California Water Service Group — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; the filing also reports fourth-quarter results. Amounts below are in U.S. dollars unless noted. The company is a regulated water and wastewater utility serving about 517,500 customer connections. California generated approximately 94% of consolidated revenue.
Financial performance and condition
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Operating revenue | $698.2 million | $676.1 million | +3.3% |
| Net operating income | $110.5 million | $107.1 million | +3.2% |
| Net income | $65.6 million | $72.9 million | −10.1% |
| Diluted EPS | $1.36 | $1.52 | −10.5% |
| Operating cash flow | $179.0 million | $147.8 million | +$31.2 million |
| Capital expenditures | $271.7 million | $259.2 million | +$12.5 million |
| Net utility plant | $2,232.7 million | $2,048.0 million | +9.0% |
| Long-term debt, including current portion | $814.9 million | $531.7 million | +$283.2 million |
Net operating margin was approximately 15.8% of revenue and net margin approximately 9.4%. Operating cash flow less reported capital expenditures was negative $92.7 million. Cash and cash equivalents were $47.2 million at year-end, versus $94.8 million a year earlier; current assets were $188.7 million and current liabilities $321.2 million. The current ratio was approximately 0.59.
Purchased water, power, and pump taxes totaled $252.9 million, or 43.0% of operating expenses. Purchased water alone was $207.1 million. The company paid $0.75 per share in dividends for 2018; the board subsequently declared a quarterly dividend of $0.1975 per share, equivalent to an indicated annual rate of $0.79.
Fourth quarter: Revenue was $167.4 million, net income $15.4 million, and diluted EPS $0.32. The comparable 2017 figures, as corrected, were $164.3 million, $15.1 million, and $0.31, respectively.
Material changes and notable items
- Revenue increased $22.1 million year over year, supported chiefly by rate changes and balancing-account revenue.
- Net income declined $7.4 million. The filing attributes the decrease principally to the $6.9 million annual revenue reduction from California’s cost-of-capital decision, $5.0 million of higher new-business development expense, higher depreciation, labor, maintenance, property-tax and interest costs, and lower unrealized benefit-plan investment income. These pressures were partly offset by rate increases and lower income taxes.
- California’s authorized return on equity fell from 9.43% to 9.20%, and authorized return on rate base from 7.94% to 7.48%. New rates took effect July 1, 2018; the filing estimates a $6.9 million annual revenue reduction from the cost-of-capital decision.
- The federal tax-rate reduction to 21% reduced customer rates. The company recorded a $107 million estimated ratepayer refund liability related to excess deferred taxes and continued working with regulators on the refund process.
- Cal Water issued $300 million of floating-rate first mortgage bonds due in 2020. Year-end short-term borrowings fell to $65.1 million from $275.1 million. A further $100 million bond maturity was due in the second quarter of 2019, expected to be repaid initially through the credit line pending long-term financing.
- The company received $56.0 million net proceeds from an $85 million TCP contamination settlement in 2017; it had used $43.9 million on remediation by year-end 2018. Settlement proceeds are designated for remediation-related purposes.
Outlook, risks, and contingencies
- Cal Water’s 2018 general rate case sought $828.5 million of infrastructure investment for 2019–2021 and proposed annual revenue increases of $50.7 million in 2020, $31.5 million in 2021, and $33.0 million in 2022. These were proposals, not approved guidance; rate changes were expected to take effect in 2020 following regulatory review.
- Management expects annual capital spending to rise over the next five years. It reported 2018 capital spending above the $260 million upper end of its budget range and expects to fund long-term needs through debt, equity, and operating cash flow.
- Management believed available groundwater and wholesale supplies would meet demand in 2019 and beyond, while noting exposure to drought, climate and weather, water quality, wholesale water prices, power interruptions, conservation, and regulatory decisions. Water use and cash flows are seasonal.
- Key financial risks include the timing and sufficiency of authorized rate recovery, substantial infrastructure funding needs, interest-rate and refinancing exposure, pension obligations, and the company’s concentration in California. Contractual obligations totaled approximately $2.32 billion, including $675.9 million of estimated water-supply contract payments.
- Financial reporting controls: Management and Deloitte concluded internal control over financial reporting was ineffective at December 31, 2018 because of a material weakness in controls over pension and healthcare balancing accounts. The error understated 2017 and the first three quarters of 2018 revenue and was corrected in the filing. The auditor gave an unqualified opinion on the financial statements but an adverse opinion on internal control. Management said remediation was being implemented in the first quarter of 2019.
- The filing reports $2.3 million of liabilities for known legal matters and says ordinary-course disputes were not expected to materially affect results. Environmental, contamination, inverse-condemnation, cybersecurity, and service-continuity exposures remain among the disclosed risks.
Most important facts for investors to verify
- Progress and final outcomes of the California and Washington rate proceedings, and whether proposed California rate increases and infrastructure spending are approved.
- Implementation and testing of controls that remediate the material weakness, and whether subsequent filings avoid further corrections.
- Repayment or refinancing of the $100 million 2019 maturity and $300 million floating-rate bonds due 2020, alongside planned capital spending and dividend commitments.
- Regulatory treatment and timing of the estimated $107 million tax-related ratepayer refund, and permitted use and recovery of TCP remediation costs.
- Actual water-supply availability and costs, customer usage and balancing-account collections, and whether operating cash flow can support the investment program.