H2O America

Ladies and gentlemen, thank you for standing by, and welcome to the SJW Group Third Quarter Earnings Conference Call. At this time, all participants are in the listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone keypad. Please be advised that today's call is being recorded. If you require any further assistance during the conference, please press star 0, and an operator will be happy to assist you. I would now like to hand the conference over to Jim Lynch, Chief Financial Officer. Thank you. Please go ahead, sir.

Thank you, Operator. Welcome to the third quarter 2020 Financial Results Conference call for SJW Group. I will be presenting today with Eric Thornburg, Chairman of the Board, President, and Chief Executive Officer. For those who would like to follow along, slides accompanying our remarks are available on our website at www.sjwgroup.com. Before we begin today's presentation, I would like to remind you that this presentation and related materials posted on our website may contain forward-looking statements. These statements are based on estimates and assumptions made by the company in light of its experience, historical trends, current conditions, and expected future developments, as well as other factors that the company believes are appropriate under the circumstances. Many factors could cause the company's actual results and performance to differ materially from those expressed or implied by the forward-looking statements. For a description of some of the factors that could cause actual results to be different from statements in this presentation, we refer you to the financial results press release and to our most recent forms 10-K, 10-Q, and 8-K filed with the Securities and Exchange Commission, copies of which may be obtained on 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 an opportunity to ask questions at the end of our presentation. As a reminder, this webcast is being recorded, and an archive of the webcast will be available until January 25, 2021. You can access the press release and the webcast at our corporate website. I will now turn the call over to Eric.

Thank you, Jim. Welcome, everyone, and thank you for joining us. I'm Eric Thornburg, and it is my honor to serve as chairman, president, and CEO of SJW Group. It was just over a year ago that SJW Group completed its transformative merger with Connecticut Water. We knew going into the combination that our teams across the country had similar values, a commitment to service, and that our people would work well together for the benefit of customers, their coworkers, shareholders, and the environment. In the months that followed our historic combination, I cannot tell you how proud I am of our people and their passion for protecting public health, employee safety, serving our customers and communities, and living our shared values. Just four months into our integration, we, like others, were faced with COVID-19. It was to be the first of many challenges in 2020 that had included wildfires and brownouts in our California service area, a significant late winter snowstorm in Maine, a tropical storm in Connecticut, and drought in Texas. The challenges of 2020 have forged bonds and shown the strengths within and across our operations. In many ways, this has accelerated our integration, especially the work of our employee health and safety team, which has been outstanding. Using a pre-COVID-19 pandemic plan as their foundation, and with the support of their colleagues, they created protocols, policies, and PPE guidelines that have kept our people safe while allowing them to do the critical work necessary to deliver life-sustaining drinking water to 1.5 million people across all four of our states. Of course, mental health is just as important as physical health. In view of the times, we expect have expanded the variety of mental health resources available to employees and their families. As we all react to stress differently, having an array of options available allows our people to find the resources that are best for them. Offerings range from an employee peer support team to online mindfulness sessions to professional counseling through our employee assistance program and medical programs. Our managers have received training on how to have those sensitive conversations with peers and coworkers that they're concerned about. Our employees are resilient and we continue to support their mental and physical health and wellness. SJW Group remains focused on its core growth strategy of investing in water systems so we can provide safe and reliable water service to customers and communities and earn a fair return for shareholders. We've been reminded of the critical nature of investments in clean, safe drinking water for public health and sanitation like never before. Despite some delays due to COVID-19, our operations in Connecticut, Maine, and Texas are on track to deliver their 2020 capital programs. And in California, San Jose Water will achieve the $320 million three-year capital program authorized in the last rate case. In July, ground was broken on Mainwater's Saco River drinking water treatment facility in Biddeford, which is part of the Biddeford and Saco Water Company acquired by CTWS in 2013. This generational investment of more than $50 million replaces a facility that has been serving customers in Southern Maine since 1884. The new facility is being designed to meet sustainable infrastructure standards set by the Institute for Sustainable Infrastructure. This project was slightly delayed in 2020 due to COVID, but will be completed on time in the spring of 2022. Continuing our commitment to invest in critical infrastructure, The overall 2021 capital plan for SJW Group subsidiaries has been set at $237.8 million, including the largest capital plans in the history of our New England and Texas subsidiaries. We remain focused on our core business and executing on our growth strategy in a most extraordinary year. This is a true testament to commitment of our people and the passion of our leaders and value of our mission. We reaffirm our earlier guidance of $1.95 to $2.05 per share in 2020. I will now turn the call over to Jim, who will review our Q3 financial results. After Jim's remarks, I will address other regulatory and business matters. Jim?

Thank you, Eric. Our quarter and year-to-date operating results reflect an increase in earnings related to the third full quarter of combined operations with Connecticut Water Service, or CTWS, and an increase in customer usage and authorized rate increases in our California and Texas water utilities. These increases were partially offset by higher water costs due to a decrease in the availability of surface water supplies in our Northern California service area due to dry weather conditions this past winter and the increase in customer usage. Third quarter revenue was $165.9 million or a $51.9 million increase over reported third quarter 2019 revenue of $114 million. Net income for the third quarter was $26.1 million or $0.91 per diluted share. This compares with $9.5 million or $0.33 per diluted share for the third quarter of 2019. Diluted earnings per share for the quarter reflects the result of CTWS, which contributed 25 cents per share. In California and Texas, authorized rate increases contributed 11 cents per share, a decrease in administrative and general expenses added 9 cents per share, an increase in customer usage contributed 7 cents per share, and other items combined contributed 11 cents per share. These increases were partially offset by higher water procurement costs due to the decrease in California surface water production of $0.16 per share, an increase in production costs of $0.06 per share due to higher customer usage, higher depreciation expense of $0.06 per share, and an increase in interest expense on new long-term debt of $0.05 per share. Also recall that in the third quarter of 2019, we recorded a reserve against our 2018 and 2019 water conservation memorandum account, or our WCMA balances, as we determined we no longer met accounting recognition requirements. The impact of establishing the reserve on 2019 earnings was 29 cents per share. In addition, in 2019, we earned interest of six cents per share on temporarily invested proceeds from our December 2018 equity offering and incurred CTWS merger expenses of 5 cents per share. During the third quarter of 2020, no similar account reserves were established, investment income earned, or merger expenses incurred. Turning to our quarterly comparative analysis, the $51.9 million increase in revenue we experienced was primarily due to the merger with CTWS, which contributed $37.1 million. Increased customer usage in California and Texas contributed another $2.4 million, and we generated $2.3 million in cumulative authorized rate increases. In addition, in 2019, we recorded a $9.5 million reserve against the 2018 and 2019 California WCMA balances. As noted, no similar reserves were required to be established in 2020. Water production expenses increased $13.3 million compared to the third quarter of 2019. The increase included $6.5 million related to CTWS water sales. In addition, cost increased $5.4 million for the purchase of additional water supply in our Northern California service area due to the surface water shortage, and $2.2 million due to higher customer usage. Other operating expenses increased $13.7 million during the third quarter, primarily due to higher depreciation expense of $7.3 million, $4.4 million in new general and administrative expenses, and $3.7 million in higher property and other non-income taxes. The increases were primarily a result of the inclusion of CTWS's third quarter activities. In addition, we experienced a $1.7 million decrease in merger-related expenses as none were incurred during the third quarter of 2020. The effective income tax rate for the third quarter was 15% compared to 21% for the third quarter of 2019. The effective tax rate decrease was primarily due to the flow-through impact of certain CTWS tax deductions. Turning to the first nine months of 2020, revenue was $428.8 million, a 46% increase over the same period last year. Net income for the first nine months of 2020 was $48.2 million, or $1.68 per diluted share, compared to $28.9 million, or $1.01 per diluted share during the same period in 2019. The change in diluted earnings per share for the year was due to many of the same factors noted for the quarter. CTWS results contributed 69 cents per share. Higher customer usage in California and Texas contributed 49 cents per share. Rate increases contributed 26 cents per share. And other items added 35 cents per share. These increases were partially offset by higher water procurement costs due to a decrease in California surface water production of 51 cents per share, increased interest expense on new long-term debt of 40 cents per share, increased production costs due to higher customer usage in California and Texas of 37 cents per share, and increased depreciation expense of 17 cents per share. In addition, in 2019, the impact of the WCMA reserve was 28 cents per share, income earned on temporarily invested 2018 offering proceeds was 17 cents per share, and we incurred CTWS merger expenses of 16 cents per share. In 2019, we also issued customer rate credits related to our customer billing settlement with the CPUC of $0.06 per share. None of the 2019 September year-to-date items recurred in 2020. Turning to our revenue, our 2020 year-to-date results reflect an increase of $134.2 million. The increase was primarily due to our merger with CTWS, which contributed $97.4 million. In California and Texas, increased customer usage, which added another $16.6 million, and we experienced $7.4 million in cumulative authorized rate increases. As I previously noted, in 2019, we recorded a $9.4 million WCMA reserve. In addition, in 2019, we recorded $2.2 million in customer rate increases related to our CPUC billing settlements. and no similar reserves or rate credits occurred in 2020. Water production expenses increased $46.3 million in the first nine months of 2020. The increase was primarily due to $19.6 million in new CTWS expenses. In California and Texas, we experienced an increase of $17.5 million in water procurement costs related to the decrease in Northern California surface water. $10.4 million in higher customer usage, and $2.4 million in higher per unit costs for purchase water, groundwater, and energy charges. These increases were partially offset by a $3.6 million decrease in California cost recovery balancing and memorandum accounts. Other operating expenses increased $45.9 million in the first nine months of 2020, primarily due to a $21.2 million increase in depreciation expense $18.2 million in higher general and administrative expenses, and $10.3 million in higher property and other non-income taxes. These increases were primarily a result of the inclusion of CTWS year-to-date activities. In addition, through the first nine months of 2019, we incurred $6.1 million in merger expenses related to the CTWS merger that did not reoccur in the first nine months of 2020. Year-to-date 2020 other operating and expense included $12.3 million of additional interest expense on SJW Group's $510 million senior notes issued in October of 2019 and $6.3 million of new interest from the addition of CTWS borrowings. In the first nine months of 2019, other income and expense also included $6.3 million of interest income earned on the temporary investment of proceeds from the company's December 18 equity offering. As noted, no similar income was earned in 2020. Turning to our capital expenditure program, we added $56.3 million in company-funded utility plant in the third quarter of 2020, bringing total company-funded additions for the first nine months of the year to $130.4 million. We are on track to add between approximately $195 million to $200 million in utility plans in 2020. This compares to our pre-COVID-19 target of approximately $220 million. Our year-to-date 2020 cash flows from operations decreased approximately $20.7 million over the same period in 2019. The decrease was primarily due to the authorized collection of $36.9 million in balancing and memorandum accounts in 2019, a decrease of $13.9 million due to a combination of higher unbilled revenue balances and slower collections from customers during the COVID-19 pandemic, a $6.7 million increase in the payment of amounts previously invoiced and accrued, and a $5 million upfront payment in connection with our City of Cupertino service concession agreement. These decreases were partially offset by a $39.5 million increase in net income adjusted for non-cash items and $2.3 million increase in accrued interest as a result of the newly issued debt. At the end of the quarter, we had $184.2 million available on our bank lines of credit for short-term financing of utility plant additions and operating activities. The average borrowing rate on line of credit advances during the first nine months of 2020 was approximately 1.89%. So with that, I will stop and turn the call back over to Eric.

Thank you, Jim. Just as leaders and employees of SJW Group have adapted to work in an environment that requires social distancing, so too have our economic regulators. The planned merger of the Avon Water Company and Heritage Village Water Company with Connecticut Water was completed in Q3. The Connecticut Public Utilities Regulatory Authority approved our application and agreed that a combination of our Connecticut operations into a single subsidiary will provide efficiencies that benefit customers. The California Commission dismissed the order instituting investigation into the merger with Connecticut Water Service and has closed the proceeding. The California Commission approved our request to establish a PFAS memorandum account, allowing San Jose Water to track for potential future recovery expenses already incurred, as well as future costs related to PFAS sampling and monitoring and customer communication. For those investors who are new to California utility regulation, a memo account is an accounting device that, after approval by the Commission, may be used to record various expenses it incurs. The utility may later seek authorization from the Commission to recover the recorded amounts in rates. The establishment of a memo account does not guarantee that the utility will recoup the tracked amount. As previously reported, the California Commission's ruling to discontinue the water revenue adjustment mechanism and modified cost balancing account in favor of a Monterey-style WRAM and incremental cost balancing account came as a surprise to the industry. While disappointing, the ruling does require a more comprehensive sales forecast analysis and places greater importance in arriving at realistic consumption numbers. San Jose Water does not operate under a water revenue adjustment mechanism and modified cost balancing account. And the ruling should actually benefit us as we look to further align both actual fixed cost rate recovery and customer usage with authorized amounts in our upcoming GRC filing. In California, Connecticut, and Maine, we are preparing rate case filings. San Jose Water is required to file every three years, and that filing will happen in January 2021. Connecticut Water has not been in for a general rate case in more than a decade. In fact, thanks to the adoption of repair tax accounting, the company provided customers with a two-year rate credit through a 2014 rate settlement agreement. In 2018, the company was authorized to recover the cost of the $36 million Rockville drinking water treatment facility without the need to file a full rate case. The Connecticut case will be driven largely by the significant infrastructure investments that have occurred since 2010 that were not recovered through WICA filings or the Rockville settlement. We expect new rates in Connecticut to be in place by mid Q3 2021. Connecticut has a statutory timeline of 200 days once a case is filed. which provides some certainty regarding the timing of a decision. Connecticut also recently filed for an increase of 1.1 percent in the Water Infrastructure and Conservation Adjustment, or WCA, surcharge. If approved by PURA, the increase would increase revenues by a million dollars and would be effective in January of 2021. In Maine, where rates are set on a division-by-division basis for the 10 operating divisions, we anticipate filing general rate increase applications in two divisions and water infrastructure surcharge, or WISC, increases in six divisions by year-end 2020. In October, SJWTX, our Texas utility, filed the first acquisition application in Texas to request treatment under the new fair market value legislation. The Commission has developed a process to determine the fair market value of an acquired utility's rate base, which would be used for future rate-making purposes. If approved by the Texas Commission, this bolt-on acquisition would add over 200 customer connections and bring additional water supply to serve this growing area. SJW TX's connections are nearing 19,000, and its growth is impressive, nearly tripling in number since the acquisition in 2006, and reflecting 8% customer growth in the last 12 months. 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 SJW TX. Delivering exceptional customer service is critical to our success, and our customer service working group is sharing experiences and best practices across all of our states. This is an employee-driven team that operates with the support and engagement of senior leaders. The team is empowered to dive deep into our customer satisfaction ratings identify opportunities to better serve customers, and to collaborate on solutions. We have seen an uptick in account aging in Q3, most likely due to the moratorium of shutoffs that had been mandated in California, Connecticut, and Maine. Texas had rescinded its moratorium in June. The moratoriums in Connecticut and Maine have now ended as well. California's will remain in place at least until April of 2021. We continue to communicate with customers, especially those that have an overdue balance on their accounts and are eager to help them through deferred payment plans and other available programs that vary by state. Turning to our environmental, social, and governance initiative, there is much to be proud of. Our newly formed diversity, equity, and Inclusion Council is comprised of employee volunteers who are committed to building an environment where employees can be their true selves and feel included, welcomed, and valued at work, and where the company can be a force for good in the community. The first steps of our journey together started with listening to personal stories of our own people as they shared their life experiences with racism and inequality. The stories were powerful, and the commitment from our team is strong. SJW Group has been recognized by 2020 Women on Boards as a winning company because more than 20% of our directors are women. Actually for SJW Group, it's close to 50%. That is one of the factors that contributes to our best in class corporate governance score from ISS. We are proud of our governance score It reflects our steadfast commitment to transparency, regulatory compliance and ethical conduct. 2020 continues to be an unpredictable year. Our teams have faced the challenges and continue the vital work of delivering life-sustaining water that is essential for the health and safety of families and communities. We have protected our people so that they can serve their customers. We are guided by these fundamental principles, protect our people, protect public health, and exemplify our core values, integrity, respect, service, compassion, trust, transparency, and teamwork. It has served us well, and we will continue to rely on that approach as we move forward. With that, I would like to turn the call back to the operator for questions.

As a reminder, ladies and gentlemen, if you'd like to ask a question at this time, please press star and the number one on your touchtone telephone. If you'd like to remove yourself from the queue, please press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Angie Storizynski with Seaport Global. Your line is open.

Hello, thank you very much for taking my question. So my first question is about 21 guidance, if you will be providing it, mostly because, you know, given the upcoming Connecticut rate case and its resolution on the third quarter of 21, again, I'm just wondering if that's going to prevent you from issuing 21 guidance in, say, February.

Thank you, Angie. Appreciate your question. We are taking careful consideration of our guidance for 2021 just for the fact that you mentioned we'll have a rate case and we don't want to, you know, try to predict or telegraph what we're expecting in that decision. So we'll be working on that and give you a little bit more clarity on that as we approach the first quarter of next year. But we're working through that. We understand that investors have appreciated the fact that we did provide guidance for the first time in our history this year, and we'd certainly like to continue to provide that guidance. So we'll be working through that, and we'll let you know as the year unfolds.

Okay. And even besides this Connecticut rate case, You know, given the lessons learned from this year, and admittedly, it is an unpredictable year for many, many reasons. I mean, should I expect that you would bake in some conservatism regarding, you know, purchase the water costs for San Jose water? Again, I'm basically clearly trying to gauge how this guidance is going to come out. And there seems to be so many moving pieces that, again, given the experience of the CA, I would expect you to be relatively conservative, at least of the initial take. Is that fair?

Yeah. Angie, you know, I really appreciate your point. You know, you look back in 2019, we had 5 billion gallons of surface water. And as the year, as we approached 2020, we thought, you know, we were being relatively conservative at 3.5. And as you now know, we're probably just a little over a billion. So that was a significant adjustment. What we will do is be very transparent about the amount of surface water that is in any projection or forecast that we provide so that there's real clarity of that. The other part I'd mention is I think the the spread there is going to be reduced as we go forward. Because as I said, we had 5 billion in 2019. That was very unusual. And yet in rates, we have about 2.6 billion in our current rate design. So I would not anticipate us building into any forecast in the future, you know, an amount that would exceed what is built into base rates. So that would reduce the spread, if you will, so that we can provide better clarity and comfort to investors.

Great. And my last question, I appreciate that you guys don't have a full RAM, so the recent CPU decision on it doesn't really apply to you. But what if those... you know, regulatory or potentially legal challenges from other California utilities, you know, are successful and the commission either reverse the decision or at least conduct a thorough study of the decoupling mechanism. Do you think that that would potentially open a door for you guys to ask or ask again for full RAM and would you be interested in that?

Well, first, as we follow this case, what we're definitely going to continue to work on is making sure we, in our rate design, recover more of our fixed costs and the basic service charge, and then as well make sure that we align what's in rates with the amount of water customers actually purchase during the year. And if we get those two numbers really right, it mitigates and minimizes that risk any risk of or mitigates a great deal of the risk of that difference there. And we were successful in the last case. And in addition, if there is a change in policy at the commission, you know, we'd carefully review that and would consider taking advantage of asking again for a RAM and the balancing account just because it can work for the benefit of customers and for shareholders. But, you know, we don't anticipate that, and so we're building our current filing in a manner that we think really balances the interest there and protects both customers and shareholders.

Great. Thank you.

Thank you, Angie. Appreciate your interest in us.

Thank you. And our next question comes from the line of Jonathan Reeder with Wells Fargo. Your line is open.

Hey, good morning. I just want to build on Angie's first question a little bit. So how should we be thinking about, you know, the surface water availability in California as we head into, you know, 2021? I know it's, you know, early in the rainy season and all that, but, you know, at least the state's kind of starting from a deficit. What are the forecasts looking like? You know, just stuff along those lines.

Yeah, sure, Jonathan. Look, while the rainy season has begun, there's been no sign of rain anywhere. And so there's really no difference, no update that I can provide from a weather standpoint. We would typically expect to see the majority of rainfall in the January, February, early March timeframe. So I would be very conservative with the number at this point because there is no change in the current conditions. We do expect to, you know, to have at least a billion gallons, probably, you know, a billion and a quarter. And so that's what we've got this year. And we'll continue to update investors, be very transparent about the number, and make sure that we're clear in any guidance we provide what the assumption is for surface water. But, you know, definitely I think caution and conservatism is the rule.

Okay. How close is, you know, maybe looking at it a little bit differently, how close is the state to maybe heading into another drought where then, you know, some of those worries would go away from the loss, you know, revenue adjustment mechanism kicking in? Is that something that, you know, is kind of on the radar right now? Or, you know, would it take another year like, you know, this past year before, you know, we're put into that situation, do you think?

Jonathan, I would say we're not really anywhere close to a significant drought across our operations other than our surface water supply. When you look at the groundwater table, it's really in great shape. The Valley Water District, our wholesaler, has their semi-tropic groundwater bank at capacity. you know, really in a strong, strong position there at this point. It is just really this one small segment of our supply that, you know, we just didn't get the rains in the Santa Cruz Mountains last year. I guess I'd also again remind you that we're comparing year over year. So we're comparing a 5 billion gallon year to a 1 billion gallon year, year over year. And, and that produces some big, some big differences. So next year it, you know, the year-over-year comparison should be much different.

Yeah, Jonathan, I'd just add one other thing, is that the real way that the surface supply works in the Santa Cruz Mountains is, you know, in the early portion of the rainy season, you kind of saturate the soil, and then you start getting benefit of the runoff as the season matures. this year the timing of the period when we did not get the rain was really right around the month of February. And what that allowed is it allowed the terrain up there to dry back up, if you will, in which case when we did get the rain in the March and April timeframe, we didn't get the runoff that we otherwise would have gotten had it been a normal rain year. So there were a lot of, geographic-centric issues related to the lack of rain with regards to our surface water this year that weren't experienced throughout the state.

It sounds like something that's pretty difficult to monitor from far away. I appreciate that color. Last question for me, and Jim, I'm guessing you might have anticipated some along these lines. In a recent presentation you guys uh had a five percent long-term eps growth rate target uh that you indicate is that still the target and you know kind of if so how should we be thinking about you know what the base is for that target yeah clearly uh you know we we're leveraging that uh guidance uh jonathan off of uh uh uh

conservative view of our CapEx spend and rate-based growth over that five-year period that was presented in that presentation. And as far as the beginning base with which we start that, we certainly have to consider a slight downtick in the surface water, as Eric described. And we'll consider all of that as we come out with our guidance for 2021. If, in fact, the direction we elect to do is to provide that guidance. But in any event, we will continue to provide the transparency we need to, as Eric mentioned, on the surface water and provide some quantification of the impact of that on our quarterly calls.

Okay. So without actually specifying what that base is, should we be thinking of it as like maybe the 2021 base with whatever that surface water is? kind of assumption is that, you know, the thought is at least 5% growth off of that 2021 base.

Yeah, again, we have to kind of huddle up on that to determine what we're comfortable with in terms of including in rates. And quite frankly, some of that is going to be predicated on what happens in the first or the last two months of this year. right? Because that's really the beginning of the rainy season up in the Santa Cruz mountains. That's when we start to get the saturation of the ground up there.

Okay. Okay. All right. Well, I guess we'll wait for February and hopefully you guys are able to provide a little guidance. I think it would be helpful, you know, as investors look to try to kind of reframe what might be kind of normalized earnings for you guys. So. Appreciate the time this morning, and talk soon.

Perfect. Thanks, Jonathan.

Thank you. As a reminder, ladies and gentlemen, if you have a question at this time, please press star and the number one. I'm not showing any further questions, so I'll now turn the call back over to Eric Thornburg, CEO, for closing remarks.

Thank you for your participation in our call today. The SJW Group is a company with a 154-year track record of serving customers, communities, and shareholders. This quarter marks the 309th consecutive dividend payment by our company over 77 years and 53 consecutive years that SJW Group stockholders have received an increase in their calendar year dividend. It's my sincere hope that you and your families remain safe and healthy. during this great challenge of 2020. Again, I wish to express my profound gratitude to the employees of SJW Group. And again, thank you for your participation in the call today.

Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a great day.