Business context and reporting period
Registrant mismatch: The supplied filing is SJW Group’s Form 10-Q for the quarter ended September 30, 2018, not a filing identified as H2O America. The summary below reflects SJW Group’s filing. Amounts are in thousands of dollars except per-share data.
SJW Group operates regulated water utilities in California and Texas, alongside smaller non-tariffed water-service and real-estate activities. Water sales are seasonal, and management cautions that interim results are not necessarily indicative of full-year results.
Financial results and key metrics
| Metric | Three months ended September 30, 2018 | Three months ended September 30, 2017 | Nine months ended September 30, 2018 | Nine months ended September 30, 2017 |
|---|---|---|---|---|
| Revenue | $124,853 | $124,578 | $298,981 | $295,696 |
| Operating income | $25,828 | $39,198 | $55,958 | $82,725 |
| Operating margin | 20.7% | 31.5% | 18.7% | 28.0% |
| SJW Group net income | $15,788 | $19,540 | $29,944 | $41,899 |
| Diluted earnings per share | $0.76 | $0.94 | $1.45 | $2.03 |
| Dividends per share | $0.28 | $0.22 | $0.84 | $0.65 |
- Cash flow: Nine-month operating cash flow was $73,711, versus $87,967 a year earlier. Investing activities used $105,957, including $97,753 of company-funded utility-plant additions. Financing provided $37,774; cash rose $5,528 to $13,327.
- Debt and liquidity: Long-term debt, excluding current portion, was $431,341; line-of-credit borrowings were $76,000. The company reported $69,000 of unused short-term credit capacity from aggregate facilities of $145,000. Current assets were $80,367 and current liabilities $151,680. The filing states the company and subsidiaries were in compliance with applicable debt covenants.
- Capital and investment: Total assets were $1,536,868 and stockholders’ equity $474,957 at September 30, 2018. 2018 utility capital spending was budgeted at approximately $120 million; $97.8 million, or 82%, had been spent through September. Planned five-year utility capital expenditures were approximately $760.8 million, with a significant portion subject to regulatory approval.
Material changes versus prior comparable periods
- Third-quarter revenue increased only $275, while net income fell $3,752, or approximately 19%; nine-month revenue rose $3,285, while net income declined $11,955, or approximately 29%.
- Merger-related expenses were $8,442 in the quarter and $14,994 for nine months; there were no such expenses in the 2017 comparatives. Higher purchased-water and groundwater costs, depreciation, and other operating costs also weighed on results.
- Nine-month 2017 results included a $6,903 gain on real-estate sales that did not recur. 2018 also included a $527 unrealized loss on California Water Service Group stock; SJW sold its remaining shares during the third quarter.
- The lower 2018 effective tax rates—21% for the quarter and 20% for nine months, compared with 41% and 38%—reflect the federal corporate tax-rate reduction and estimated reversal of excess deferred taxes. Certain regulated tax benefits are being passed through to customers and management said these have no net-income impact.
- Operating cash flow fell approximately $14.3 million year over year, while net line-of-credit borrowing increased and dividends paid were higher.
Guidance, outlook, management commentary, risks and unusual items
- Rates and regulation: San Jose Water Company’s general rate case sought revenue increases for 2019–2021; a proposed decision issued October 16, 2018 adopted a settlement in part, with contested issues still pending. If approved, new rates were expected to take effect January 1, 2019. Tax-law-related customer rate reductions and pass-throughs were also implemented or being recorded through regulatory accounts.
- Water supply: Management believed supplies would meet customer demand through the remainder of 2018. However, on October 1, Santa Clara Valley Water District reservoirs were at about 33% of capacity and San Jose had recorded no rainfall in the current rainfall season to that date. Texas subsidiary CLWSC had entered Stage 1 drought restrictions. Surface-water availability affects supply costs, and purchased-water and groundwater charges can change.
- Merger: SJW agreed to acquire Connecticut Water Service in an all-cash transaction for $70 per CTWS share, with closing expected in the first quarter of 2019, subject to shareholder and regulatory approvals and other conditions. SJW anticipated further merger fees. It had a lender commitment for a bridge facility of up to $975 million if other financing was unavailable, subject to customary conditions; debt financing could materially increase leverage and reduce financial flexibility.
- Merger-related exposure: The agreement may require SJW to pay CTWS a $42.5 million termination fee in specified circumstances and reimburse up to $5 million of expenses in certain cases. Regulatory proceedings, shareholder approval, litigation, financing availability, delay, or termination could affect completion and results.
- Customer billing investigation: The California regulator opened an investigation into historical service-charge billing, including alleged overcharges over a period extending as far back as 1987 and alleged double billing. The regulator cited estimated refund amounts of approximately $2.1 million for 2014–2016, $2.0 million for 1987–2013, and $4.9 million for alleged double billing. SJW disputed liability beyond refunds agreed in a partial settlement and stated it did not believe double billing occurred; the potential outcome and penalties remained uncertain.
- Legal proceedings: CTWS shareholder lawsuits challenge aspects of the merger and proxy disclosures. SJW said it believed claims against it were without merit, but could not estimate potential loss for the state-court claims. The filing describes the litigation and regulatory risks as potential sources of delay, expense, and adverse effects.
- Other items: The company adopted new revenue-recognition and other accounting standards in 2018; management said the revenue-standard adoption had no material overall financial impact. The filing also says management was evaluating the effect of the new lease standard expected to apply in 2019.
Important facts for investors to verify
- Confirm the intended issuer: this source is SJW Group, not H2O America.
- Track the final outcome and effective rates from the California general rate case, including any resolution of contested issues.
- Monitor the billing-practice investigation, potential customer refunds or penalties, and whether the booked reserve covers the eventual obligation.
- Verify CTWS merger approvals, timing, final financing mix and terms, and the resulting debt burden; the proposed bridge facility is not guaranteed funding.
- Assess continuing merger costs, water-supply conditions, purchased-water cost changes, and capital spending against cash generation and available credit.