CALIFORNIA WATER SERVICE GROUP annual report, FY2016

Business context and reporting period

California Water Service Group filed this Form 10-K for the fiscal year ended December 31, 2016. It operates regulated water and wastewater utilities in California, Hawaii, Washington, and New Mexico, alongside non-regulated water-related services. California accounted for approximately 93% of consolidated operating revenue. The company served 511,500 customer connections at year-end, up from 509,000 in 2015.

Financial and operating performance

Margins are calculated from reported revenue and income figures. Fourth-quarter 2016 revenue was $150.9 million, net income was $15.1 million, and diluted EPS was $0.31; first-quarter net loss was $0.8 million, reflecting seasonal variation.

Balance sheet and liquidity

• Total assets were $2.412 billion; net utility plant was $1.859 billion.
• Long-term debt including current maturities was $558.0 million, and short-term borrowings were $97.1 million, for total reported borrowings of approximately $655.1 million. Short-term borrowings rose from $33.6 million in 2015.
• Cash and cash equivalents were $25.5 million, versus $8.8 million a year earlier. Current assets of $142.1 million were below current liabilities of $250.2 million.
• The company reported a 52.6% consolidated total capitalization ratio under its credit agreement calculation and stated it complied with its covenants.
• Common equity was $659.5 million; long-term debt represented 45.8% of capitalization, compared with 44.5% in 2015.
• Annual dividends paid rose to $0.69 per share from $0.67; the board subsequently declared a $0.18 quarterly dividend.

Material changes versus the prior comparable period

• Revenue increased by $21.0 million. Rate changes and usage-related items added $38.2 million, partly offset by a $14.3 million decline in MCBA revenue and a $7.5 million decrease in other balancing-account revenue.
• Net income rose $3.7 million. Management attributed the improvement principally to regulatory account resolutions, recovery of prior-year drought program costs, and higher estimated unbilled revenue; higher operating costs and interest expense partly offset the gains.
• Purchased water expense increased $13.0 million to $181.5 million, with higher purchased volumes and wholesale rates. Total water production expense rose to $220.0 million.
• Administrative and general expense decreased $14.6 million, mainly from lower pension, postretirement, drought-program, and uninsured-loss costs. Other operations expense rose $12.8 million, including a $3.2 million write-off for a cancelled Bakersfield water project.
• Net interest expense increased $3.2 million, primarily reflecting the 2015 and 2016 first-mortgage bond issuances.
• Capital expenditures increased to $228.9 million, above the high end of the company’s prior budget; operating cash flow did not cover reported plant expenditures.

Outlook, management commentary, risks, and unusual items

• The CPUC approved Cal Water’s 2015 general rate case settlement in December 2016. It authorized approximately $45.0 million of gross revenue increases beginning January 1, 2017, with additional potential increases in 2018 and 2019 subject to an earnings test, and authorized $658.8 million of California system improvements over 2016–2018.
• Management expects 2017 capital expenditures of $200 million to $220 million and anticipates rising infrastructure replacement and maintenance needs over the next five years. It expects long-term funding from debt, equity, and operating cash flow.
• Management believed available groundwater and wholesale supplies would meet demand during 2017 and beyond. California snowpack at January 31, 2017 was reported at 148% of long-term average in the northern Sierra; drought, weather, supply availability, and wholesale pricing remain material uncertainties.
• California drought conditions reduced customer use by 2.7% in 2016. Net under-collected WRAM/MCBA receivables were $39.2 million at year-end, down from $42.0 million, and may affect cash flow while awaiting recovery.
• Major risks include extensive regulatory dependence and rate-case timing; California concentration; water supply and quality, drought and conservation; rising purchased-water and compliance costs; capital-market access and interest rates; pension funding; labor relations; cyber and operational disruption; and natural disasters or contamination.
• The pension plan remained underfunded: projected benefit obligation was $564.8 million against plan assets of $376.5 million. Management estimated 2017 contributions of $31.5 million to pension plans and $9.3 million to the other postretirement plan.
• Known legal matters carried a $6.0 million liability, mostly for main and service leaks. A 2016 settlement over a water-main discharge required pipeline replacement, stream restoration, and payments totaling $0.52 million; the agreement included no admission of wrongdoing. Management did not expect the ultimate resolution of other matters to materially affect results.
• The independent auditor issued an unqualified opinion on the financial statements and internal control; management also reported effective disclosure controls and internal control over financial reporting.

Important facts for investors to verify

• Track implementation and earnings-test conditions for the approved California rate increases, along with recovery timing for regulatory balancing accounts.
• Assess whether planned capital investment can be funded without materially increasing borrowings, and monitor liquidity given current liabilities exceeded current assets at year-end.
• Review purchased-water cost trends, supplier contract terms, drought and conservation effects, and the company’s ability to recover associated costs through rates.
• Monitor pension assumptions, required contributions, and the effect of discount-rate or investment-return changes on the funded deficit.
• Verify the status and potential exposure of legal, contamination, environmental, and regulatory matters; the filing does not quantify a clear maximum exposure for all contingencies.
• Consider the seasonal quarterly results and the company’s substantial dependence on California operations when evaluating annual earnings and cash generation.