California Water Service Group

NYSE:CWT

Earnings Call Transcript 2018-Q1

[Operator]

Good day, ladies and gentlemen. And welcome to the California Water Service Group Conference Call to discuss the proposed acquisition of SJW Group and its First Quarter results.

At this time, all participants are in a listen-only mode. Later, we will conduct 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 Mr. David Healy, Cal Water Vice President and Corporate Controller. Sir, you may begin.

[David Healey, VP, Controller and Assistant Treasurer]

Thank you, Brian. Welcome everyone to California Water Service Group's conference call to discuss its proposed acquisition of SJW Group and its first quarter results.

With me today is Martin Kropelnicki, our President and CEO; and Thomas Smegal, our Vice President, Chief Financial Officer. Replay dial-in information for this call can be found in our quarterly earnings release, which was issued earlier today. The replay will be available until June 25, 2018.

As a reminder, before we begin, the company has two slide decks to accompany the earnings call this quarter. The slide decks were furnished with an 8-K this morning and is also available at the company's website at www.calwatergroup.com. Before looking at this quarter's results and the discussion of the proposed acquisition, we'd like to take a few moments to cover forward-looking statements. During the course of this 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 current shareholders as well as interested parties to carefully read and understand the company's disclosures on risks and uncertainties found in our Form 10-K, Form 10-Q, press releases and other reports filed from time to time with the Securities and Exchange Commission.

I'm going to pass it over to Tom to begin.

[Thomas Smegal, VP, CFO & Treasurer]

Thanks, Dave. Good morning, everyone and thanks for joining us to discuss our proposal to acquire SJW Group for $68.25 per share in cash, as well as our first quarter results. I'm joined by Martin Kropelnicki, President and CEO of California Water Service Group. Marty will begin with the discussion of our compelling proposal and why we believe it's clearly superior to SJW's proposed merger with Connecticut Water and to SJW's standalone prospects. Following that we will review our first quarter results. After our prepared remarks, we will open the call to your questions.

So, let me hand it over to Marty.

[Martin Kropelnicki, President & CEO]

Thank you, Tom. Good morning, everyone. It's been a busy morning. I appreciate you taking time to join us here this morning. I want to begin by saying that our proposal to acquire San Jose Water for $68.25 a share in cash is a good deal for SJW stockholders. Our offer provides SJW stockholders substantial and immediate value and is clearly superior to the SJW pending merger with Connecticut Water.

If you turn to page three, I'd like to take a few moments to highlight what's included in our proposal. First, we propose to acquire SJW for $68.25 a share in all cash transaction valuing at approximately $1.9 billion including the assumption of debt.

Second, the proposal exceeds the all-time high closing price and represents the 20% premium to SJW's closing price yesterday, I'd also like to point out at the time when they written offer on April 4th and sent a letter to the SJW board that was a 30% premium on the closing stock price. Our offer provides significant, immediate and certain value for the stockholders that far exceeds which could be received under the pending all stock merger with Connecticut water.

In addition, our proposal not subject to any financing contingencies and we are confident that where we can move forward to conduct due diligence into definitive agreement quickly.

SJW is the superb strategic and operational fit with Cal Water. Together we will create a stronger larger California based water utility. We believe this is it would be seamless acquisition that would integrate quickly into our operations with little to no integration risk.

Because we know SJW extremely well and their number there literally about a mile down the street from us. Our joining service territory enables us to officially bring these companies together to create one operating system within the State of California.

The combined company would have a stronger financial position benefit from our greater scale, and overall make us a stronger utility within the State of California. Our proposals offer substantial benefits to our customers, employees and communities that we serve.

I will talk about these in greater detail in just a minute. If I can get everyone to turn to page four I want to talk about why we are bringing our proposal directly to SJW stockholders. First, we’ve had a very good and long-standing relationship and admired San Jose Water Corporation. We had numerous attempts over the years in discussions to constructively try to bring the two companies together and fortunately each time we’ve had this, we’ve never been able to bring it to be a meaningful conclusion.

This includes our efforts from September of 2017 last year while we made a formal private proposal to their board at a substantial premium 25% to 30% that was rejected outright without further discussion. It’s also noteworthy that our offer in September was four of cash stock or a combination there of to accommodate their stockholders.

Approximately six weeks ago San Jose Water announced that they entered into a definitive agreement to merge with Connecticut Water and did so without talking to us. Since then we privately reached out them several times to discuss our superior proposal, but they simply refused to engage. In fact, we were surprised to learn that SJW’s board rejected our proposal of April 13 but waited until yesterday to inform us.

SJW’s actions have prevented their stockholders learning about the substantial and immediate value that we can deliver. In comparison under all stock merger with Connecticut Water the stockholders would have to wait for uncertain benefits that would approve over long term, well bearing the execution associated with operating two separate businesses locate approximately 3,000 miles apart in different regulatory environments.

We believe SJW’s stockholders deserve the right to know about our proposal, so they can decide for themselves if they want to go forward with the superior certain value for the promise of long-term accretion that may never be materialized.

I will now turn it over to Tom and let him cover the strategic rationale as laid down on page give.

[Thomas Smegal, VP, CFO & Treasurer]

Thanks, Marty. So, slide five details the compelling strategic rationale for our proposal. The combination of Cal Water and SJW would create a large and stronger California based, be better able to anticipate and meet the needs of the 3 million customers our company serve in the Western United States including over 1.4 million people in San Francisco Bay area.

We are both headquartered in San Jose, literally about a mile apart and we are intimately familiar with the community, it’s priorities and its decision makers. We also have deep inside into many of the operational water supply, water quality and environmental sensitivities of water systems in California and San Jose’s system in particular. Our familiarity with San Jose Water’s operations and our joining service territories would enable us to seamlessly integrate and efficiently operate the combine system.

This is something that will be far more difficult to accomplish with the partner that has no local presence. Furthermore, our combined economies of scale and greater purchasing power would enable us to continue to efficiently invest in critical infrastructure needed to insure a reliable water supply that meets increasingly stringent water quality standards.

If I can have you turn to page six, there are substantial financial benefits to Cal Water stockholders. As you can see the combination enhances Cal Water’s position as the nation’s third largest publicly traded regulated water utility.

We would have a stronger financial profile and better access to capital as we carry out our strategy. The combined company would have net income of a $126 million total assets of $4.2 billion and rate base of $1.9 billion with approved ROEs ranging from 8.9% to 10.1%.

We expect the transaction would be accretive to earnings and would deliver a meaningful cost synergy primarily related to eliminating redundant public company costs, economies of scale and purchasing and operating efficiencies. We are also committed to maintaining our strong investment grades credit rating and believe that our continued investment in our rate base would drive long-term EPS growth and support steady growth in our dividend.

And now, I'll turn it back over to Marty.

[Martin Kropelnicki, President & CEO]

Thanks, Tom. If I can get everyone to turn to page seven, I'd like to talk about the tangible benefits to other stakeholders.

In particular on slide seven, we provide an overview of the meaningful benefits our proposal would bring to our customers, employees and communities that we serve. In particular, there are six major points that I'd like to highlight on this page.

First, we are confident that the customers of the combined company would receive better service through increased operational efficiencies and sharing our resources as well as award winning customer service and leading-edge information technology systems.

Second, we are prepared to make firm commitments to deliver significant value to California customers including the sharing of cost savings and other benefits we received in ways a partner with our local presence cannot. Our increased scale will allow us to reduce the fixed cost that are paid by each customer.

Third, Cal Water has also had a proven track record operating efficiency including building and maintaining critical infrastructure to provide reliable high-quality water service and we planned to continue diligently investment and maintaining the infrastructure of both utilities.

Next, for our employees, we believe the combination will lead to greater opportunities as is the larger California based utility, we'd have greater ability to invest in our talented operations and customer service personnel and offer them broader clear opportunities across the stake.

Next, the two companies are represented by the same union and we would honor all of SJW's existing collective borrowing agreements importantly there will be no change in the number of union represented field or customer service personnel.

Working together, we could further enhance quality of life in the communities in the local communities. For example, we would leverage, Cal Water's industry leading water quality initiative across a larger service territory. We also believe our increased size and scale will enable us to expand our programs such as conservation, affordability, sustainability, environmental protection and the communities that we serve.

If I can get everyone to turn to page eight. We like to talk a moment to discuss next steps. We believe our proposal is far superior to SJW agreed upon merger with Connecticut Water. And we are confident after reviewing the two options, the SJW's stockholders will reach the same conclusion. We remain ready to engage constructive with SJW and are prepared to work closely to complete due diligence and finalize the definitive agreement.

I'm going to now turn over to Tom, who is going to talk about our results for the first quarter of 2018.

[Thomas Smegal, VP, CFO & Treasurer]

Thank you, Marty. So, I'm going to flip slide decks now to the earnings results call slide deck. And we'll start on page six to go over the summary of our financial results for the first quarter.

So, in the first quarter, our operating revenue was up 8.4% to $132.2 million, our operating expenses were also up 11.4% up to $124.2 million. Our interest costs were up, we'll talk about that in a moment. Our net income we had a loss during the quarter of $2.5 million as compared to a gain of $1.1 million in the first quarter of 2017, and on EPS basis we lost $0.05 as compared to a $0.02 gain in the first quarter of 2017.

I do highlight on this page our capital investments are up significantly, and again we'll talk about that as we go through the deck.

Flipping to slide seven of the earnings deck. Our financial highlights, the first quarter is always the leanest of the year for earnings and revenue. If you look back last several years, we have had losses from time-to-time in the first quarter. And that's really due to the seasonality of our business when our water sales come in and how the customers in our service territories use water.

The earnings decrease of $3.6 million is largely attributable to some factors which are outside the company's immediate control. Including a $1.5 million reduction in unrealized income from our benefit planned investments. That's related to the stock market activity during the quarter. $800,000 increase in our unsecured lost expense that's primarily related to main breaks and we'll talk about one significant main break in a moment. And $700,000 reduction in our unbilled revenue.

And as we've talked about on these calls in past quarters, the unbilled revenue is a volatile a number for us having to do with weather and customer consumption and the number of other factors that does bounce around a bit from quarter-to-quarter. So, these items may or may not be indicative of what we see later in the year.

Now, we also had changes in expenses that we would expect to continue in some form throughout 2018, including an increase of $1.5 million in our depreciation and amortization that’s related to the CapEx that we had last year. A $700,000 increase in employee wage expenses we do expect that we’ll have higher employee wage expense in 2018 and 2017.

We had a $600,000 increase in property and other taxes again related to capital investments and a $0.5 million increase in net interest expense and again that has to do with the increased CapEx.

Offsetting these items, the company had general rate increases of $4.7 million which were offset by $1.2 million reduction due to the cost of capital decision in California as well we also had a $700,000 reduction to our maintenance expense during the quarter.

I highlight here on slide 7 our company and developer funded the capital investments for $70.7 million that’s an increase of 36.3% compared to 2017. There has been a lot of activity going on and company related to complying with the price of propane regulation here in California so TCP, we’re installing treatment at 34 sites in California to meet the new water body standard and that project was ongoing in December and January and February to meet the new standard. We do anticipate continuing to target $200 million to $220 million of CapEx in 2018.

And I'm going to turn it over to Marty for slide eight.

[Martin Kropelnicki, President & CEO]

Great. Thanks, Tom. I always ask Tom to include slide eight in first quarter conference call because it really does a good job illustrating the seasonality that goes along with our business or what our revenue looks like for the year. so, what’s on slide eight is our adopted revenue curve, this is driven by the California rate case and this is the revenue by month and that was adopted so being the coupled we’re always true in up to be adopted revenue number through a two-way balance in account which is the RAM account and the modify cost balance in account.

So, as you can see in the first quarter the first quarters always are lowest quarter of the year as we hit spring consumption starts to go up and so there’s revenue our best quarter is always the third quarter as you can see on this chart and as they go into the fourth quarter you start to see kind of the declining consumption and seasonality start to take effect so this slide really explains kind of our results for the quarter, where they are which is the Q1s always are leanest quarter in terms of getting rate release.

[Thomas Smegal, VP, CFO & Treasurer]

I think we’re going to jump I talked about the EPS bridge the items that are in there that’s slide nine, so we’ll skip over that for the time being and Marty will talk about the cost of capital decision.

[Martin Kropelnicki, President & CEO]

Great. As many of you saw, we had a proposed decision from the State of California that had an 8.2% proposed 8.2% ROE during the common period California Water as well as the other major water utilities in the state and did a very good job as Lobby and the Commission and the State discussed this issue which ultimately led to another public hearing in the Sacramento.

The good news is the result of everyone’s hard work we were able to get the proposed ROE raised to a 9.2% ROE for California Water Service company with the cost of 5.51 and a cap structure that includes 53.4% equity.

The cost of capital adjustment will reduce customer rates by an estimated $6.7 million this year and it’s primarily due to the refinancing efforts of the company so if you look at that $6.7 million about $1.5 million or so is really the adjustment to the equity for stockholders.

The remaining amount really has to do with the refinancing on efforts the company has done, and that money has been able to stay through refinancing. If you remember in rate case our rate making that is a pass-through cost so the last couple of years as we’ve been refinancing our debt at lower rates, that’s a pass-through cost that should be adjusted and given back to rate payers.

The decision was retroactive to January 1 and set authorized returns through 2020. The CPUC also approved the cost of capital adjustment mechanism, we believe this is significant in that because it allows for a trigger for the ROE to change with every 100-basis point change to Moody’s AA bond utility index.

So, as we go into a rising interest rate environment to the extent rates change by more than a 100 basis points over a year. We can apply to have our ROE adjusted to foreign and we can adjust to 50% of that change.

So, if rates go up 1%, 4% we can apply to have our ROE adjusted by 15 basis points, and we believe that significant going under the period, going out as in just rate start to move up. Tom?

[Thomas Smegal, VP, CFO & Treasurer]

Thanks, Marty. Quick update on the tax cuts and jobs act implementation. So, in all four of our state operations, the commissions have initiated procedures to ensure the customer’s benefits from the tax reform and the California commission has asked its utilities to incorporate the expense change, so, that’s the literally the change from 35% to 21% tax on embedded on the summary of earnings for regulatory purposes to changes that on June 1st.

So, we’re going to go ahead and lower our rates starting June 1st. As of now, we’re recording a liability for the amount that has been over collected in rates and will pass that on at a future date.

We expect that the balance sheet activity related to the deferred tax assets and liabilities will be handled in rate cases. The next rate case in each of our jurisdictions we'll deal with that issue, particularly the California general rate case that Marty is about to talk about.

So, we will file something in July with that application to purpose how to refund the customer the excess, after remeasurement of deferred tax liability.

Now, let me turn it Marty, to talk about GRC

[Martin Kropelnicki, President & CEO]

Great. So, as we’ve talked about before general rate cases in the State of California are massive projects that involves thousands of hours of preparation. So, we will be filing our 2018 general rate case here in early July. We anticipate requesting more capital than what was awarded in the last cycle and it’s primarily driven by the replacement of aging infrastructure including the replacement transmission, distribution mains.

The company will begin the forecast – capital investment rates base rate, capital needs for 2019-to 2022 in the second quarter earnings release. So, in other words, we’re going to tell you, what we've included in the rate case for our capital request.

These rates once approved will be effective for January 1, 2020, it’s about an 18-month process, if everything goes to schedule, with the California commission and it covers the capital investments for 2019 to 2021.

The company staff that working for more than two years to prepare and support this case, and as you may recall, we’ve made a lot of changes over the last five years and how we planned for and execute our capital program. So, from my perspective, I feel like we were the best prepared regarding this rate case, then we’ve ever been.

And we’ve also gone to looking at a kind of a three-rate case cycle in terms of capital planning. So, looking at that horizon going really 10 years out, and what the replacement needs are for the company.

So, second quarter conference call, we'll be able to give you more color on what we’re looking for in the 2018 general rate case, it will be filed in early July. Tom?

[Thomas Smegal, VP, CFO & Treasurer]

Thanks, Marty.

So, I’ll talk briefly about the status of our regulatory mechanisms and water conditions in the California. Particularly with respect to the RAM and the MCBA.

So, along with our escalation filing in January, that was $15.9 million of general rate relief, California water received in adjustments in our adopted sales volumes, through what’s call this sales reconciliation mechanism, the SRM, and that is about a 9% change in our adopted sales. The great news is that we had in the first quarter, reported sales volume that are 101% of our new adopted sales after the SRM.

And our rent receivable balance decline by $0.9 million, and it’s a good sign that people are coming out of the drought and the SRM mechanism is working.

So, it’s good sign for us to see that RAM balance start to come down that is a receivable. That’s a money that could be invested or spend otherwise in ongoing operations for the company once we receive it from customers.

We also began billing surcharges to recover about $50 million in net RAM MCBA receivables, we started doing that in the middle of the month.

And then on weather conditions, we had really very close to a miracle March. I think people are afraid to calling at that, we did have a miracle March about 15 years ago. But tremendous amount of rainfall here in California in March and even into April. And so, we’re really lower than normal, but okay, as far as water conditions, we’re not in drought conditions in most of the state. And I think the reservoir storage is in pretty good shape.

So, another year goes fine in California without a concern over the water supplies, but always next year and there is always concern as we see changes in the precipitation patterns in California.

As we see less snow and more rain, we do have to be wary long-term about how the state and the company deal with that.

And then flip to just a couple of other notes on slide 2016, other notes for 2018. We always mentioned our vice letter projects because that's a component of our authorized rate base at the commission through January 1, the CPUC had approved vice letter projects totaling a $2.8 million of annual revenue. We have not filed any additional vice letters in the first quarter. I do anticipate that we will be filing a few in the second quarter, but we don't have a final on that, so we'll update you on the second quarter earnings call on those files.

We estimate our effective tax rate for 2018 to be between 23% and 25%, pretty close to the statutory rate of 28% and this year again a reduction as we mentioned on the year end call, reduction in the budgets for repairs eligible mains projects and the law is continuing to be interpreted, so there obviously could be some changes as we go forward during the year.

Last bullet I'll mention on these notes is that there was an accounting change where the non-service component of pension expenses is now shown in other income and expense and the company has - so if you look at the financial statements that will be filed later today, you'll see that presented in a different way than you've seen it before.

And I'm going to flip it over to Marty and Marty can take us to the summary.

[Martin Kropelnicki, President & CEO]

Great. Thanks, Tom. Just wrapping up the quarter Q1 typically is close to breakeven as you saw the adopted revenue curve. We never get too excited about Q1 and we always tell people don't get excited about Q1.

So, we ended up about where we thought we would be obviously we did have a big main break in the Bayshore district, which affected a number of homes, church and school. So, the uninsured loss that Tom mentioned was our reserve basically our retention of our $500,000 before our insurance kicks in and I just want to take a moment to complement the Bayshore team under Roth management did a superb job responding to the crisis.

They quickly responded to the event, the school and church were shut down, but we had the church back open for - it was a catholic church for mass on Saturday night and we had the kids back in school on Monday morning despite extensive flooding of the school.

In addition, there were five homes that were affected, and we had the majority of those homeowners back in their homes within the first 24 hours. One house sustained substantial damage and we're in the process of getting that opening up and re-work for the homeowners there. So, team did a great job responding to that.

The cost of capital decision. Well, the California cost of capital decision will reduce rates this year, which is a good thing for rate payers. We're particularly pleased that the CPUC moved significantly from their initial proposal and it was a lot of work to get there and I appreciate the fact that the commission was going to meet with us and hear the issues as well as what was discussed with the other water companies.

So, I think we've got to a good resolute about 9.2 for cost of capital for the next three years.

As Tom mentioned, we're seeing the positive effects for the regulatory mechanisms, particularly the sales reconciliation mechanism which has started to reduce the net RAM MCBA balance.

Tom, I believe this is the first time since 2008 where actual consumption has been higher than adopted and that's the function of us kind of truing up that sales forecast, if you remember early on the decoupling, we had a pretty big gap there. We would be 75% of adopted sales and that delta between 75 and 100 gets booked in the balance and accounts.

So, it's nice to see those numbers finally cross. And lastly, we are steadfast focused on the California rate case that filed on time and I look forward to sharing some of the data with you on that in our second quarter conference call.

And with that, operator, we will open it up for questions.

[Operator]

[Operator Instructions] And our first question comes from the line of Spencer Joyce from Hilliard Lyons. Your line is now open.

[Spencer Joyce, Hilliard Lyons]

Marty, Tom, good morning. Thanks for the call this morning.

[Martin Kropelnicki, President & CEO]

Good morning, Spencer. How are you?

[Spencer Joyce, Hilliard Lyons]

Hey doing well. Thanks. Two questions from me. First, I want to jump back to the acquisition, just -- can you refresh on why perhaps from a high level that the combination of SJW and CWT, really hasn’t played out, kind of over the decades. Whether they push back regular -- from a regulatory standpoint or was it cultural, I mean just refresh us on maybe why it hasn’t happened yet?

[Martin Kropelnicki, President & CEO]

Sure, well remember we're franchised monopolies and when you are a franchised monopoly, you need two people to agree to get married. So, we've always had a great relationship with San Jose Water going way, way, way back, believe or not a long time ago we were in the same building together. We had members of the SJW Board used to be on our board. So there is a lot of history that go way back between these two companies.

And so, I think while there has been discussions throughout the year, they just didn’t materialize for probably a whole host of reasons. For us that what kind of prompted us now to actually make a hard offer and submit it in writing was the fact that they were going into a registration statement with Connecticut merger and we thought it was time to put our offering right in and submit it.

And again, we also believe that there are significant benefits to be had. If you look at two public companies that are operating literally about a mile apart, you have two sets of Board of Directors, two sets of officer teams, two public companies that listing fees on the New York Stock Exchange, two public company audits, two sets of D&O insurance. And so there is a lot of duplicative costs that we believe bring synergies into this deal that make it a very compelling offer to be considered by both parties involved in the transaction.

And in California what we put in our release is that we would share those synergies with our ratepayers. So there is a good benefit for stockholders and for ratepayers.

[Spencer Joyce, Hilliard Lyons]

This might be a difficult follow-up to address, but if we assume that SJW and Connecticut sort of closed kind of as inertia might indicate at this point. It's reasonable to assume that a lot of the same positives of combining kind of the legacy San Jose franchises and Legacy Cal Water assets would still persist a year or two, three years down the road.

I mean is there anything about the tie up with Connecticut that would I guess where do you all off in the future, I mean is there anything kind of about being on the East Coast per se that you think may not work for Cal Water long-term?

[Martin Kropelnicki, President & CEO]

That is a tough question to answer. I would say historically we have been a West Coast Company, and Spencer as you know a lot of people will view California regulation as being challenging, difficult and sometimes maybe outlandish, but we’ve kind of mastered that skill and we’ve built a good rapport and brand within the State of California.

So, I think we’re comfortable being kind of a West Coast focused company. We have in California for example, we have a 12% to 13% growth in our CapEx and its California is big, it’s a massive state. People forget how California is.

So, being here, we think it’s a great place to be. It’s the largest state in the Union. It’s the largest contributor to the U.S. GDP. It’s the largest Ag state. So, there are lot of water needs here that certainly keep us challenged and where we have remained focused.

Now could we consider [indiscernible] yeah, we could, but I think we kind of like the West Coast feel and I think as we all know, running utility is the game of economies of scale. So, to the extent you have pieces of the operation that are close to each other, that’s really where you get the operational synergies that result in savings and improved service for customers.

[Spencer Joyce, Hilliard Lyons]

Yes, a point well taken there and thanks for kind of addressing that question. Separately, Tom if I might ask, so it looks to me like the tax rate in Q1 was a little bit above what we still expect for the full year. I was wondering if you could talk about maybe what the cadence of the rate kind of across Q2, Q3, Q4 might be.

I guess historically Q4 is kind of been the lowest from an effective rate standpoint, but should we continue to model that way, or may we see a similar rates kind of across the next three quarters.

[Thomas Smegal, VP, CFO & Treasurer]

So, I think it's difficult for us to determine where we're going to land in that range over the next three quarters. What I'll tell you is that a lot of the remaining tax deductions that we or tax benefits that we have, have to do with the repairs deductions.

I mentioned that on the slides and so that's really the pattern of installations of mains and getting those mains in service. And oftentimes just due to the construction schedules in California, those are, those are closing the plant a little bit later in the year and that allows us maybe to make those estimates and get that tax benefit later in the year.

That isn't necessarily going to be the pattern this year, but that's been the pattern in the last couple years. Maybe that's what you're seeing in terms of the lower tax rate in the fourth quarter.

[Spencer Joyce, Hilliard Lyons]

Okay. That's helpful. That's all I had. Thanks guys.

[Martin Kropelnicki, President & CEO]

All right. Thanks, Spencer.

[Operator]

And our next question comes from the line of Jonathan Reeder from Wells Fargo. Sir, your line is now open.

[Jonathan Reeder, Wells Fargo]

Hey good morning, Marty.

[Thomas Smegal, VP, CFO & Treasurer]

Good morning, Jon.

[Martin Kropelnicki, President & CEO]

Good morning Jonathan.

[Jonathan Reeder, Wells Fargo]

Hey, I was wondering, could you -- how you envision financing the SJW deal. Is it 50-50 stock…

[Martin Kropelnicki, President & CEO]

As part of our offer that submitted to the SJW Board, we Morgan Stanley, who is our advisor they prepared a highly confident letter noting that we could finance this deal with no contingencies. Obviously, you would have to file an application with the State of California and get regulatory approval and then upon closing, put your cap structure together.

So, I don't think we can talk about that yet, because there is a couple steps ahead of us that we have to maintain other than saying that we are highly confident we can get this transaction done and pay off cash.

[Jonathan Reeder, Wells Fargo]

Okay. Maybe somewhat of another way added the $126 million of net income that you said, can you kind of elaborate some of the key assumptions to get there? In particular, does that assume retention on a permanent basis of some of the cost synergies you expect?

[Thomas Smegal, VP, CFO & Treasurer]

I don't have the synergy model in front of me. I mean we basically did a pro forma analysis with kind of limited data with only what was available in the last filings. I believe SJW and Connecticut filed their merger documents last night. And I think there is probably some more information in the documents.

I took a quick look and it looks like the estimates for SJW and Connecticut were about 20% lower than what the consensus was on the street. But that's as far as we were able to get into like yesterday given our Board Meeting and our earnings release and preparing for this call. So obviously one of the things we'll be working on right now after this call will be really digging into the numbers and updating our accretion to boost our analysis.

[Jonathan Reeder, Wells Fargo]

Okay. And then lastly, the SJW Board I mean you may have seen just how they rejected your proposal publicly. I think they might have sent you a letter. But how do you see the next steps playing out with regard to the potential deal?

[Martin Kropelnicki, President & CEO]

Well, I think essentially what we're doing, is let the efficient market work? We've gone forward with our offer and we put it out there for their stockholders to see. And their stockholders will be making a vote on the SJW Connecticut merger and their stockholders will have to decide do we want to do a stock-for-stock combination deal through an S4 registration or which you'll rather have in all cash offer from someone like us.

And so, I think it will ultimately be to the stockholders, we believe we've offered a superior deal for SJW within all cash on all cash offer.

[Jonathan Reeder, Wells Fargo]

Strategically from your advantage point, but is there an outreach that you're going to be engaging in what was from a stockholder standpoint from regulatory standpoint. How that the -- that's helping get your proposal cross the finish line then.

[Martin Kropelnicki, President & CEO]

Well obviously, the debt that we just went through was filed with the SEC and in the 8-K. and that's going to generate questions I'm sure from our regulators. I know I've already gotten some calls from some of the local politicians and the phones been ringing up the hook.

So, I think it's going to be out there. I think the real issue here is just how much operational synergies can be achieved and how can we bring a better deal for rate payers as well as the stockholders.

The other thing I want to just take a note to mention is really on the employee side, and some of you have heard me say this, now we are a company of pipes and pumps of physical assets, the real assets are really the employees of the company because they are the ones that are serving the customers and we’re prepared to make those commitments, to honor those commitments for SJW because it’s the same union that we operate in.

And so again that we think there’s just a lot of operational synergies that could be achieved through this transaction and it’s hard to achieve those synergies, with the partners on the opposite side of the U.S.

[Jonathan Reeder, Wells Fargo]

Right. Okay, well good luck as you move forward with this as well as combining the received files as obviously the course of you signing out, but looking forward to further update.

[Martin Kropelnicki, President & CEO]

All right, thanks Jonathan.

[Operator]

And our next question comes from the line of Angie Storozynski from Macquarie. Your line is now open.

[Angie Storozynski, Macquarie]

Thank you. So, my first question is looking the past, I’ve seen similar issues with the deals that cannot happen and usually management succession is a problem and looking at the management succession arrangement around the SJW and the Connecticut Water I think it’s would be kind of career that that’s where it is. So, is there maybe anyway to address this impairment to a combination between you guys and SJW?

[Thomas Smegal, VP, CFO & Treasurer]

It’s hard when the other party doesn’t want to engage, and we have submitted written offers to the board kind of several times and they refuse to engage with us. I can’t say what that dialogue would be like, but obviously by combining forward, and by the way we believe this isn’t a hospital bed we believe it’s a good space, very fair but based on a market premium on cash for SJW. We would love to be at the table talking about that.

[Angie Storozynski, Macquarie]

Okay. And then secondly, so you guys have the under invested assets we're clearly hopeful to see another big step up in your CapEx from the Jersey you're about to file. So okay so you have plenty of goals, opportunities in your existing business and yet you think it’s worthwhile to make an offer with some 2.4 times rate base in California utility.

So just talk me through the larger key and how this premium of other big rate base that you’re paying would be accounted for, would you be able to earn your ROE on that full amount you’re paying, how would the goodwill be recognized on the balance sheet versus your future earnings dollars?

[Martin Kropelnicki, President & CEO]

Sure, some of those things I can address, some of things I can’t address obviously because we’re not at the point where we can model goodwill, because we’re just really one of us sitting at the table. But it goes road back to two things, right one when you operate the utility to the extent you can expand that utility, you can take your fixed cost and spread it to our larger base. That’s an economy of scale and utilities fundamentally work under economies of scale. So, first that’s first and foremost.

So, we already serve a population about 400,000 people in the Greater Bay area. We’re all around SJW, so pulling that piece in would allow us, would give us a much broader base to expand our spread, our fixed cost over in the Bay Area region just by itself let alone through the whole state.

Second thing it’s about the synergies. And again, we have a lot good duplicative cost between two publicly traded companies that basically are doubled cost. So, squeezing not those centers, getting those synergies to the bottom line enable us to basically pay a premium for SJW.

And it really is driven by the fact that they are right next door to us. To the extent, they’re in a different state, it would certainly affect the amount of premium we could pay to the extent they are in a different rate jurisdiction, it would affect the amount that we’re able to pay in terms of premium.

So, the fact that we believe that there are significant synergies there, we're willing to share those synergies with rate payers to help reduce their rates and bring down their cost by lowering the fixed cost. We think that’s a significant point.

[Angie Storozynski, Macquarie]

But it was just a little bit of a bigger picture question given that I haven’t really seen acquisitions, the scale acquisition California for a very long time. Would the state allow you to put into the rate base the entire purchase price of the company or would it be just the rate base that is already authorized by the commission?

[Thomas Smegal, VP, CFO & Treasurer]

So that’s -- there is a State law that allows a premium to be put into rate base it would be subject to regulatory proceeding and negotiations. And really the regulator, I've dealt with the merger of Cal Water and Domingo’s Water back in 1999-2000. The regulator is really looking at the customer savings and the customer benefits, from such an acquisition and that’s a limitation on the amount that you could put, premium that you could put into your rate base and earn on.

But in that instance, those were two relatively off companies at the time, a large merger, we were able to get the recognition of some of the premium in rate base. And – we’re counting on that, at this point that’s really hard to tell this early, a process has haven’t started yet. But, we expected to take that angle with the commission, as long we could show that the plenty of synergies and savings for customers and that it was a real clear benefit to the customers of both of our companies.

[Angie Storozynski, Macquarie]

Okay. Thank you.

[Operator]

[Operator Instructions] One moment for questions please. And we do have one from Tyler Frank from Baird. Your lines are open.

[Tyler Frank, Robert W. Baird]

Hi guys. Thanks for taking the question. It is {indiscernible] can you discuss what sort of capital needs you would need if any this year, and how is to about things from equity standpoint and debt standpoint? And then any further color you could provide on that from capital need standpoint from - there is word about {indiscernible]. Thank you.

[Thomas Smegal, VP, CFO & Treasurer]

Let me address ongoing, so this were not to go through, we’ve been – in the past calls and presentation that our financing strategy it use our line for credit to finance capital investment and we have a two year limitation from a California commission on our line of credit in California and so we do need to get off that line by October of 2018. So, we expect to do some financing between now and end.

So, it’s unclear at this point whether that would be in an ongoing operation whether that would {indiscernible] debt or equity. Our goal was the years has been to try to match the debt equity structure, that’s been awarded by the commission. So, we’ll continue to look to that as our guide when doing in debt or equity decision.

[Martin Kropelnicki, President & CEO]

Yeah, and I would just again refer from page 17 of the slide deck. We show our history on the capital program. So, our current 10-year comp annual growth rate is just shy of 13% -- it's 12.9%. For 2018, we estimate about a 2010 it’s the third year, end of the rate case cycle for us. So, it will be a little lighter this year than last year.

But Tom and I have said we don’t see {indiscernible] drive the need down for more capital and so. And going forward nothing has changed in Cal Water, we've been fully engaged and fully on track of our capital program where we want to continue to do that that's what the core of what we do.

And in terms of the capital needs for SJW, again we have committed information, we have what’s available in the SEC filings and we’re still in process of analyzing that. But I would speculate that they’re regulated by the same regulator we are, and they probably have similar experiences of their rate case in endpoint to the process.

I don’t think any of the California utilities had capital rich and there is a very kind of diligent process, the commission goes through. They review all projects on a project-by-project basis. So, I would think that SJW probably has similar maybe not as large with capital needs as what we have.

[Tyler Frank, Robert W. Baird]

Okay, thank you.

[Martin Kropelnicki, President & CEO]

Thanks, Tyler.

[Operator]

And I’m showing no further questions. I would now like to turn the call back to Marty Kropelnicki for any further remarks.

[Martin Kropelnicki, President & CEO]

Great, when we covered a lot of information. These earnings we appreciate everyone being with us. And two things, one, we're look forward to talking about our 2018 general rate case at the Q2 conference call at the end of July, we'll be able to provide a lot more color on our rate case at that point once it gets filed.

And there will be more to come on SJW rate case. And this closing, I like to say for any stockholders of SJW, we believe, we put forth the good face offer and all cash that we believe it was superior. And we look forward to any discussion of SJW about combining the two things to create synergies that improve customer service and can improve results for stockholders.

And with that, we want to - Tom and I will talk to you in Q2. Have a good day.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. And you may now all disconnect. Everyone, have a great day.