Business context and reporting period
This is SJW Group’s Form 10-K for the fiscal year ended December 31, 2018; the filing also reports fourth-quarter results. Although the request identifies H2O America, the filing is for SJW Group (NYSE: SJW). The company primarily provides regulated water service through San Jose Water Company in California and Canyon Lake Water Service Company in Texas, alongside a smaller real estate business.
Financial performance and liquidity
| Metric | 2018 | 2017 |
|---|---|---|
| Operating revenue | $397.7 million | $389.2 million |
| Operating income | $73.4 million | $101.9 million |
| Net income attributable to SJW Group | $38.8 million | $59.2 million |
| Diluted EPS | $1.82 | $2.86 |
| Cash flow from operations | $91.3 million | $101.1 million |
| Company-funded capital expenditures | $136.0 million | $141.2 million |
- Revenue rose 2.2%, while operating income fell about 28% and net income fell about 35%. Operating margin declined to approximately 18.5% from 26.2%.
- Fourth-quarter 2018 revenue was $98.7 million, operating income $17.5 million, net income $8.8 million, and diluted EPS $0.38. Fourth-quarter 2017 figures were $93.5 million, $18.2 million, $17.3 million, and $0.84, respectively.
- At year-end, total assets were $1.956 billion, stockholders’ equity $889.3 million, long-term debt $431.4 million, and lines of credit outstanding $100 million. Cash and cash equivalents totaled $420.7 million, including $412 million of equity-offering proceeds held in a money-market fund. Unused bank lines were $45 million; the company reported compliance with debt covenants.
- Operating cash flow decreased about $9.8 million year over year. Investing activities used $146.8 million; financing activities provided $468.4 million, chiefly reflecting the December equity issuance. Dividends paid were $23.1 million, or $1.12 per share; the payout was approximately 60% of net income.
Material changes and drivers
- Water utility revenue increased with authorized rate changes, higher usage, customer growth, and recycled-water sales. These were partly offset by lower revenue from balancing and memorandum accounts, including Tax Act-related rate reductions and lower water-conservation account revenue.
- Production expenses increased $10.6 million. Higher purchased-water, groundwater-extraction, and energy costs, along with higher usage, were partly offset by increased use of lower-cost surface water. Average production expense per million gallons rose to $4,213 from $4,063.
- Depreciation and amortization increased $6.3 million as utility plant expanded. The $18.6 million of merger-related expenses was new in 2018 and was a significant operating-cost headwind.
- 2017 included gains from the TWA sale and real estate disposals that did not recur in 2018. The lower 2018 effective tax rate of 21% versus 37% in 2017 reflected federal tax reform and other tax effects, but did not offset the decline in operating income.
- The company issued 7,762,500 shares in December 2018, raising approximately $412 million net. This materially increased year-end equity and shares outstanding; proceeds were intended principally to fund the proposed CTWS acquisition.
Outlook, risks, contingencies and unusual items
- Merger: SJW proposed to acquire Connecticut Water Service (CTWS) for $70 per share in cash. CTWS shareholders approved the transaction, but regulatory approvals remained outstanding. Connecticut’s PURA issued a proposed denial; SJW and CTWS withdrew that application in January 2019 and announced plans to refile in the second quarter. Maine’s proceeding was also withdrawn, with a new application planned. The CPUC investigation was expected to conclude in the second quarter of 2019. Completion was not assured. SJW anticipated up to $435 million of new debt financing; the committed bridge facility was reduced to $563 million after the equity offering. Termination fees and expense reimbursement may apply in specified circumstances.
- Capital plan: Management forecast approximately $109.9 million of 2019 capital expenditures and $699.2 million over five years, subject to regulatory approval. The company expected depreciation and property-tax costs to rise with utility-plant investment. It believed its California and Texas water supplies would meet 2019 demand.
- Rates and water demand: California’s approved 2019 rate increase was $16.4 million, or 4.55%, effective January 1, 2019. Conservation mandates, weather, usage, and the mix and cost of water supply may affect revenue and margins. California groundwater storage was in the SCVWD’s normal stage at year-end, but local rainfall and reservoir levels were below five-year seasonal averages.
- Billing investigation: SJW recognized a $2.02 million customer-refund obligation for the settled period from June 2011 through December 2016. A separate CPUC investigation may examine earlier billing practices and possible penalties; the company said it could not estimate any additional loss. The regulator’s staff had cited potential refunds of approximately $2.0 million for 1987–2013 and $4.9 million for alleged double billing, plus possible penalties, but these were disputed and not recorded as probable liabilities.
- Other material exposures include regulated rate recovery and regulatory lag, water-supply and drought risks, infrastructure failures, environmental and water-quality requirements, cybersecurity, pension funding, and the financing and integration risks of the proposed merger. Management reported effective disclosure controls and internal control over financial reporting; the auditor issued an unqualified opinion.
Important facts for investors to verify
- Whether the renewed Connecticut and Maine regulatory applications and the CPUC investigation permit the CTWS merger to proceed, and the final purchase price, timing, and financing.
- The ultimate outcome and financial exposure from the CPUC billing-practice investigation, including any refunds or penalties beyond the $2.02 million accrued.
- Whether authorized rate increases and balancing-account recoveries keep pace with purchased-water, groundwater, energy, and infrastructure costs.
- Actual capital spending, water availability, customer usage, and operating cash generation compared with management’s plans.
- The effect of the share issuance and any merger-related debt on leverage, credit ratings, dividends, and per-share earnings.