California Water Service Group — Q2 2015 Form 10-Q
Business context and period. Unaudited results for the quarter and six months ended June 30, 2015, compared with the corresponding 2014 periods. The company provides regulated water and related services in California, Washington, New Mexico, and Hawaii, alongside non-regulated services. Results are seasonal, with water use and revenue generally higher in warm, dry months.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Operating revenue | $144.4m | $158.4m | $266.4m | $268.9m |
| Net operating income | $16.5m | $23.3m | $24.0m | $24.4m |
| Net income | $9.8m | $17.2m | $11.4m | $11.7m |
| Diluted EPS | $0.21 | $0.36 | $0.24 | $0.24 |
| Operating cash flow | — | $48.3m | $43.2m | |
| Capital expenditures | — | $75.8m | $57.0m |
Q2 operating margin was approximately 11.4% (14.7% prior year); six-month operating margin was approximately 9.0% (9.1% prior year). Margins are calculated from reported revenue and net operating income.
- At June 30, cash was $24.5m; short-term borrowings were $126.6m, versus $79.1m at year-end 2014. Long-term debt, including current maturities, totaled approximately $423.3m.
- Current assets were $150.2m and current liabilities $270.4m. The company reported $416.8m of long-term debt excluding current maturities.
- Utility plant expenditures were $75.8m; accrued payables for utility-plant investment were $21.9m. Dividends paid in the first half were $16.0m; dividends declared were $0.335 per share for the half-year.
Changes versus the prior comparable periods
- Q2 revenue fell 9%, and net income fell $7.3m. Management attributed the principal revenue pressure to a $10.1m reduction in estimated unbilled revenue, reflecting lower consumption amid drought and mandatory conservation. The unbilled-revenue change does not affect WRAM balances until billed.
- Q2 water production was 21% lower year over year; water production costs declined $8.9m despite an 11% blended increase in purchased-water wholesaler rates. Administrative and general plus other operating expenses rose $4.3m, including higher pension/postretirement, drought-program, wage, and conservation costs.
- For the first half, revenue declined 1% and net income declined $0.3m. Water production fell 16%; production costs declined $9.1m. Administrative and general plus other operating expenses increased $6.4m, led by pension/postretirement costs, wages, and drought-program expense.
- First-half operating cash flow increased $5.2m, while utility-plant expenditures rose $18.8m. Short-term borrowing increased to help fund capital spending and operations.
Outlook, regulation, risks, and unusual items
- Outlook: Management estimated a 38% effective tax rate for 2015 and budgeted company-funded capital expenditures of $125m–$145m. It anticipated funding future capital needs through a relatively balanced mix of long-term debt and equity; no earnings guidance was provided.
- Rate proceedings: On July 3, 2015, Cal Water filed its next California general rate case, seeking rate increases of $94.8m for 2017, $23.0m for 2018, and $22.6m for 2019, and proposing $693.0m of investment over 2016–2018. These are requests, not approved rates. A $30.5m net undercollection from 2014 WRAM/MCBA balances was being recovered through customer surcharges over 12, 18, or 20-plus months.
- Drought: California’s statewide mandate targeted a 25% reduction in urban potable-water use through February 2016. Cal Water’s conservation budgets and enforcement measures took effect June 1, 2015. Drought memorandum-account costs were $1.4m at quarter-end; no drought surcharges or penalties had been collected in the first half. California snowpack and rainfall accumulation for the 2014–15 water year was reported at 72% of normal. Management believed supplies would be adequate to meet demand in 2015 and beyond.
- Liquidity: New five-year revolving credit facilities provide up to $450m in aggregate. At June 30, $85.8m was available on the parent facility and $237.6m on Cal Water’s facility. The company said it complied with financial covenants and could access the full facilities. It noted that internally generated funds after dividends have not met capital expenditure needs.
- Benefits and tax matters: First-half pension and other postretirement plan contributions were $14.1m and $3.7m, respectively; estimated 2015 contributions were $31.2m and $15.0m. Unrecognized tax benefits were approximately $9.2m. State tax audits were ongoing; management did not expect their resolution to materially affect results or financial condition.
- Contingencies: Known legal-matter liabilities were $2.0m, with $1.5m of reasonably possible losses above accrued amounts. Management did not believe ordinary-course litigation would materially affect the company, taking existing reserves into account. Groundwater-contamination litigation and potential recovery of related costs remain relevant.
- Key risks include regulatory decisions and rate-recovery timing, drought and conservation-related usage changes, water and power costs and availability, water-quality/environmental requirements, access to capital and interest rates, pensions, litigation, and cybersecurity. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether drought-driven conservation and the decline in unbilled revenue persist, and how they affect reported revenue versus future WRAM/MCBA collections.
- Progress and eventual approved rates and investment plans in the 2015 California general rate case; distinguish requested amounts from authorized rates.
- Capital spending against the $125m–$145m company-funded budget, and the resulting need for short- and long-term financing.
- Recovery timing and interest economics for regulatory undercollections, including the $47.9m net WRAM/MCBA receivable balance reported at June 30.
- Water-supply conditions, drought-account costs, and progress toward mandated conservation targets.
- Changes in pension/postretirement costs, contributions, legal exposures, and tax-audit or unrecognized-tax-benefit balances.