H2O America (HTO) Q2 FY2025 Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the H2O America Second Quarter Financial Results Call. [Operator Instructions] Please be advised that today's conference is being recorded. I'd now like to hand the conference over to Ann Kelly, Chief Financial Officer and Treasurer. Please go ahead.

Thank you, operator. Welcome to the Second Quarter 2025 Financial Results Conference Call for H2O America. I will be presenting today with Andrew Walters, Chief Executive Officer; and Bruce Hauk, President and Chief Operating Officer. For those who would like to follow along, slides accompanying our remarks are available on our website at h2o-america.com. Before we begin today, I would like to remind you that this presentation and the 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 results 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 H2O America disclaims any duty to update or revise such statements. You will have an opportunity to ask questions at the end of the presentation. This webcast is being recorded, and an archive of the webcast will be available until October 20, 2025. You can access the press release and the webcast at H2O America's website. In addition, some of the information discussed today includes the non-GAAP financial measures of adjusted net income and adjusted diluted earnings per share that have not been calculated in accordance with generally accepted accounting principles in the United States, or GAAP. These non-GAAP financial measures should be considered as a supplement to the financial information prepared on a GAAP basis rather than an alternative to the respective GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are presented in the table in the appendix of our presentation. I will now turn the call over to Andrew.

Welcome, everyone, and thank you for joining us. Before I begin, I would like to take a moment to acknowledge those impacted by the devastating flooding in the Texas Hill Country earlier this month. We are deeply saddened by the loss of so many lives. . Our hearts go out to those affected, including our communities, our coworkers, our customers and those who have lost loved ones. We also want to thank all of the first responders for their heroic efforts as well as our entire Texas Water team who continue to serve their neighbors with integrity and courage as they face concerns about the health and safety of their own loved ones. Now I'll turn to our second quarter updates. There have been many changes at our company since the first financial results update. In May, we rebranded SJW Group as H2O America and changed our ticker to HTO. The name and ticker better reflect who we are as a company. Water is now front and center in our name, which is fitting for one of America's largest investor-owned pure-play water and wastewater utilities. It also reflects our national platform and the strength we bring to our local utility operations so they can better serve their local customers. On June 30, Eric Thornburg retired as President and CEO, leaving an impressive career that spaned more than 4 decades. He leaves an enduring legacy in the industry and at our company. We wish them the best. I was honored to step into the CEO role on July 1 and was joined by Bruce Hauk as President and Chief Operating Officer; Kristen Johnson, as President of Shared Services and Chief Administrative Officer; and Ann Kelly as our Chief Financial Officer and Treasurer. Just yesterday, we welcomed another highly accomplished leader to H2O America. Megan Mattern is our new Principal Accounting Officer, Chief Accounting Officer and Controller. She joins us from UGI International, where she recently served as Vice President and Chief Financial Officer. Megan brings 2 decades of experience in complex regulated environments, spanning global energy, utilities and infrastructure, making her an outstanding addition to our national leadership team. She shares our commitment to culture, service and communities. At H2O America, we protect what's precious and we do it right, we do it together, and we do it with heart. I'm pleased to share that our second quarter of 2025, we delivered strong financial results, including net income of $0.75 per share on an adjusted 14% increase over the second quarter of 2024. Our performance reflects our continued execution of our proven growth strategy, focus on investments in our infrastructure and our water systems across our national footprint and constructive engagement in consensus building with key local stakeholders, all with an eye on affordability. Some highlights from the second quarter. We spearheaded legislation in Connecticut that was signed into law and will allow for faster recovery of PFAS investments and avoid rate shock for customers. We supported legislation in Texas that will similarly reduce how long it takes us to recover capital investments through infrastructure recovery mechanisms and provided for a future test year in general rate cases. We championed a law in Maine that allows water utilities to offer affordability programs to customers. We requested and received approval in California to recover the capital invested in our advanced metering infrastructure project. And finally, Texas Water's second system improvement charge was approved by the Public Utilities Commission of Texas. I am also happy to share that we invested $207 million in water and wastewater utility infrastructure across all 4 states through June 30, and we are on track to meet our $473 million capital plan for 2025. Just after the quarter ended, we announced an agreement to acquire Quadvest, a water and wastewater utility serving Greater Houston, Texas area, the second fastest-growing metropolitan area in the country. We expect the acquisition to close by mid-2026, at which point our combined Texas Water operation would become the second largest investor-owned water utility in Texas, serving 7 of the 50 fastest-growing counties in the United States, placing us in the top 2% of counties nationwide. Quadvest adds significant operational scale to both our Texas operations and H2O America, with a strong and growing developer pipeline of connections under contract and pending future development. We expect the transaction to be dilutive to earnings in 2026 and 2027 before becoming accretive in 2028 and meaningfully accretive to our long-term growth. Bruce will have more on the Quadvest acquisition and state regulatory matters later in the call. Overall, it's been a strong, strategic and financial first half of the year with several milestones we're proud of. With that, I'll turn it over to Ann to walk us through our financial results.

Thank you, Andrew. Yesterday, after the market closed, we released our second quarter operating results. As Andrew mentioned, we are pleased to report diluted EPS of $0.71 and adjusted diluted EPS of $0.75 for the quarter. With these strong results, we are reaffirming our 2025 guidance range of adjusted diluted earnings per share of $2.90. We are also reaffirming H2O America's 5% to 7% earnings growth rate through 2029, and we continue to expect to be in the top half of the range. . We are very pleased with our strong performance in the first half of 2025. However, it's important to note that this period reflects the full benefit of new rate cases at San Jose Water, which was effective on January 1, 2025, and Kitwater, which was effective July 1, 2024, compared to the prior year. And as a reminder, last year's results also benefited from tax favorability in the second half of 2024, including an $0.11 onetime benefit in Q3 '24 from a change in accounting method. As we look ahead, we remain focused on disciplined execution to meet our annual and long-term growth targets. The factors impacting second quarter earnings per share are shown on Slide 10. At a high level, increased revenue from rates and usage drove a revenue increase of $0.57. The revenue increase was partially offset by higher water production expenses of $0.27, other operating expense of $0.19 and an additional $0.05 due to an increase in the number of shares outstanding. Turning to the next slide, I will provide more detail on each of these areas. Our revenues increased 13% in the second quarter. Rate increases from the general rate cases in California and Connecticut, along with increases from our infrastructure mechanisms in Connecticut, Maine and Texas contributed $10.9 million to the revenue increase. $6.7 million is attributable to pass-through water cost for our wholesalers as these costs continue to increase each year. Higher customer usage added another $4.9 million as increased usage in California more than offset a reduction in Texas due to ongoing conservation measures. I'll speak more about that in a moment. And the revenue increase associated with the higher usage was partially offset by a reduction in regulatory mechanisms. As I mentioned a moment ago, water conservation measures remain in place in much of our Texas service area. Recent rains over the past months have helped our water supplies. However, the recovery has not yet been enough to lift water conservation measures. We are more than halfway through our peak lawn irrigation season, and we do not expect any adjustment to our 2025 guidance based on Texas revenue. Water production expenses increased 15% in the quarter and was primarily driven by an increased cost of $8 million from our water wholesalers that are largely offset in revenue. There was also a $2.7 million increase in expense associated with our higher production volume and a $300,000 reduction in other production costs and regulatory mechanisms. Turning to Slide 13. For the quarter, we reported an increase of 13% in other operating expenses. Customer credit losses increased $4.6 million over the same period of 2024. You may recall that in the second quarter of last year, San Jose Water received a nonrecurring payment from the California water and wastewater arrearage payment program to relieve outstanding payment delinquencies. General and administrative expenses increased $3.7 million, primarily driven by contracted work and acquisition costs and lower maintenance costs offset increases in other areas. Factors impacting earnings per share for the year-to-date period are shown on Slide 14. At a high level, increased revenue from GRCs and infrastructure recovery mechanisms drove a revenue increase of $1.04. The revenue increase was partially offset by higher water production expense of $0.45. And as noted during my remarks for the quarter, purchased water costs are largely offset in revenue. Operating expenses increased $0.27 driven by increases in customer credit losses in addition to increased expenses for insurance and contracted work and an additional $0.08 was due to an increase in the number of shares outstanding. Breakdowns of revenue, water production expenses and other operating expense for the first 6 months of 2025 are available in the appendix of our slide presentation. On the financing side, through the first 6 months, we took advantage of investor interest and raised approximately $84 million of our $120 million to $140 million expected annual equity proceeds through our at-the-market equity program. At the end of the quarter, we had $161 million drawn on our $360 million bank lines of credit, which left $199 million available for short-term financing of utility plant additions and operating activities. The average borrowing rate for our line of credit has been approximately 5.45% compared to 6.53% in the prior year. Also, after quarter end, Maine Water borrowed $25 million under an existing loan agreement for 30-year debt at 6.7% fixed interest, and CTWS repaid the outstanding $25 million balance under its credit agreement. On the tax front, our consolidated income tax rate was 16%, which was consistent over the first half of last year. And with that, I'll turn the call over to Bruce, who will provide updates on key state regulatory developments and the Quadvest acquisition.

Thank you, Ann. I am pleased to share that our constructive engagement with regulators legislators and policy leaders continue to create value for our customers and the company. At San Jose Water, our request for a $6.8 million revenue increase for our advanced metering infrastructure project was approved and effective on July 1, 2025. The increase reflected our capital investment of $44 million in AMI. Just this month, we launched the SJ Water Hub, the customer AMIM payment portal. This platform gives customers NIL real-time information on their water usage and enables them to create high water usage alerts so they can conduct leaks earlier and better manage their bills. We expect to fully build out our AMI platform to serve all customers by 2027. Maine Water successfully completed the general rate case in the Camden Rockland division. The Maine Public Utilities Commission authorized a $865,000 increase in revenues. The MPUC also authorized a total of $547,000 in water infrastructure charge increases effective on July 1, 2025. At Texas Water, our system improvement charge increase of $4.1 million was approved and became effective on May 15, 2025. And at Connecticut Water, our latest Water Infrastructure and Conservation Adjustment surcharge increase of $1.6 million went into effect on April 1, 2025. I want to give kudos to teams in our local states that are executing our $472 million 2025 CapEx plan, which was a significant increase over last year in designing and managing projects that are bringing critical infrastructure online to serve our customers, including our water supply resiliency projects in the Texas Hill county. Turning to the next slide. Our regulatory affairs teams are making a meaningful difference at state legislators for our customers, the company and all of our stakeholders. Our approach of engaging with local stakeholders across our national footprint paid real dividends in this year's state legislative sessions. Connecticut, we championed the water quality treatment adjustment to recover $190 million we estimate is needed through 2029 to meet the PFAS standards. The WQTA provides for annual recovery of our investment to address PFAS and other emerging contaminants. Further, the WQTA increases the percent of capital in our 5-year plan that is recovered on a timely basis to 75% from 66%. I want to stress the recovery is for the total amount spent during the period, not just for completed projects. We have filed the required assessment report and expect to be able to make our first WQTA to recover invested capital beginning in early 2026. To date, Texas has been a historic test year for water utility rate cases. Under new legislation signed by Governor Abbott, utilities will now have the option to use a future test year or a hybrid test year. In addition, the governor signed a bill that reduces the processing time for system improvement charge requests from 120 days down to 60 days. Both laws take effect in September and are expected to support more timely recovery of capital investments. In Maine, we worked to get a new law on the books that allows Maine Public Utility Commission to authorize an affordability tariff for income-eligible customers. This is a win for customers facing financial challenges. We are working with the Office of Public Advocate on implementing this as part of our application before the MPUC to unify our 10 separate rate districts into a single tariff. We expect a decision on the unification proceeding in the fourth quarter. We'll now turn to an update on the Quadvest acquisition in Texas we announced earlier this month. Adding Quadvest to the Texas Water Company is a unique opportunity to strategically diversify, enhance and expand H2O Americas operations in one of the fastest-growing regions in the U.S. It will allow us to strengthen our network of developers and drive stronger returns for our investors. We're bringing together 2 highly aligned teams that share a culture of servant leadership positioning us to integrate seamlessly and execute effectively. By joining forces, we're expanding our geographic reach and enhancing our overall scale and diversification. This creates a more balanced utility portfolio and strengthens our ability to invest in infrastructure, operations and talent in Texas and across all states we serve. Texas currently represents about 7% of H2O America's customer base. By 2029, we anticipate double-digit growth fueled in large part by Quadvest, which will propel Texas to 26%, making it our second largest state in terms of customers served. I'll have more on the growth story on the next slide. Just 1 day after the announcement, we notified the Public Utilities Commission of Texas of our intention to use fair market value for the transaction. That notification started a 30-day window for the PUCT to appoint 3 appraisers. Under Texas fair market value rules, the appraisers have 120 days to complete their work and the appraisals will be averaged to determine the fair market value. As we move through the regulatory process, we expect the transaction to close in mid-2026. Concurrent with the Quadvest acquisition, Texas Water County is undertaking large infrastructure investment projects to increase the resilience of our water supply in the Texas Hill Country including the interconnection of KT water supply. We expect that project to be in service by the end of 2026. If the current time line holds, we anticipate filing a general rate case in early 2027 for the combined Texas water operations. This filing would include the Quadvest rate base as determined through the fair market value process. We would expect new rates for Texas Water to become effective in early 2028. The Quadvest acquisition is anticipated to be accretive in 2028 and meaningfully accretive to our long-term growth rate. I also want to give you a sense of the growth potential of the Quadvest assets. When we made our announcement, we were using December 31, 2024, connection numbers that showed Quadvest had 136,000 water and wastewater connections that were either active or under contract pending development. We have updated those numbers through the second quarter. Quadvest now has more than 140,000 connections that are either active or under contract and pending development, a 4% increase over 6 months. It is worth noting that regulated active customer growth was 2,000 connections, a significant 6% increase. Of course, future connection growth will vary based on a number of conditions, so this is no guarantee of future growth rates. However, these results are in within the range of our expectations, and we believe solid growth will continue in the Greater Houston area, the second fastest-growing metropolitan area in the United States. With that, I will turn it back over to Andrew.

Thank you, Bruce. The second quarter was strong for H2O America, and we have even more to look forward to in the rest of 2025. We remain focused on driving shareholder and customer value through disciplined infrastructure investment, advancing the Quadvest acquisition, deepening our strong partnerships with local stakeholders and unrelenting pursuit of operational excellence and identifying creative and sustainable solutions that maintain affordability while investing in critical infrastructure as demands continue to grow across the water utility industry. And now I'll turn the call back over to the operator for questions. .

[Operator Instructions] Our first question comes from Storozynski with Report.

My question is about -- Okay. So the question on Texas, the SMV notification or the intent to use SMV. So what happens next? So we're waiting for those appraisers to be appointed and you're not going to be filing your perspective of what you think the value of the asset is, right? We're going to be waiting for the appraisers to express their views.

Correct, Angie. The process is we filed on July 9, the notice of intent to use fair market value. That sets off a 30-day process for the PUCT to appoint the 3 appraisers to do the valuation. And then that kicks off after 30 days, another 120 days for those appraisals to be completed and discern the value. The fair market value for rate-making purposes based on the average of the 3 appraisers. Subsequent to that, we would file the sale transfer merger post those appraisals being discerned and that kicks off that process.

Okay. Okay. So yes. So we just basically have to wait for their assessment of the value just to have any sense of what the rate base of the assets will be, I understand. Okay. And secondly, the update on the connection increase. I mean, yes, it is strong, but it's slower -- seemingly a slower growth than what we saw in the past, at least based on the report -- or the chart that was included in your slides. Is it just the law of large numbers, so the base is getting bigger, and that's why the growth off of the larger base is decelerating?

Yes. I think that's primarily it, Angie, is that as you grow the business, the percent increases are going to be coming down each year just because, as you mentioned, the law of large numbers. So that's why we've kind of guided folks to look at the actual total number of increases over the past couple of years versus the percentage.

Okay. And then one other question about that's meaningfully accretive to the long-term EPS growth rate. I'm going to ask you what it means meaningfully. Is it 100 bps versus whatever the 6% to 7% range that you're currently guiding to? Is it more than 100 basis points? What would be considered meaningful?

Look, I think meaningful obviously can be in the eye of the beholder in terms of how you think about it. But when you start talking about percentages of a growth rate, 100 basis points would absolutely be a meaningful increase as an example. But we won't comment on that until we move further along the line.

Okay. And then one more question. So we're hearing some opposition to the Aquarion transaction in Connecticut. I mean you're just an observer of the issue in the state. I mean do you have any general views about if you would be still interested in this asset if the current sales process were to fail?

Look, I think the asset would be very strategic for our company from that perspective. We've made our bed, so to speak, in terms of where we're heading right now with our Texas acquisition, that's going to keep us busy for a bit. But yes, would that acquisition be strategic for us? It would be. And the reason why it's strategic is because it would be good for our customers and allow us to have a significantly lower rates that we would be able to charge customers at the end of the day. That's the part that's unique about an investor-owned utility is those cost savings belong in the pockets of our customers as opposed to being able to go somewhere else.

[Operator Instructions] Our next question comes from Jonathan Reeder with Wells Fargo.

Angie asked a couple of my other questions, but I wanted to say congrats on getting that Connecticut PFAS recovery mechanism in place. Just to understand a little bit of the nuances around it. Does the July 1, 2025, effective date mean that any PFAS CapEx after that date can be recovered through the mechanism? And then further what is the expected kind of approval process once the first filing is made in 2026?

Thank you, Jonathan, for that question. And I believe your comment is accurate in terms of it's a forward recovery, we will be able to file -- I believe it's in July -- or I'm sorry, January of the beginning of the year. and recover that in 2026. And I think it's very similar to the process that we have in our WICA in terms of recovery. So it's a couple of 2-, 3-month type of a review process for implementing it into rates.

Yes. And I would just add that the unique part too, as opposed to WICA, where they have to be in service and completed. This one takes us all the way to what we have spent. And I think that's a unique addition, it helps further kind of reduce rate shock for customers. And there's some really solid positives that we're going to be able to bring to our customers by being able to put that investment in over time as opposed to big lumps that they would otherwise see.

Yes. And just to add to that, Jonathan, it's more of like a forward look recovery of spend versus in-service to what Andrew described. And that was a comment that was made in my prepared remarks, and that's what that was intended to convey.

Yes. No, that is a good little wrinkle to it that it's just on the dollar spent. What about the Texas future hybrid test year law? Does it require the PUCT to adopt the future hybrid test year? Or could that still be a point of contention during the rate case process by either the commission itself or interveners?

Well, as you know, Jonathan, any time you have a historic future or hybrid, there's always contention in what you file potentially. But the process kicks off in terms of the approval of the bill, but then there's a rule-making process that will go through. So the specifics of the procedures will be a process that we go through with the PUCT and that will start in September.

Okay. And that will -- will that figure out whether it's future or a hybrid test year, you're saying like whether it's even like a requirement that the commission approve that future test year?

The procedures will lay out the process for a hybrid or a future. I mean we've already got established procedures for Historic, but it's up to the applicant to choose the path forward to filing. So I believe it would be up to the applicant to choose the type of filing they want to make and the law would allow it pursuant to the rules and procedures through the rulemaking through the commission.

Okay. And yes, congrats on a good Q2 and a very busy Q2.

That concludes today's question-and-answer session. I'd like to turn the call back to Andrew Walters for closing remarks.

Thank you again for joining us today. As H2O America proudly leverages our national platform to support our distinct local operations, all united by a shared mission, delivering reliable service and high-quality water to 1.6 million people across 4 states. At the same time, we continue executing our growth strategy and delivering shareholder value, including our unwavering commitment to the dividend, which we have paid for more than 80 consecutive years. Our success is built on a culture of service and partnership. We value our customers, communities and the environment and capital providers, and I couldn't be prouder of our team whose dedication makes it all possible. Ann, Bruce and I are always available for follow-up. We appreciate your interest in H2O America. Thank you, operator.

This concludes today's conference call. Thank you for participating. You may now disconnect.