H2O AMERICA quarterly report, Q2 FY2019

Business context and reporting period

Filing identity: The supplied filing is SJW Group’s Form 10-Q for the quarter and six months ended June 30, 2019—not a filing identified as H2O America. SJW Group provides regulated water utility services in California and Texas and operates a real estate segment.

Water sales are seasonal, and management cautions that interim results are not indicative of a full year. Amounts below are in millions of dollars except per-share data.

Financial performance and position

• Revenue increased 3.9% in Q2 and 3.7% for the half year. Operating income declined 3.6% in Q2 but rose 14.1% for the half year; net income attributable to SJW Group rose 5% and 37%, respectively.
• Operating margin was approximately 21.3% in Q2 versus 23.0% a year earlier, and 19.0% for the half year versus 17.3%. Q2 diluted EPS fell despite higher net income, with weighted average diluted shares up to 28.5 million from 20.7 million in Q2 2018, following the prior equity issuance.
• Management attributed earnings growth principally to higher water rates, balancing-account items, interest income on invested equity proceeds, and lower merger expenses. Offsets included higher unit costs for purchased water and groundwater, higher administrative costs, and increased depreciation.
• Production expenses were $42.1 million in Q2, up from $39.9 million; for the half year they were $68.9 million, down from $70.3 million, reflecting greater surface-water use. Administrative and general expense and depreciation increased in both comparison periods.
• Operating cash flow was $49.8 million for the half year, versus $45.4 million. Investing used $72.5 million, primarily for utility plant; financing provided $23.9 million. Cash and money market funds totaled $421.8 million at June 30, including $412.0 million in a money market fund.
• At June 30, long-term debt, excluding current portion, was $510.9 million and line-of-credit borrowings were $55.0 million; the comparable year-end figures were $431.4 million and $100.0 million. The company had $90.0 million of unused short-term credit lines. Current assets were $503.9 million and current liabilities $127.1 million.
• Company-funded utility capital expenditures were $62.3 million in the first half. The 2019 budget for Water Utility Services was approximately $131 million, excluding customer-funded projects; planned five-year capital expenditures were approximately $699.2 million, with a significant portion subject to regulatory approval.

Material changes, outlook, and risks

• Rates and regulatory matters: California’s 2019 rate increase of 4.55% took effect January 1. A CPUC decision denied the requested WRAM/SRM but authorized recovery of a $1.243 million memorandum-account balance, subject to a further filing and approval. A request to recover $9.020 million in 2018 conservation-account balances remained pending.
• Billing-practice settlement: After quarter-end, on July 24, SJW and CPUC staff sought approval of a settlement requiring approximately $2.1 million in customer credits and $5 million of investment in utility plant that earns no return and is not recoverable in rates. SJW recorded the $2.1 million credit as a Q2 revenue reduction. CPUC approval was pending and expected in Q3.
• Merger uncertainty: SJW’s proposed all-cash acquisition of Connecticut Water Service for $70 per share remained subject to regulatory approvals. A new Connecticut application was filed in April; a hearing was scheduled for July 26 with a decision expected by September 4. A Maine application was filed in May, and the California CPUC investigation was suspended pending Connecticut’s decision. The filing states there is no assurance the merger will close. The merger could involve substantial additional debt; the bridge financing commitment had been reduced to $563 million. Termination under specified circumstances could require a $42.5 million fee or reimbursement of up to $5 million.
• Water supply and conservation: Management believed supplies would be sufficient through the remainder of 2019. As of July 1, Santa Clara Valley Water District reservoirs were at approximately 60% of capacity, with storage at the 20-year average. Permanent restrictions and conservation targets remain relevant to customer demand and revenue.
• SCVWD increased purchased-water and groundwater-extraction unit charges effective July 1, 2019, by 6.1% and 6.6%, respectively. Management noted that the utility may seek rate adjustments to offset eligible cost increases.
• No formal earnings guidance is provided in the filing. Management’s outlook includes the stated 2019 and five-year capital plans, expected additional merger costs, and its view that water supplies should meet demand through year-end.
• The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Merger approval, potential added debt and regulatory conditions, conservation-related demand, water-cost changes, and rate-case timing remain key uncertainties.

Important facts for investors to verify

• Confirm the filing issuer: this document is for SJW Group (ticker SJW), despite the request metadata naming H2O America.
• Track PURA and MPUC decisions and any CPUC action affecting the proposed Connecticut Water merger, including financing needs, regulatory commitments, and potential termination costs.
• Check whether the CPUC approved the billing-practice settlement and whether the customer credits and non-recoverable $5 million plant commitment were implemented as described.
• Monitor the pending conservation-account recovery request, future rate proceedings, and the impact of conservation restrictions and water-supply costs on usage and margins.
• Assess execution of the $131 million 2019 capital budget, changes in debt and credit-line use, and the use of the substantial cash and money-market balance.