H2O America (HTO) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the SJW Group Second Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this call may be recorded. Now I'd like to introduce your host for today's conference, Ms. Suzy Papazian, General Counsel. You may begin.

Thank you, operator. Welcome to the Second 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 and our merger 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 to our most recent forms 10-K, 10-Q, 8-K and S-4 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 October 22, 2018. You can access the press release and the webcast at our corporate website.

I will now 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 joined by Jim Lynch, Chief Financial Officer of SJW Group; and Palle Jensen, Executive Vice President of San Jose Water.

As Jim will discuss in greater detail later, SJW delivered strong results for the second quarter of 2018. We also achieved several key milestones that enable us to better serve our local customers and communities. For example, the official opening event for our newly upgraded Montevina Water Treatment Plant, the closing of the Deer Creek Ranch water system acquisition, further expanding SJWTX' presence in Texas and the continued additions of $33 million to utility plant, bringing our year-to-date total additions to over 50% of our 2018 target.

With those brief introductory remarks, Jim will now provide you with a detailed review and analysis of the Q2 results and other financial commentary. After Jim's remarks, I'll provide additional information on regulatory and other key business matters, including the progress of our proposed merger with Connecticut Water service. Jim?

Thank you, Eric. Our second quarter operating results reflect the positive impact of higher customer usage and rate increases in both California and Texas, partially offset by our cost of capital decision in California. We also experienced higher water cost due primarily to price increases and higher usage, which were partially offset by lower-cost surface water production and transaction costs incurred in connection with our proposed merger with CTWS. Second quarter revenue was $99.1 million, a 2.9% decrease over the second quarter of 2017. Year to date, revenue was $174.1 million, a 1.8% increase over the same period last year.

Net income for the quarter was $12.9 million or $0.62 per diluted share. This compares with $18.7 million or $0.90 per diluted share for the second quarter of 2017. For the year, net income was $14.2 million or $0.68 per diluted share compared to $22.4 million or $1.08 per diluted share in 2017. The decrease in diluted earnings per share for the quarter was $0.28. Increased customer usage contributed $0.07 per share, and rate increases contributed another $0.21 per share. These increases were offset by lower balancing and memorandum account revenue, primarily due to less dependence on our Water Conservation Memorandum Account, or our WCMA, of $0.18 per share; merger costs incurred in connection with our CTWS transaction of $0.10 per share; and higher water production expenses of $0.08 per share, net of a $0.12 per share benefit due to increased surface water production. In addition, in 2017, we recorded a gain of $0.15 per share on the sale of real estate investments in the second quarter that did not recur in the second quarter of 2018.

Year to date, diluted earnings per share decreased by $0.40. The net decrease was driven by many of the same factors as the quarter. Increased customer usage contributed $0.31 per share, and rate increases contributed $0.46 per share. These increases were offset by lower balance in the memorandum account contributions of $0.42 per share, primarily due to the WCMA and the impact of the California cost of capital proceeding; merger-related cost of $0.25 per share; higher water production expenses of $0.22 per share, net of an $0.18 per share benefit from increased surface water production; and an increase in depreciation and amortization cost of $0.12 per share. In addition, year-to-date 2017 earnings included the previously mentioned gain on sale of real estate investments.

Rate increases for the quarter and year-to-date resulted in $5.7 million and $11.8 million respectively of additional revenue. San Jose Water implemented a 4.2% general rate increase on January 1, 2018, as provided for in our 2015 California general rate case application. The company also implemented a 3.4% rate increase effective July 1, 2017, to recover a 10% increase in purchased water cost and groundwater pump taxes implemented by the Santa Clara Valley Water District, or the District. Increased customer usage resulted in $1.8 million of additional revenue for the quarter and $8.1 million year-to-date. These increases were partially offset by a net $10.9 million and $17.4 million decrease for the quarter and year-to-date respectively in balancing and memorandum account revenue due to higher customer usage, implementation of the Tax Cuts and Jobs Act, or the Tax Act, and a lower return on rate base authorized in our cost of capital proceeding. Recall that the company has been directed by both the California and Texas Commissions to pass the Tax Act benefits from regulated company activities to our regulated customers.

Water production expenses increased $1.1 million during the quarter and $5 million year-to-date. The increases were primarily due to increased customer usage of $1.7 million for the quarter and $4.3 million year-to-date, along with the previously mentioned cost increases by the District. The increases were partially offset by an increase in lower-cost surface water production of $3.3 million and $4.6 million for the quarter and year-to-date respectively and the impact of cost recovery balancing and memorandum accounts of $1.2 million for the quarter and $700,000 year-to-date. Other operating expenses increased $5 million for the quarter and $11.4 million year-to-date, primarily due to payroll increases and higher depreciation. In addition, CTWS merger-related costs were $2.7 million for the quarter and $6.5 million year-to-date.

Other income and expense in the second quarter and first 6 months of 2017 included the pretax gain of $6.3 million on sale of 444 West Santa Clara Street Limited Partnership's interest in the commercial building and land the partnership owned and a pretax gain of $580,000 on the sale of undeveloped land which SJW Land Company owned. No similar real estate transactions occurred in 2018.

Turning to our capital expenditure program. We added $33.1 million in company-funded utility plant in the second quarter of 2018, bringing total company-funded additions year-to-date to $62 million.

Turning to liquidity. Year-to-date 2018 cash flows from operations decreased approximately 20% over 2017. The decrease was the result of $6.4 million in reduced tax receivables; a decrease in accrued water production expenses of $3.2 million; and a $3 million reduction in net income after adjustments for noncash items and partially offset by an increase in general working capital of $1 million. At the end of the quarter, we had $86 million available on our bank lines of credit for short-term financing of utility plant additions and operating activities.

With that, I will stop and turn the call back over to Eric. Eric?

Thank you, Jim. California's water supply outlook remains positive for 2018, and adequate water supplies are available to meet our highest demand months this summer and fall. We remain under a call for 20% conservation from the Santa Clara Valley Water District, our local wholesale water supplier. With conservation becoming a true way of life in California, on May 31, 2018, Governor Edmund G. Brown signed into law Assembly Bill 1668 and Senate Bill 606. Both bills set an initial limit for indoor water use of 55 gallons per person per day by 2022 and further reduced the limit to 50 gallons per person per day by 2030. San Jose Water maintains a long tradition of promoting conservation and is committed to working with state officials and the California Public Utilities Commission on implementation details to assure its success.

San Jose Water continues to process its general rate case application with the California Public Utilities Commission. We remain on track of a final decision in December 2018 and new rates starting on January 1, 2019.

San Jose Water held a successful opening event for our newly upgraded Montevina Water Treatment Plant. This $62 million project employs state-of-the-art ultrafiltration membrane treatment technology and enhances San Jose Water's ability to meet the region's growing water supply challenges, ensure compliance with increasingly stringent drinking water regulations and allow for the continued delivery of high-quality, safe and reliable water service to our customers. The opening was well attended by local elected officials, colleagues from the Santa Clara Valley Water District as well as key business partners who are instrumental in its success. Delivering safe, high-quality water and reliable water service while also protecting and preserving the environment are critically important and are the main reasons behind our undertaking of the Montevina Water Treatment Plant upgrades. Progressive and responsible environmental leadership is paramount to the business of providing water service, and San Jose Water's commitment extends back to its inception in 1866.

Over the last 150 years, San Jose Water has actively worked to earn and cement our status as a leader amongst water utilities in ensuring water treatment, water quality protection and water operations by building and operating North America's first full-scale microfiltration plant, utilizing industrial control systems to optimize energy and water resources, deploying hydro turbines and photovoltaic systems to enhance efficiencies and reduce its carbon footprint, expanding the recycled water distribution system within Santa Clara County to maximize recycled water use and further stretch the region's increasingly precious potable water supplies and finally, receiving the prestigious Partnership for Safe Water Directors Award for 5 consecutive years, recognizing the company's commitment to superior distribution and water quality.

More recently, San Jose Water invested in satellite and acoustic-sensing technology to discover underground leaks before they surface. The deployment of more than 2,000 acoustic sensors has already allowed us to identify, locate and repair dozens of non-surfacing leaks to prevent property damage and minimize water loss. This technology, in combination with San Jose Water's systematic main replacement and efficient leak response programs, should further reduce our non-revenue water that has averaged approximately 7% over the past 5 years.

San Jose Water is also completing a pilot project to test Advanced Metering Infrastructure, or more commonly known as AMI or smart meters. AMI allows customers to easily track their water usage, more timely identify leaks and other abnormal usage patterns and use water more efficiently. The implementation of this technology will enable utilities and its customers to meet the state's conservation as a way-of-life objectives, and we anticipate filing an application with the California Public Utilities Commission for its deployment in the future. While significant progress has been made, we are committed to continuing our focus on sustainable solutions, employing innovative technologies and providing steadfast environmental leadership to ensure that current and future generations have access to clean water and a healthy environment.

Turning to Texas, and as previously reported, SJWTX, Inc. closed on the acquisition of the Deer Creek Ranch water system on July 3, 2018. The acquisition adds approximately 750 connections and increases SJWTX' current customer count by about 5%. Importantly, SJWTX' service area now extends into Western Travis and northern Hays Counties, paving the way for future acquisition opportunities. We welcome Deer Creek Ranch customers to the SJWTX family and look forward to delivering safe, high-quality and reliable water service to businesses and residents. With a diverse portfolio of water supplies, a growing wastewater business and continued additions to customer base through organic growth and acquisitions, we remain optimistic about the prospects for SJWTX.

SJW's success has and will continue to be measured by our ability to deliver safe, high-quality and reliable water service at reasonable rates. Connecticut Water Service, Inc. shares in this vision of success, which is one of the core reasons we've chosen to partner with them. Since the announcement of our merger in March, we have never wavered in our belief in the benefits of the combination. In fact, we remain actively engaged with all of our stakeholders, spending time with mayors, council members and other elected officials as well as regulatory agencies in California, Texas, Maine and Connecticut to discuss the benefits of our combination and answer any questions. This includes working closely with the California Public Utilities Commission to answer their questions about our plans through an Order Instituting Investigation, or OII, approved by the commission on July 12, 2018. An OII is a fact-finding initiative for the commission to gather information that will help it determine whether this combination is subject to its review and if so, whether it is in the public interest. The commission has committed to complete the OII within the next 5 months, and we look forward to providing the commission more information through the OII.

SJW professionals operate 2 high-quality water systems in economically vibrant and growing regions. We prudently invest capital to maintain our water systems, employ efficient and sustainable business processes and provide exceptional customer service. We are confident over the long haul that our investments will contribute to lasting growth and profitability, earnings and dividends to our shareholders.

With that, I will turn the call back to our operator.

(Operator Instructions) Our first question comes from Ryan Connors with Boenning and Scattergood.

A quick, quick question on -- a couple of questions on the merger transaction time line. I think there's a lot of confusion about exactly what the key milestones are. I think everyone can understand the fundamental debates, but there's some confusion about the exact milestones and the time line and time frame over which this will come to a conclusion. So can you just kind of give us a little bit of a brief synopsis of the key time line milestones we need to be looking out for?

Absolutely. Thanks for the question, Ryan. Well, of course, we require regulatory approval in both Connecticut and Maine, and those cases have been filed. And given the time lines there, we would expect to receive regulatory approval in the fourth quarter, if not sooner, depending upon the circumstances. And California, as you know, they've opened up the Order Instituting Investigation. And the importantly, in that process, the commission committed to a time line that would result in a finding in December of the fourth quarter. So again, that's consistent with our plans to close in the fourth quarter. And of course, we will require shareholder approval in both Connecticut and in California here with our SJW Group. And so as soon as our proxies are -- our proxy's definitive, then we can begin counting votes and get towards the meeting to declare the vote complete. So we continue to be confident that we can close late in the fourth quarter.

Okay. So you're saying that once the regulatory approval is hopefully received, that's when the proxy process will be pretty expeditious from there?

Well, the proxy process is independent of the regulatory approval. So as soon as our proxy is declared definitive with our work with the SEC, then we can begin to solicit votes from our shareholders and Connecticut Water's shareholders.

Right. Right. But the proxy can't really be definitive until the regulatory hurdles are met, right?

Actually, you can, Ryan. In fact, we would expect that we're very close to being definitive now.

Okay. Okay. Great. So late fourth quarter for an actual proxy meeting and vote. The other question was, obviously, a significant part of the stock in both sides is held by passive investors in this day and age. I mean, have you been contacted -- what can you tell us about the process in terms of the Institutional Shareholder Services and those types of groups? I mean, have you been in touch with any of them to -- have they reached out in doing in their independent assessment to help advise some of the passive investors? Or how is that part of the process working?

Ryan, as soon as we go definitive, then we can begin to actually meet with institutional investors and begin to make our case for that. And we will also be presenting to ISS, and they will make their recommendation on the vote for both companies' shareholders. And so I will say that not long after we announced the transaction, we did some roadshows. And we got really outstanding reception to the combination and the potential for the combination between the 2 companies. So lots of strong support was voiced to us at that time. But we're really anxious to get out and to begin the solicitation process. Ryan, I might also remind you that we do have a voting agreement with 16% of the shares of SJW stockholders. And so they've already got -- we've already got 16% committed to the transaction.

Next question comes from Michael Gaugler with Janney.

I guess I'll start with a housekeeping item first. Going forward, $2.5 million a quarter for CTWS expenses, is that a good guess?

Yes. There is -- the expenses -- Michael, this is Jim. The expenses are going to kind of ebb and flow as we go through the different parts of the transaction. I think that this next phase, going into Q3, we're going to be doing primarily our S-4 filing, and we're going to then be going to our shareholders. And so kind of looking out, we haven't estimated what the total expenses are going to be from the transaction just because we've got some -- a number of professionals that are helping us through this process. And so I think that without giving a number to look at going forward, I think you can expect the expenses we pay on the transaction to be the normal and customary ones that you would expect.

Okay. One more then on the merger. Referencing back to your slides, the CPUC OII, listen, given this is not a California utility being merged with or purchased, it certainly seems like it would be outside their jurisdiction to review. What's the basis for the review?

Yes, thank you for that question, Michael. Yes, when we began this process, we did rely on historic precedent and did not expect that the commission would assert any jurisdiction in this case. But it was clear that the commission had questions, some of those questions being raised by our interlopers. And so we worked with the California Public Utilities Commission. To their great credit, they've chosen this OII process, which is a great way to do some fact-finding. And we will be sharing the exact same information that we will be sharing in Connecticut and Maine, with our California regulators highly confident that they will reach the same conclusion that this is really a great transaction for our customers, our communities and our shareholders as well. And so we're pleased with the OII process with the December end date.

Okay. And then one last one. Since you mentioned it in your slides as well, the acoustic leak detection rollout, I cover Mueller also, and so does Ryan, I believe, so I'll ask, how has it been working out versus your original expectations?

I'll tell you what, Michael, we are really excited about this. We plan to deploy more. We've got them, like I said, just 2,000 out there now. And these devices listen to the distribution system at night when usage is down. And we -- like I said, we have found leaks that have yet to surface. And so we avoid the more catastrophic failures and the cost of repaving streets to a greater extent and of course, saving precious water that is a significant operating expense for us when we buy water from Santa Clara Valley Water District. So very enthusiastic about the technology.

Now maybe you can point that out to your regulator when you go in for your next ROE discussion.

It's a great performance metric. No question. 7% or less, that's got to be one of the lowest non-revenue water use rates in the country.

At this time, I'm showing no further questions. I'd like to turn the call back to Eric for closing remarks.

Well, again, thank you for participating in our call today. We value your input. We look forward to sharing with you our successes in the future, and we appreciate the support of SJW Group. Take care now.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.