Filing Summary
Issuer clarification: The supplied filing is SJW Group’s Form 10-Q, not a filing identified as H2O America. It covers the quarter ended March 31, 2018; dollar amounts below are in thousands unless noted.
Business Context and Reporting Period
SJW Group operates regulated water utilities in California and Texas, alongside non-tariffed utility services and real estate operations. Its principal utility, San Jose Water Company, serves approximately 230,000 connections. Water demand and revenue are seasonal, so first-quarter results are not representative of a full year.
Financial Performance and Liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $75,042 | $69,045 |
| Operating income | $7,331 | $11,704 |
| Net income | $1,285 | $3,671 |
| Diluted earnings per share | $0.06 | $0.18 |
| Operating cash flow | $22,582 | $28,242 |
| Capital expenditures, company-funded utility plant | $28,961 | $27,745 |
Revenue increased 8.7%, while operating income fell about 37% and net income fell about 65%. Operating margin was approximately 9.8%, down from 16.9%; net margin was approximately 1.7%, down from 5.3%. Management attributed lower earnings primarily to higher water production costs and costs associated with the proposed merger.
Operating cash flow was down approximately $5.7 million year over year. Investing activities used $31.6 million, and financing activities provided $8.1 million, including $14.0 million of net line-of-credit borrowings. Cash declined to $6.954 million from $7.799 million at year-end.
At March 31, long-term debt was $431.175 million and line-of-credit borrowings were $39.0 million. Total current liabilities were $95.360 million versus current assets of $61.060 million (current ratio approximately 0.64). The company reported $106 million of unused short-term credit capacity within $145 million of credit lines and was in compliance with stated debt covenants. Quarterly interest expense was $6.052 million, broadly unchanged from $6.057 million.
Quarterly dividends were $0.28 per share, up from $0.22. The company-funded 2018 utility capital budget was approximately $120 million; $29 million had been spent by quarter-end. Management projected approximately $760.8 million of utility capital expenditures over five years, with a significant portion subject to regulatory approval.
Material Changes Versus the Prior Comparable Period
- Water Utility Services revenue rose to $73.701 million from $67.482 million, chiefly reflecting higher customer usage and rates. Consolidated revenue also includes lower real estate income and regulatory-account adjustments.
- Total operating expenses increased $10.370 million. Water production expenses rose $3.948 million, reflecting increased usage and higher purchased-water and groundwater charges, partly offset by greater surface-water use. Depreciation and amortization rose $1.464 million.
- The income statement recorded $3.806 million of merger-related expense, versus none in Q1 2017. Management separately described approximately $2.7 million of merger costs included in net income; the filing does not clearly reconcile that figure to the reported expense line.
- Other expense included a $667,000 unrealized loss on the California Water Service Group investment. A new accounting standard moved fair-value changes on that equity investment into net income; adoption also shifted $2.203 million from accumulated other comprehensive income to beginning retained earnings.
- Cash from operations declined as adjusted net income and collections were lower and accrued water-related charges decreased.
Outlook, Management Commentary, Risks and Contingencies
- Rates and regulation: The CPUC approved a 2018 escalation-year revenue increase of $15.670 million, effective January 1. A March cost-of-capital decision reduced the San Jose Water Company rate of return from 8.09% to 7.64%, reducing its 2018 revenue requirement by $5.843 million. Its pending 2019–2021 general rate case requests revenue increases of $34.288 million, $14.232 million and $20.582 million, respectively; these are requests, not approved outcomes.
- Tax changes: Federal corporate tax-rate reductions are being tracked through regulatory accounts, with benefits expected to be passed to customers. The company recorded related regulatory liabilities, including $933,000 at San Jose Water Company and $139,000 at its Texas utility.
- Water supply: Management believed available sources would meet customer demand through the remainder of 2018. However, as of April 1, Santa Clara Valley Water District reservoirs were about 40% full, and state water-project allocation was reported at 20% of requested amounts. Surface-water availability matters because it is less costly than groundwater or purchased water. Restrictions and a 20% conservation target remained in place.
- Merger: SJW agreed to an all-stock merger with Connecticut Water Service, with each eligible CTWS share converting into 1.1375 SJW shares. The companies expected closing in Q4 2018, subject to shareholder and regulatory approvals and other conditions. SJW disclosed possible termination fees, including $42.5 million in specified circumstances, and up to $5 million of expense reimbursement in certain cases. The merger was not assured; failure or delay could adversely affect results and stock price. After quarter-end, SJW received an unsolicited proposal from California Water Service Group and CTWS received one from Eversource Energy; both boards said their respective proposals were neither superior nor reasonably likely to lead to a superior proposal.
- Other risks and items: Management anticipated additional merger costs through the expected closing period. Water costs may change with supply mix and supplier charges; recovery of certain costs depends on regulatory proceedings. The filing reported ordinary-course litigation but no pending proceedings expected to have a material effect. It also noted an ongoing Texas franchise-tax audit.
Important Facts for Investors to Verify
- Whether merger approvals, transaction conditions, timing and potential termination or reimbursement costs changed after the filing date.
- How actual water demand, rainfall, conservation requirements and the mix and price of water sources affect production costs and margins.
- Whether requested rate increases and recovery of balancing-account amounts are approved, and the timing and customer impact of tax-related regulatory adjustments.
- How merger spending, capital expenditures, dividends and additional borrowing affect cash flow, liquidity and debt levels.
- The distinction between the $3.806 million reported merger-related expense and management’s approximately $2.7 million description, and the impact of investment fair-value volatility on earnings.