California Water Service Group — Q2 2016 Form 10-Q
Business and period: The company provides regulated water and related services in California, Washington, New Mexico, and Hawaii, alongside nonregulated utility services. This unaudited filing covers the quarter and six months ended June 30, 2016. Water use and earnings are seasonal, typically higher in warm, dry months.
Financial performance
Amounts below are in millions of dollars, except per-share data. Comparisons are with the corresponding 2015 period.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Operating revenue | 152.4 | 144.4 | 274.2 | 266.4 |
| Net operating income | 18.5 | 16.5 | 24.8 | 24.0 |
| Net income | 11.5 | 9.8 | 10.7 | 11.4 |
| Diluted EPS | $0.24 | $0.21 | $0.22 | $0.24 |
| Net cash from operations | Not reported separately | Not reported separately | 59.1 | 48.3 |
| Utility plant expenditures | Not reported separately | Not reported separately | 116.2 | 75.8 |
Q2 revenue rose 5.6% and net income rose 16.9%; calculated net margin was approximately 7.5%, versus 6.8%. For the first half, revenue rose 2.9%, but net income fell 6.2%; calculated net margin was approximately 3.9%, versus 4.3%. Higher first-half operating costs and interest expense offset revenue growth.
- Operating cash flow increased by $10.7 million year over year. Cash and equivalents were $30.8 million at June 30, versus $8.8 million at December 31, 2015.
- First-half utility plant expenditures were $116.2 million, substantially above the prior-year $75.8 million. Operating cash flow less these expenditures was negative $57.1 million; this is a simple calculation, not a company-reported measure.
- At June 30, long-term debt, including current maturities, was $561.9 million; short-term borrowings were $75.1 million. Short-term borrowings were $33.6 million at year-end 2015. Current assets of $159.0 million compared with current liabilities of $202.0 million.
- Stockholders’ equity was $636.8 million, down from $642.2 million at year-end. Dividends declared were $0.1725 per share in Q2 and $0.3450 for the first half.
Changes, outlook, and management commentary
- Q2 earnings improved mainly because of higher accrued unbilled revenue, reflecting greater consumption near quarter-end, and higher net other income from an unrealized gain on benefit-plan insurance investments. Unbilled usage is not included in the WRAM until billed and is seasonal.
- For the first half, management attributed lower net income mainly to increases in other operating costs, maintenance, depreciation, property taxes, and net interest expense. Net interest expense rose 13.5% to $14.9 million, primarily reflecting First Mortgage Bonds issued in late 2015 and March 2016.
- California drought-related conservation reduced customer consumption and associated MCBA revenue; the mechanism also reduced water production costs. First-half water production costs were nearly flat as 8% lower production offset an 8% blended increase in purchased-water rates. In Q2, production costs rose 9%, mainly on higher wholesale rates.
- The company issued the remaining $50 million of a previously agreed $150 million First Mortgage Bond placement in March 2016, receiving approximately $49.7 million net of issuance costs; part of the proceeds repaid $48.6 million of credit-line borrowings. Credit facilities totaled $450 million, with stated availability at June 30 of $94.9 million for the parent and $280.0 million for Cal Water. The company reported compliance with financial covenants.
- Management’s 2016 company-funded utility plant expenditure budget is $180 million to $210 million. It expects future utility-plant funding to use a relatively balanced mix of long-term debt and equity; no earnings guidance was provided. The estimated 2016 effective tax rate is 37%.
- The California GRC application seeks rate increases of $94.8 million for 2017, $23.0 million for 2018, and $22.6 million for 2019, and approval for $693 million of investment over 2016–2018. A decision was expected by year-end 2016, with any resulting rate change expected January 1, 2017; these are requested amounts, not approved outcomes.
- Management said water supplies should be adequate to meet demand in 2016 and beyond. California snowpack and rainfall accumulation was 119% of normal as of June 30, although central and southern areas had below-average precipitation. State conservation rules had allowed suppliers to self-certify and, where applicable, reduce targets effective June 1, 2016.
Risks, contingencies, and unusual items
- Key risks include regulatory decisions and rate-case timing, drought and conservation effects on sales and cash flows, weather, purchased-water and power costs, water quality and environmental rules, groundwater availability, financing costs, and credit covenants. The filing reports no material change to the risk factors in the 2015 Form 10-K.
- Net WRAM and MCBA undercollections were $28.9 million at June 30, 2016, down from $47.9 million a year earlier; financing these balances can cost more than the interest recoverable from customers. Regulatory assets totaled $363.3 million.
- On July 21, 2016, regulators approved a settlement related to an alleged discharge of about 8.2 million gallons of drinking water into Polhemus Creek from a cracked water main. Cal Water agreed to replace 2,000 feet of main, perform stream restoration, and pay $524,519 in total. The agreement includes no admission of wrongdoing and releases claims subject to completing the projects.
- Known legal-matter liabilities were $3.4 million at June 30. Management did not believe the ultimate resolution of existing matters would materially affect financial position, results, or cash flows. The filing states that disclosure controls were effective at the reasonable-assurance level.
Most important facts for investors to verify
- Track the CPUC’s decision on the California GRC, including approved rates, timing, and authorized capital investment.
- Assess whether drought-related conservation, water consumption, and balancing-account collections support recurring revenue and cash generation; distinguish billed revenue from seasonal unbilled estimates.
- Monitor execution of the $180–$210 million company-funded capital budget, cash flow relative to investment, and the need for additional debt or equity financing.
- Review short-term borrowing levels, credit availability, covenant compliance, and interest expense as capital spending and financing needs continue.
- Confirm recovery of drought and WRAM/MCBA balances, and completion and costs of the Polhemus Creek settlement projects.