in the public interest. The combination will result in a leading pure play water utility that we believe will have the financial strength, scale, resources and sharing of best practices to ensure families and communities will continue to receive safe and reliable water service across all of our operations. We look forward to working with PURA to demonstrate how our application will provide immediate benefits to customers, employees and local communities. I will now turn the call over to Jim for a review and analysis of the Q1 financial results. After Jim's remarks, I will provide additional information on water supply and other key business matters. Jim?

Thank you, Eric. Our first quarter operating results reflect the positive impact of our general rate case or GRC increase in California and the increased use of our California surface water supplies, partially offset by a decrease in customer usage. First quarter revenue was $77.7 million or 4% increase over the first quarter of 2018. Net income for the quarter was $5.9 million or $0.21 diluted earnings per share. This compares with $1.3 million or $0.06 diluted earnings per share for the first quarter of 2018. The increase in revenue was driven by $3.1 million increase in rating rates, a $2.6 million change in balancing and memorandum accounts and $800,000 from new customers, primarily in our Texas service area. These increases were partially offset by a $3.9 million decrease in customer usage. San Jose Water implemented a 4.5% general rate increase on January 1, 2019, as authorized in our 2019 California JRC. The rate increase was driven primarily by the cost of infrastructure improvements, and a reduction in 2019 authorized usage levels that more closely align with actual post-drought customer water use activity. San Jose Water also implemented a 3.61% rate increase effective July 1, 2018 to recover a 9% increase in purchased water costs and a 10% increase and groundwater extraction charges implemented by the Santa Clara Valley Water District or the district in July of 2018. The increase in balancing the memorandum accounts was primarily due to customer benefits related to our 2018 costs of capital proceeding and adoption of the 2017 Jobs and Tax Act. In the first quarter of 2018, these customer benefits were captured in company balancing accounts by the first quarter of 2019. The benefits were reflected in lower customer rates. There was no impact on net revenue as a result of this change in 2019. Total 2019 first quarter water production costs were 5% lower than the first quarter of 2018. The lower water production expenses were primarily due to a $4.2 million benefit from the increased use of lower cost surface water produced from our recently renovated Mon Aveda [ph] Water Treatment Plant and $2.4 million from decrease customer usage. The decreased water usage was primarily due to above average rainfall we experienced in our California service area. The water production cost decreases were partially offset by a $2.7 million of higher unit costs for purchased water and groundwater extraction charges and power. Other operating expenses increased $1.2 million or 1% for the quarter, primarily due to a $1.6 million increase in higher depreciation related to utility plant additions and $723,000 increase in administrative and general expenses due to higher personnel costs. These increases were partially offset by a decrease of $1.2 million in merger expenses related to our proposed Connecticut Water transaction. Other income and expense in 2019 included $1.8 million of money market fund interest -- in 2019 included $1.8 million of money market fund interest earned on $412 million of invested proceeds we received from our December 2018 equity offering. In addition 2018 other income included an unrealized loss on our investment in California Water Service Group stock. The stock was subsequently sold in the second and third quarters of 2018. The net increase of $0.15 in diluted earnings per share for the quarter was primarily attributable to availability of surface water of $0.11 per share, $0.08 per share in rate increases, $0.06 per share in net balancing the memorandum account, $0.05 per share in interest earned on funds from the equity issuance, and $0.03 per share due to the decrease of merger related costs. These increases were partially offset by $0.10 per share decrease in customer usage, $0.04 per share in increased depreciation expense and $0.04 per share of other expenses. Turning to our capital expenditure program, we added $29.6 million in company funded utility plant during the quarter. This represents 23% of our total 2019 planned capital expenditures. From a financing perspective, first quarter 2019 cash flows from operations increased 12% over first quarter of 2018. The increase was primarily the result of $6.2 million in net income adjusted for non-cash items, and an increase in net taxes payable of $2.4 million, partially offset by a decrease in accrued water production expenses of $4 million and a decrease in other changes of $3.6 million, including $2.2 million related to a service charge refund to our California customers. On March 28, 2019, San Jose Water issued $80 million in unsecured senior notes, with a 30 year life at 4.29%. Proceeds from the note issuance were used to refinance outstanding balances on our bank lines of credit. At the end of the quarter, we had $113 million available on our bank lines of credit for short-term financing of utility plant additions and operating activities. The average borrowing rate on lines of credit advances during the quarter averaged 3.46%. With that, I will stop and turn the call back over to Eric.

Thank you, Jim. Our California service areas water supply outlook remains very favorable, owing to a wet February and March that further increased local precipitation levels and the Sierra snowpack. Deliveries from the state and federal water projects have been set at a robust 70% and 80% of normal allocations respectively, reflecting the improved water supply conditions. Locally, groundwater levels in the Santa Clara Valley remain in their normal range signifying that a full water bank is also available. Our Lake Elsman has also benefited from the wet winter. We have a full reservoir of our low cost high quality surface water supply source ready for processing throughout the remainder of the year. Operationally, we are preparing for peak usage months ahead, anticipating full availability of water supplies. Turning to Texas, I'm happy to report that SJWTX’s net utility plant totaled over $100 million for the first time. This milestone reflects the successful execution of our growth initiatives, which has added 11 water systems over the last 11 years, including the Deer Creek Ranch Water System last year, as well as our sensible capital program that ensures continued investments in our Texas system to deliver high quality, safe and reliable water service. Customer growth continues to be driven by a booming economy in one of the fastest growing regions of the country. In fact, Kemal County was the second fastest growing county in the United States in the period 2017 to 2018. Last year, organic growth in Texas helped increase our customer base by 8%. With more than 12,000 lots where our water remains -- stand ready to serve new businesses and residential customers, and what we hope will be the near future. We remain optimistic about SJWTX’s growth potential, and its future contributions to consolidated earnings. I'm extremely proud of SJWs long standing commitment to protecting and preserving our environment and our recent reaffirmation to that commitment through the creation of a Board Sustainability Committee and the preparation of our inaugural corporate sustainability report in 2018. Sustainability has always been a critical part of the company's culture. And I'd like to turn the call over to Andy Gear to detail some key initiatives. Andy?

Thank you, Eric. Water conservation sits at the nexus of our environmental and sustainability activities. The most recent droughts in our Texas and California service areas appear to be behind us. However, hardships and dirt as a result of water use restrictions and reductions imposed by state and local water agencies serve to remind us how important this vital resource is to our communities. Over the last 10 years, SJW Group has made significant investments to reduce water loss through sustained water main replacement programs. In our most recent California general rate case for San Jose Water, we received authorization to replace annually 1% of our 2,400 miles of water mains, at a cost of more than $60 million per year. We've also expanded our use of technology to find and repair non-surfacing leaks in our distribution systems. San Jose Water is in the third year of a program to deploy acoustic leak sensors throughout the distribution system, which help us find the repair leaks when they are still small. Finding leaks before they surface helps to minimize water loss and reduces periods of service interruption, as well as the cost of repairs. On the operational side, we know that cleaning water mains through a unidirectional flushing program is essential to maintain water quality. Traditional flushing programs clean mains by discharging water at a high velocity into a storm drain. However San Jose Water has found a better way to do this, using new water main flushing technology. Our closed loop water main flushing truck utilizes a portable treatment plant that filters sediments flushed from the distribution system monitors and tracks water quality parameters, provides treatment if needed, and then injects the water back into the distribution system in a sanitary closed loop with minimal water loss. This technology has allowed us to increase productivity to over 20 miles of pipe flush per month, while saving 5 million to 6 million gallons of water per year. In each of these initiatives, we're leveraging capital investments in new technologies to drive down water loss and operational costs, while providing enhance service to our customers.

Thank you, Andy. SJW continues to make prudent investments in our water systems, employ efficient and sustainable business practices and provide exceptional customer service. Additionally our regional business model facilitates efficient design, construction, maintenance, and operation of our water systems, while providing high quality service at about a penny a gallon. Our investments are smart and enduring and we’re confident over the long haul that the investments we have made will continue to the long-term sustainability and resiliency of our water systems and growth in profitability and dividends. With that, I will turn the call back to the operator for questions.

Thank you. [Operator Instructions] Our first question comes from Durgesh Chopra with Evercore ISI. Your line is open.

Hello, Jim.

Yes. Hi, Durgesh.

Good morning. Just can you like on the timeline for the Connecticut Water merger petition, just wanted to understand if you could just walk through like obviously you filed the petition with the Connecticut commission is the California review when and if that happens is that basically going to happen once the Connecticut decision comes out or the commission could start that review again? Just -- if you could just give a little bit more clarity on what your understanding of the process is?

Sure, Durgesh, absolutely. So just to remind you and other listeners the Connecticut Public Utility Regulatory Authority has 120 days statutory period in which to review a change in control filing. So that’s a hard schedule and we expect the final decision on that matter on July 31, 2019. So I'm going to ask Palle Jensen, our Executive Vice President at San Jose Water to comment on the California component.

Yes, hi Durgesh, this is Palle Jensen. The California commission suspended the OII proceeding that was looking into the any merger related rate impact on California customers that was suspended by the commission on March 3rd of this year. The commission’s intent in that ruling is to weigh out the proceeding in Connecticut to see what determinations are rendered by the PURA in Connecticut. And then subsequent to that if it’s a favorable decision for the transaction, then the commission in California will take a look at any impact there might be on the customers in the San Jose service area. So that review is currently scheduled to take place after the decision by PURA in Connecticut.

Excellent, thank you. Just a quick follow-up on that, is that the California review assuming that once -- assuming that we get a sort of a decision from Connecticut. And if California decides to review is that 90 day review period, am I right about that or what’s the -- like the last time I think the timeline was pretty tight as to when the OII would conclude?

Yes, we have as you may have recall from the early part of that proceeding California we have already submitted responses to the commission. The commission has taken comments by other parties as well. So a large portion of the California review stands currently has already been completed. We also had a public participation hearing which is part of the process in early January. So our expectation is that the California review can be somewhat truncated, it’s hard to tell you an exact timeframe for that. But we believe most of the review has already been completed and we will just be awaiting a California determination and California decision. And so there’s an administrative process for that. But we think it can be done in a fairly timely manner after the review -- after the completion in Connecticut.

And that decision -- sorry one last follow up clarity that decision is going to be whether they have jurisdiction to rule on the deal or not, correct?

Well there are a couple of pieces to that. One is that whether they're going to determine whether they have any jurisdiction. And then secondly, they're going to determine, if the transaction will have any rate impact on customers in the San Jose service area.

Okay, perfect. Thank you. I appreciate all the clarity there. Thanks.

[Operator Instructions] Our next question comes from Jonathan Reeder with Wells Fargo. Your line is open.

Hi. Just a follow-up on Durgesh’s question there. Palle, would you expect the California commission to anticipate or want to see some sort of one-time rate credit to the San Jose customers like you're offering Connecticut Water customers, which in theory, I guess isn't tied to merger savings upfront?

Jonathan, this is Palle Jensen. It is really hard to say what the commission's action may be. But the -- historically the process for such reviews have taken place in the companies, in the transacting companies next rate case, which we are currently scheduled to file in January of 2021. So the time for the commission's review would be most appropriate to be done in the general rate case, because it would give us about a year to take a look at the impacts of the transaction here in California. So that would be my expectation is that the commission would probably wait to take a look in the general rate case.

Okay. So if there are any savings that transfer over to California?

Correct.

Yes, Jonathan, this was Eric. The savings that are coming off of kind of primarily public company costs for Connecticut Water Service is the source of the rate credit in Connecticut. So that's kind of the linkage we have there. So we don't have that savings in California, obviously, because the company continues. So that's the linkage, that's why we would expect that that would be more dealt with in a future rate case, any savings that come to California, after the close of the transaction.

Okay. And then, Eric, has there been any response locally, have you gotten any feedback from the revised filing. Not necessarily from PURA, but other influential parties within the state?

We have our first hearing on Monday in Connecticut, that'd be the first opportunity to have any discussions with PURA, we're making some opening statements and finalizing the calendar. But at this point, there's been nothing official coming from PURA in regards to the conditions we've put forth, et cetera. So -- but we feel very confident with them. We think they address the concerns expressed in the previous draft decision and then some. So we remain very optimistic that we've addressed those concerns.

Is it safe to say consumer evocate you believe would still be on board given they were on board back in December?

I think the tone and tenor of the commitments we’ve put forth are very consistent with what the consumer evocate had endorsed in the prior case. But this is a new case and a new time. So, we'll work to earn their trust and their commitment to this as well after the proceedings begin.

Okay. And then last question, I know it's pretty fresh, but any thoughts on the new PURA commissioner appointment?

Well, we certainly welcome the new commissioner, we look forward to making our presentation to her. Sounds like, she has a real good experience down in Baltimore. I guess, Commissioner July, I think that's how she pronounces her name. So we'll look forward to meeting her and it sounds like they've had some mergers and acquisitions in the Maryland as well. So sounds like, she comes with a lot of experiences that should inform the condition in Connecticut.

Okay. Look forward to updates along the way as you try to get approval. Thanks.

Absolutely. Thank you, Jonathan.

Thank you. Our next question comes from Anand Rao with KOR Capital. Your line is open.

Hi, guys. I was wondering, it looks like things are optimistic on the new merger, refiled merger update. But I was wondering in the event that you guys were unable to get this done, obviously, you guys are optimistic. But if it didn't get done, what would you guys do with the cash that you’re now sitting on, the excess cash, I guess, it's like $420 million or so.

Yes, so it's about $412 million. This is Jim Lynch and our Board has not had any conversations about what we would do with the cash in the event that the transaction doesn't proceed forward. In fact, the Board right now is very supportive of the actions we've taken to move the transaction forward. And we're very optimistic in that regard. Clearly, if the transaction were not to go forward, as we've disclosed in the offering prospectus, we would take a look at other alternative uses for that. And those uses, as we've described include a possible stock buyback, a possible dividend, or in the event that there is a near-term other acquisition that we could pursue, we would take a look at whether or not that would make sense. But certainly, and as I have said on prior calls, it's not our intention to retain an inefficient capital structure and right now as we currently stand without an alternative use for the funds, I would think that that we were -- we are in an efficient structure.

Great, that's helpful. And then also, just finally, I noticed, back in August, I guess, California Water had put Florida proposal which is sent to your Board in the amount of about $70 per share. I mean, is that something that you guys would with the stock it's been about a year since then the stocks right around 60 bucks a share? Is that something that you guys would consider, I mean, the letter looks pretty detailed, and they talk about how they would even provide a ticking fee in the event, a deal is not consummated within a pre-arranged timeframe. Is that something you guys would consider, or are you guys sort of gung ho on the current trajectory with California -- with Connecticut water?

We're absolutely committed to our transaction with Connecticut water. We're optimistic about that, we recognize it won't be easy. We still have work to do with the commission in Connecticut. But we believe that's the right course for our shareholders and that's the path we're moving forward on.

Great. Okay. All right, well, I appreciate your time. Thanks for the answers and look forward to monitoring how the transaction goes.

Thank you, we appreciate it. Thank you.

Thank you. I'm showing no further questions at this time, I’d like to turn the call back over to Eric Thornburg for closing remarks.

Thank you, again, we appreciate your interest in our company. We're really proud of what we've accomplished and what we've got in front of us to take on. Just to remind you, this company has been in existence for over 150 years and has just an outstanding dividend track record. And we're excited about our growth prospects in both California and Texas and of course, with our transformative merger before us in Connecticut and Maine. We look forward to keeping you posted on our results, and we appreciate your support. Thank you very much.

Ladies and gentlemen, this concludes today’s conference. Thanks for your participation and have a wonderful day.