SJW Group

NYSE:SJW

Earnings Call Transcript 2018-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the SJW Group Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call maybe recorded.

I would now like to introduce your host for today's conference Ms. Suzy Papazian, General Counsel. You may begin.

[Suzy Papazian, General Counsel and Corporate Secretary]

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 development as well as other factors that the Company believes are appropriate under the circumstances. Many factors could cause the Company's actual results and performance to differ materially from those expressed or implied by the forward-looking statement.

For a description of some of the factors that could cause actual results to be different from statements in this presentation, we refer you to the press release and to our most recent Forms 10-K, 10-Q, 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'll 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 like to turn the call over to Eric.

[Eric Thornburg, President and Chief Executive Officer]

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's presence in Texas and the continued additions of 33 million to utility plan bringing our year-to-date total additions to over 50% of our 2018. 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 informational on regulatory and other key business matters including the progress of our proposed merger with Connecticut Water Service. Jim?

[James Lynch, Chief Financial Officer and Treasurer]

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 experience higher water costs due primarily to price increases and higher usage which were partially offset by lower costs surface water production and transaction cost incurred in connection with our proposed merger with CGWS.

Second quarter revenue was $99.1 million dollars, 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 dollars 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 dollars or $0.68 per diluted share compared to $22.4 million dollars or $1.8 per diluted share in 2017.

The decrease in diluted earnings per share for the quarter was $0.288. Increase 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 cost incurred in connection with our CTWS transaction of $0.10 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 decrease by $0.40. The net decrease was driven by many of the same factors as the quarter. Increase customer usage contributed $0.31 per share and rate increases contributed $0.46 per share. these increases were offset by lower balancing and memorandum account contributions of $0.42 primarily due to the WCMA and the impact of the California cost of capital proceeding. Merger related costs 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.

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% in purchase water cost and ground water pump taxes implemented by the Santa Clara Valley Water District or the District.

Increase 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 increase 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 six months of 2017 included the pretax gain of $6.3 million on sale of 444 West Santa Clara Street limited partnerships interest in a commercial building and Land partnership bond 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-day 2018 cash flows from operations decrease 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 non-cash items and partially offset by an increase in general working capital of a million dollars.

At the end of the quarter, we had $86 million available on our bank lines of credit for short term financing of utility plan additions and operating activities.

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

[Eric Thornburg, President and Chief Executive Officer]

Thank you. Jim. California’s water supply Alex 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 Brown signed into law all Assembly Bill 1668 and set a bill 606. Both bill set an initial limit for indoor water use of 55 gallons per person per day by 2022 and further reduce 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 to have a final decision in December 2018 and new rates starting on January first 2019.

San Jose Water held a successful opening event for our newly upgraded Montevina Water Treatment Plant. This $62 million project employees state of the art ultra-filtration, membrane treatment technology and enhances San Jose Water 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 were instrumental in its success. Delivering safe high quality water and reliable water services while also protecting and preserving the environment are critically important and are the main reasons behind our undertaking at Montevina Water Treatment Plant upgrades.

Progressive and responsible environmental leadership is paramount to the business of providing water service and San Jose Waters commitment extends back to its inception and 1866. Over the last one 150 years San Jose Waters actively work to earn and similar status as a leader amongst water utilities 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 turbans and filter tank systems to enhance efficiencies and reduce its carbon footprint. Expanding the recycled water distribution system within Santa Clara County to maximize reset recycled water use and further stretch the region’s increasingly precious potable water supplies.

And finally, receiving the prestigious partnership for safe water director’s award for five consecutive years recognizing the company’s commitment to superior distribution 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 2000 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 Waters systematic main replacement and efficient leak response programs should further reduce our non-revenue water that has averaged approximately 7% over the past five years. San Jose Waters is also completing a pilot project to test advanced metering infrastructure or more commonly known as AMI or smart meters.

AMI allowed 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 generation 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’s 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 SJWTX’s family and look forward to delivering safe, high quality reliable water service to businesses and residents. With a diverse portfolio of water supplies a growing waste water business and continued additions to customer base through organic growth and acquisitions, we remain optimistic about the prospects for SJWTX.

SJWTX success has and will continue to be measured by our ability to deliver safe high qualify a reliable water service have 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 of 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 her 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 determent 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 five months. But we look forward to providing the commission more information through the OII.

SJW professionals operate two high quality water systems an 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’ll will turn the call back to our operator.

[Operator]

[Operator Instructions] Our first question comes from Ryan Connors with Boenning and Scattergood. Your line is open.

[Ryan Connors, Boenning]

Thank you and thanks for taking my question. A quick question on the couple questions on the merger transaction timeline and I think there’s a lot of confusion about exactly what the key milestones are I mean everyone can understand the fundamental debate but there’s some confusion about the exact milestones and the timeline and timeframe over which that it does will come to a conclusion. So can you just kind of give us a little bit of a brief synopsis of the key timeline milestones we need to be looking out for?

[Eric Thornburg, President and Chief Executive Officer]

Absolutely. Thanks for that question, Ryan. Well of course we were acquired regulatory approval in both Connecticut and Maine and those cases have been filed and given the timelines 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 importantly in that process the commission committed to a timeline 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 or with SJW group. And so as soon as our proxies are our proxy definitive then we can begin counting votes and get towards that meeting to declare the vote complete. So we continue to be confident that we can close late in the fourth quarter.

[Ryan Connors, Boenning]

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

[Eric Thornburg, President and Chief Executive Officer]

Where 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 shareholders.

[Ryan Connors, Boenning]

Right. But we know that the proxy can really be definitive until the regulatory hurdles are met right that?

[Eric Thornburg, President and Chief Executive Officer]

Actually can arise and but we would expect that we’re very close to being definitive now.

[Ryan Connors, Boenning]

Okay. Great. So late fourth quarter for a fractional proxy meeting and vote. And the other question was obviously a lot of the significant part of the stock in both sides is held by passive investors in this day and age I mean would do tell you’ve been contacted and what can you tell us about the process in terms of the institutional and Shareholder Services and the types of groups I mean have and you’ve been in touch with any of them and they reached out and doing in their independent assessment to help advice some of the passive investors or how does that part of the process of working?

[Eric Thornburg, President and Chief Executive Officer]

Yeah Ryan as soon as we go to tentative 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 road shows and we got really outstanding reception to the combination of the potential for the combination between the two companies. So lots of strong support was voiced to us at that time but we’re anxious to get out and begin the solicitation process.

[Ryan Connors, Boenning]

Great. Well that’s really helpful information and thanks for your time this afternoon.

[Eric Thornburg, President and Chief Executive Officer]

Ryan, I’d 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.

[Ryan Connors, Boenning]

Got it. Good piece of information. Thank you.

[Eric Thornburg, President and Chief Executive Officer]

Thank you, Ryan.

[Operator]

Next question comes from Michael Gaugler with Janney. Your line is now open.

[Michael Gaugler, Janney]

Good morning, everyone.

[Eric Thornburg, President and Chief Executive Officer]

Hi Michael.

[Michael Gaugler, Janney]

Well 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?

[James Lynch, Chief Financial Officer and Treasurer]

Yeah. There’s the expenses Michael, this is Jim. The expenses are going to kind of have been slow 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 are as for filing and we’re going to then be going to our shareholders and so kind of looking out we have an estimated what the total expenses are going to be from the transaction just because we’ve got some number of professionals that are helping us through this process.

And so I think that you know without giving a number to look at going forward. I think you can expect expenses we’ve paid it on the transaction to be the normal and customary ones that you would expect.

[Michael Gaugler, Janney]

Okay. One more one on the merger referencing back to your slides in the CPUC you OII was and given this is not in California utility being merged with or purchased it certainly seems like it would be outside their jurisdictions. What’s the basis for the review?

[Eric Thornburg, President and Chief Executive Officer]

Yeah thank you, great question Michael. When we began this process we did rely on historic president and did not expect that the commission would assert any jurisdiction in this case. But it was clear that the commission had questioned some of those questions being raised by buyer interlopers and so we work with the California Public Utility Commission to their great credit to know 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 were pleased with the OII process with the December end date.

[Michael Gaugler, Janney]

Okay. And then one last one and since you mention it you’re slide as well. [indiscernible] contention well out a couple of people are also have service line I believe. So I’ll ask how it has been working out versus your original expectations.

[Eric Thornburg, President and Chief Executive Officer]

Tell you what Michael we are really excited about this we plan to deploy more. We’ve got them like I said just 2000 out there now and these devices listening to the distribution system have tonight when the usage is down and we like to say we have found leaks that have yet to surface and so we avoid the more catastrophic failures in 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.

[Michael Gaugler, Janney]

Now then you can point out your regulatory when you going for your next early discussion?

[Eric Thornburg, President and Chief Executive Officer]

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.

[Michael Gaugler, Janney]

Awesome. That’s all guys. Thanks.

[Eric Thornburg, President and Chief Executive Officer]

Thank you, Michael.

[Operator]

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

[Eric Thornburg, President and Chief Executive Officer]

Well again thank you for participating 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.

[Operator]

Ladies and gentlemen thank you for your participation today’s conference. That does conclude your program. You may disconnect. Everyone, have a great.