Business context and reporting period
This is SJW Group’s Form 10-K for the fiscal year ended December 31, 2017, not a filing identifying “H2O AMERICA” as the registrant. SJW Group operates regulated water utilities in California and Texas and has a real estate business. Its water systems served approximately 244,000 connections at year-end. The 2017 results include the Texas Water Alliance (TWA) through its November 16, 2017 sale.
Financial performance
Amounts are in millions of dollars unless stated otherwise.
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Operating revenue | $389.2 | $339.7 | +14.6% |
| Operating income | $98.1 | $93.1 | +5.3% |
| Operating margin | 25.2% | 27.4% | Down 2.2 percentage points |
| Net income attributable to SJW Group | $59.2 | $52.8 | +12.0% |
| Diluted EPS | $2.86 | $2.57 | +11.3% |
| Cash flow from operations | $101.1 | $114.6 | Down $13.5 |
| Company-funded utility capital expenditure | $141.2 | $129.1 | +9.4% |
- Water Utility Services revenue grew to $383.5 million from $333.0 million. Management attributed the increase mainly to authorized rate increases ($41.1 million) and higher water consumption ($15.4 million), partly offset by $8.8 million less general-rate-case true-up revenue than in 2016.
- Operating expenses rose 18.1% to $291.1 million. Production costs increased $32.4 million, reflecting higher purchased-water and groundwater charges, increased usage, and reduced surface-water availability. Purchased water expense was $86.5 million; groundwater extraction charges were $47.8 million.
- Net income included significant asset-sale gains: approximately $12.5 million pre-tax from TWA and $6.9 million pre-tax from California real estate sales, with $1.9 million of the latter gain attributable to a noncontrolling interest. 2016 included gains on real estate and California Water Service Group stock sales.
- Cash from operations was below company-funded capital spending by about $40.1 million, a simple cash-flow-minus-capex measure. Investing cash outflow overall was $113.9 million, after sale proceeds.
Financial position, liquidity and capital
- At December 31, 2017, total assets were $1.458 billion, stockholders’ equity $463.2 million, and long-term debt, net of current portion, $431.1 million. Gross long-term debt was $435.0 million; lines of credit outstanding were $25.0 million.
- Cash and cash equivalents were $7.8 million. The company reported $145 million of aggregate unsecured bank lines, of which $120 million was unused. The facilities mature June 1, 2021; borrowing cost averaged 2.3% at year-end.
- Current assets were $66.9 million and current liabilities $85.1 million. SJW Group and its subsidiaries reported compliance with debt covenants at year-end.
- Company-funded Water Utility Services capital spending was $141.2 million in 2017. Planned 2018 spending was approximately $119.7 million, and projected five-year spending approximately $760.8 million, subject in significant part to regulatory approval. The 2018 plan emphasizes distribution-system work, including about $48.0 million for pipe and main replacement.
- Dividends paid were $21.3 million, or $1.04 per share; management reported dividends equal to 36% of net income. The company stated that dividends had been paid for 297 consecutive quarters and increased annually for 50 years, while cautioning that future dividends are not assured.
Material changes, outlook and risks
- Rates and regulation: California’s 2018 escalation-year rate increase of $15.7 million, or 4.22%, took effect January 1, 2018. A CPUC proposed decision issued in February 2018 would lower San Jose Water Company’s authorized return on equity from 9.43% to 8.30% and overall return on rate base from 8.09% to 7.19%. If adopted unchanged, management estimated an approximately $10 million 2018 revenue-requirement reduction, potentially materially affecting net income. The decision was pending as of the filing.
- Future rate request: The January 2018 California general rate case application sought increases of $34.3 million in 2019, $14.2 million in 2020 and $20.6 million in 2021, plus recovery of $20.7 million from balancing and memorandum accounts. Requested rates were expected, if approved, to take effect January 1, 2019.
- Tax Act: The federal corporate rate reduction from 35% to 21% produced a $2.4 million tax benefit on nonregulated activities in 2017. For regulated operations, the company recorded an $83.7 million regulatory liability from deferred-tax remeasurement; the related benefits are expected to flow to customers. Management estimated a 2018 effective tax rate of 26%–28%, subject to change.
- Water and conservation: Water production rose to 38,584 million gallons from 35,847 million in 2016, while San Jose residential usage increased 8.1%. California drought surcharges and allocations were suspended in February 2017, but conservation and use restrictions remained. Management believed available supplies would meet 2018 demand; drought, supply mix, water costs and conservation-related demand remain material uncertainties.
- Other risks and contingencies: Water utilities face regulatory recovery delays, rising purchased-water, energy and infrastructure costs, environmental and water-quality requirements, pension funding exposure, cyber and operational disruption, and natural-disaster risk. A September 2017 noncompliant water discharge was reported to regulators and enforcement action had been pursued; the company expected no material financial impact, but the matter was unresolved. The filing reports no pending litigation expected to have a material effect.
- Unusual items and accounting: The TWA sale generated $28.6 million of cash proceeds at closing, with $3.0 million held back until 2021 subject to reductions. SJW Group recorded a provisional Tax Act accounting estimate and corrected a prior-period regulatory-asset/deferred-tax gross-up error, which it said had no income, equity or cash-flow impact and was not material.
Important facts for investors to verify
- Confirm the issuer identity: the supplied filing is SJW Group’s 2017 Form 10-K, rather than a filing under the “H2O AMERICA” company name.
- Check the final CPUC cost-of-capital decision and its actual effect on authorized rates and earnings; the filing describes only a proposed decision.
- Assess whether the requested 2019–2021 rate increases and $20.7 million of account recoveries were approved, and when collections occurred.
- Reconcile the contribution of asset-sale gains, rate increases and usage to recurring earnings and cash generation; operating cash flow declined while capital spending exceeded it.
- Monitor 2018 tax-rate outcomes and regulatory treatment of Tax Act benefits, as the reported estimate was provisional.
- Review water-supply conditions, conservation requirements, production-cost recovery, the unresolved discharge enforcement matter, and planned capital spending and financing needs.