California Water Service Group — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; unaudited. The company provides regulated water and related services in California, Washington, New Mexico and Hawaii, alongside non-regulated services. It reports one operating segment. Water demand and earnings are seasonal, typically higher in warm, dry months.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Operating revenue | $171.1 million | $152.4 million | $293.2 million | $274.2 million |
| Net operating income | $25.3 million | $18.5 million | $33.3 million | $24.8 million |
| Net income | $18.5 million | $11.5 million | $19.7 million | $10.7 million |
| Diluted EPS | $0.39 | $0.24 | $0.41 | $0.22 |
| Operating margin (approx.) | 14.8% | 12.2% | 11.4% | 9.0% |
| Net margin (approx.) | 10.8% | 7.5% | 6.7% | 3.9% |
Q2 revenue increased 12.3%; six-month revenue increased 6.9%. Net income rose $7.0 million in Q2 and $9.0 million year to date. Management attributed the gains principally to California’s 2015 general rate case increases, with contributions from lower drought-related and maintenance costs, higher unbilled revenue in Q2, benefit-plan investment gains and newly recorded equity AFUDC. Higher depreciation, interest and employee wage costs partly offset the increases.
Cash flow and investment: Six-month operating cash flow was $35.7 million, down from $59.6 million. Utility plant expenditures were $108.7 million, compared with $116.2 million; cash used in investing was $110.1 million. Financing provided $78.0 million, and cash increased $3.6 million to $29.1 million. The operating-cash-flow shortfall versus plant spending was funded principally through borrowing and other financing.
Debt and liquidity: At June 30, long-term debt, including current maturities, was approximately $556.0 million; short-term revolving borrowings were $190.1 million, up from $97.1 million at December 31, 2016. Cash was $29.1 million and current liabilities were $361.0 million. The company reported $229.9 million of combined unused revolving-credit availability and compliance with credit covenants. Short-term facility borrowing rates averaged 1.82% in the first half, versus 1.30% in 2016.
Other metrics: Total assets were $2.53 billion, including net utility plant of $1.93 billion. Dividends declared were $0.18 per share for Q2 and $0.36 year to date, versus $0.1725 and $0.3450, respectively, in 2016. The estimated 2017 effective tax rate was 37%.
Material changes and drivers
- California rate increases were a major revenue driver. Q2 general-rate-case, purchased-water/pump-tax and ratebase increases contributed a stated $17.2 million; the total rate-change component was $21.2 million, including usage and other effects.
- Six-month rate increases totaled $28.7 million, while balancing-account revenue and revenue deferrals reduced the reported revenue increase. Net WRAM/MCBA under-collections were $54.8 million at June 30, 2017, versus $28.9 million a year earlier.
- Water production costs rose 11.4% in Q2 and 7.6% for the first half, driven mainly by higher wholesale water rates and production. Depreciation and amortization increased 21.3% in Q2 and 20.5% year to date, mainly reflecting prior-year plant additions.
- Net interest expense increased 12.1% in Q2 and 12.0% year to date, principally because of increased short-term financing for capital investment and higher short-term rates.
- Effective January 1, 2017, the CPUC authorized equity AFUDC on construction work in progress; the company recorded $1.7 million for the first half. Prior-year comparative periods had no equity AFUDC.
Outlook, regulation and risks
- Capital plan: The 2017 budget estimates utility plant expenditures of $200–$220 million. Management expects to fund future plant needs through a relatively balanced mix of long-term debt and equity; internally generated funds after dividends have historically been insufficient to cover planned investment.
- Rates and investment: The approved California GRC authorizes approximately $45 million of gross revenue increases beginning in 2017, up to $17.2 million in 2018 and up to $16.3 million in 2019, subject to an earnings test for the latter years. It also authorizes $658.8 million of California system improvements for 2016–2018. Cal Water requested a 10.75% return on equity and 53.4% equity capital structure for 2018; a CPUC decision was anticipated by year-end 2017.
- Other regulatory matters: Cal Water sought CPUC approval to serve Travis Air Force Base under a 50-year agreement, with proposed initial improvements of about $12.7 million and anticipated investment of about $52 million over the contract term. A Hawaii wastewater rate case requested $1.3 million in annual revenue increases, phased over five years; the first phase was expected in Q4 2017. These matters remained subject to regulatory action.
- Water supply: Management believed supplies would be adequate in 2017 and beyond. California snowpack and rainfall were reported at 194% of normal for the 2016–2017 water year; drought emergency status had ended in 54 of 58 counties, though two company districts remained under declared drought conditions.
- Key risks: Regulatory decisions and timing of rate relief or cost recovery; water availability, weather and conservation-driven demand; water quality and environmental requirements; purchased-water and power costs; groundwater restrictions; construction execution and financing costs; labor matters; and IT, security, disaster and litigation risks. Management cautioned that forward-looking statements are not guarantees. No material changes to the previously disclosed annual-report risk factors were reported.
- Contingencies and unusual items: The company reported $6.2 million in liabilities for known legal matters and did not expect their resolution, net of reserves, to materially affect results or cash flows. Groundwater-contamination litigation and associated recovery are subject to regulatory treatment. No significant changes to contractual obligations outside the ordinary course were reported.
- Controls: Management concluded disclosure controls were effective at the reasonable-assurance level and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether rate-case increases, balancing-account collections and deferred revenues are approved and recovered on the anticipated schedule.
- How the $54.8 million WRAM/MCBA under-collection and its financing costs affect cash flow and liquidity.
- Whether capital spending stays within the $200–$220 million 2017 budget and how much incremental borrowing or equity financing is required.
- Progress and outcomes of the cost-of-capital application, Travis Air Force Base approval and Hawaii rate case.
- Whether water-supply conditions, drought restrictions, water costs and seasonal demand remain consistent with management’s outlook.
- Actual pension contributions, legal exposures and other contingencies compared with estimates disclosed in the filing.