California Water Service Group — Q2 2023 Form 10-Q
Business context and period: Unaudited results for the three and six months ended June 30, 2023. The company provides regulated and non-regulated water and related utility services across California, Washington, New Mexico, Hawaii, and Texas. Water sales and earnings are typically higher in warm, dry months; interim results may not indicate full-year performance.
Financial performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Operating revenue | $194.0 million | $206.2 million | $325.1 million | $379.2 million |
| Operating income (loss) | $15.9 million | $27.3 million | $(1.6) million | $36.4 million |
| Net income (loss) attributable to Group | $9.6 million | $19.5 million | $(12.7) million | $20.6 million |
| Diluted EPS | $0.17 | $0.36 | $(0.23) | $0.38 |
| Operating margin | 8.2% | 13.2% | (0.5)% | 9.6% |
| Net margin | 4.9% | 9.4% | (4.0)% | 5.4% |
Margins are calculated as operating income or net income attributable to the Group divided by operating revenue. Six-month 2023 operating expenses were $326.7 million, exceeding revenue; lower operating revenue was partly offset by lower operating costs. Net interest expense rose to $24.7 million for the half-year from $21.9 million, primarily because of higher short-term rates and borrowings.
Cash flow and investment: Operating cash flow was $37.5 million for the first half, down from $89.9 million a year earlier. Utility plant expenditures were $177.2 million, versus $144.6 million. Financing activities provided $144.4 million, including $112.7 million net proceeds from at-the-market common stock sales. Cash, cash equivalents, and restricted cash totaled $89.7 million at June 30, 2023.
Debt and liquidity: Long-term debt, net, was $1.052 billion; short-term borrowings were $130.0 million, up from $70.0 million at December 31, 2022. The company and Cal Water have $600 million of unsecured revolving facilities, with $470 million available at quarter-end. The company reported compliance with facility covenants. The average borrowing rate on the facilities for the first half was 5.78%, compared with 1.35% in the prior-year period.
Capital and dividends: Total equity was $1.394 billion, compared with $1.322 billion at year-end 2022. Common shares outstanding increased to 57.702 million from 55.598 million, primarily reflecting equity issuance. The quarterly dividend was $0.26 per share; the board declared the same amount for Q3 2023.
Material changes versus the prior comparable period
- Q2 revenue fell 5.9% and six-month revenue fell 14.3%. Management cited lower customer usage, the end of WRAM and MCBA mechanisms, and deferred recognition of amounts expected to be collected beyond 24 months.
- Customer usage declined 10.4% in Q2 and 9.7% for the first half. Management attributed the declines primarily to conservation and, for the first half, higher winter precipitation in California. California rate increases partly offset lower usage.
- The delayed California 2021 General Rate Case (GRC) decision meant no 2023 benefit from new MWRAM/DREMA mechanisms or final-rate relief was recorded. Management estimated the delay’s adverse revenue impact at $43–$63 million for the first half and $19–$29 million for Q2; these are estimates, not reported revenue reductions alone.
- First-half net income shifted to a $12.7 million loss from $20.6 million income. The decline primarily reflected the $54.1 million revenue decrease, partly offset by $16.1 million lower operating expenses and higher net other income.
- First-half operating cash flow declined by $52.4 million, including the absence of $20.8 million received under the Water Arrearages Payment Program in 2022.
Outlook, risks, contingencies, and unusual items
- California rates: The CPUC extended the GRC decision deadline to December 31, 2023; the ultimate timing and outcome remain uncertain. The company expects MWRAM approval retroactive to January 1, 2023, but recorded no MWRAM or ICBA asset or liability for the first half. Rate-case decisions and recovery timing could materially affect revenue and cash flow.
- Cost of capital: The CPUC authorized a 9.05% return on equity and 6.80% rate of return for 2023–2024, then a WCCM adjustment set a 9.57% return on equity and 7.08% authorized rate of return effective July 31, 2023. Management estimated the 40-basis-point reduction from the prior 7.48% rate of return could reduce annual operating revenue by about $7 million, subject to the GRC outcome.
- Capital needs and PFAS: The company proposed $1.0 billion in California infrastructure investment for 2022–2024; first-half utility plant expenditures were $177.2 million and construction work in progress was $311.7 million. If proposed federal PFAS limits are adopted in their current form, management estimates about $200 million of capital investment would be required, with three years to comply.
- Water supply and conservation: Management believes supplies will be adequate for 2023 and thereafter. California snowpack was reported at multiples of long-term averages as of June 30. Usage remains sensitive to weather, conservation, and water availability; drought restrictions and related costs may change.
- Market-sensitive gains: Net other income benefited from unrealized gains on non-qualified benefit-plan investments, compared with losses in the prior-year periods. Management cautioned that future results may be significantly affected by market volatility. These gains are not necessarily recurring.
- Regulatory customer balances: Cal Water reported a $76.6 million net under-collection in 2022 WRAM/MCBA balances being recovered through customer surcharges. It also expected $14.0 million in HCBA refunds and $17.4 million in PCBA recoveries under pending rate adjustments.
- Controls: Management concluded disclosure controls were not effective at June 30, 2023 because of a previously disclosed material weakness in internal control over financial reporting. Remediation controls were implemented in Q2 but had not operated long enough to be considered remediated.
- Contingencies: The company reported $5.1 million of liabilities, before insurance recoveries, for known legal matters, primarily potable-water leaks and other work-related matters. Management did not expect existing legal matters, after reserves, to materially affect results, but litigation outcomes are uncertain. A $32.6 million pipeline commitment was held in restricted cash and expected to be transferred to GBRA in the second half of 2023.
- Restatement disclosure: The filing describes an immaterial correction to prior-period retained earnings and equity related to a regulatory liability, customer refunds, and deferred taxes. It states the error did not affect customer billings or cash refunded.
Important facts for investors to verify
- Timing and final terms of the California 2021 GRC decision, including recovery of interim-rate and balancing-account amounts.
- Whether the estimated $43–$63 million first-half revenue impact from the GRC delay is recoverable, when it may be collected, and how regulatory decisions affect reported earnings and cash flow.
- Progress on revenue recovery, customer surcharges and surcredits, and the resulting effects on customer bills and collection timing.
- Funding needs for the capital program, future debt and equity issuance, dilution, borrowing costs, and continued compliance with credit-facility covenants.
- Remediation and testing of the material weakness in internal control over financial reporting.
- Final PFAS requirements, required investment, compliance deadlines, and regulatory recovery of associated costs.
- Actual performance relative to seasonal usage expectations and the effect of weather, conservation, and water-supply conditions.