California Water Service Group — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Financial statements are unaudited. The company provides regulated water and related services in California, Washington, New Mexico, and Hawaii, plus non-regulated utility-related services. Results are seasonal, with revenue and income generally higher in warmer months.
Financial performance
Amounts below are in millions, except per-share data and percentages.
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Operating revenue | $118.3 | $116.7 | $208.6 | $203.3 |
| Operating expenses | $102.0 | $100.7 | $184.6 | $181.1 |
| Net operating income | $16.3 | $16.0 | $24.0 | $22.2 |
| Net income | $10.4 | $12.1 | $12.4 | $14.5 |
| Diluted EPS | $0.50 | $0.58 | $0.60 | $0.70 |
| Net interest expense | $5.9 | $5.3 | $11.6 | $9.7 |
| Operating margin | 13.8% | 13.7% | 11.5% | 10.9% |
| Net margin | 8.8% | 10.4% | 5.9% | 7.1% |
- Cash flow, first half: Operating cash flow was $32.9 million, versus $30.6 million in 2009. Investing used $62.2 million, including $60.5 million of utility-plant expenditures. Financing provided $25.1 million. Cash fell $4.2 million to $5.6 million. Operating cash flow less utility-plant expenditures was negative $27.6 million.
- Liquidity and debt at June 30: Current assets were $91.6 million and current liabilities $145.7 million (current ratio about 0.63). Short-term borrowings were $55.2 million, compared with $12.0 million at year-end 2009; long-term debt was $380.0 million, plus $2.9 million of current maturities. Credit facilities total $300 million; reported availability was $244.9 million. The company said it met all borrowing covenants.
- Balance sheet: Total assets were $1.60 billion, net utility plant $1.25 billion, and stockholders’ equity $421.2 million. Pension and other postretirement benefit liabilities were $143.5 million.
- Dividends: Quarterly dividend declared was $0.2975 per share, compared with $0.2950 a year earlier. The board declared the same $0.2975 dividend for Q3.
Changes versus prior comparable periods
- Q2 revenue rose 1%; first-half revenue rose 3%, mainly from rate increases. Lower customer usage and other changes partly offset the increases. Water production volume fell 11% in Q2 and 10% in the first half year over year.
- Net income declined 14% in Q2 and 15% for the first half. Management attributed the declines principally to weaker other income, including a reduction in the value of life insurance contracts; higher interest expense also weighed on results.
- For the first half, the comparison also included a $0.7 million property-sale gain in 2009 and $0.6 million more costs in 2010 to evaluate potential acquisitions. In 2010, net other expense was $0.1 million, versus $2.0 million of net other income in 2009.
- First-half operating expenses increased 2%. Higher water and power costs, maintenance, and depreciation were partly offset by lower administrative and general and other operating expenses.
- Capital expenditures were $60.5 million in the first half, versus $52.9 million a year earlier. Short-term borrowings increased, while long-term debt proceeds were $7.9 million and repayments were $12.2 million.
Outlook, regulation, risks, and unusual items
- Management outlook: The 2010 capital budget was approximately $120–$140 million; the company expected a 38%–40% effective tax rate. Management said water supplies should be adequate for 2010 and beyond, while noting that rationing could be required if imposed by state or local authorities. California snowpack and rainfall were reported at 109% of normal as of July 1, 2010.
- Rates and regulatory recovery: The California rate-case application sought annual increases of $70.6 million in 2011 and $24.8 million in each of 2012 and 2013. A settlement of most issues, if adopted in whole, would add $34.3 million to annual gross revenue beginning in January 2011; the regulator was not bound to approve it. The filing gives differing timing indications for a decision: it describes the rate-case decision as expected in Q4 2011, but also discusses interim rates effective January 1, 2011 and later adjustment after a decision expected in Q4 2010. The filing text does not provide a clear, consistent decision date.
- Cal Water sought recovery of $11.4 million of 2008–2009 WRAM/MCBA balances; the regulator required longer recovery periods in some districts, and the company appealed. Recovery timing and outcome were uncertain. A separate draft CPUC policy on contamination litigation proceeds could limit returns on MTBE settlement-funded investment; the company planned to seek changes.
- Contingencies: The company had received $34.2 million net of fees from a partial MTBE litigation settlement and was pursuing other parties; regulatory treatment remained pending. It also reported TCP and PCE contamination litigation, including a settlement with one TCP defendant whose proceeds were to remain in a memorandum account pending regulatory allocation. Management did not expect the resolution of ordinary-course disputes, after reserves, to materially affect financial position, results, or cash flows.
- Other risks: Regulatory rate decisions and recovery, conservation and customer usage, weather, purchased water and power prices, access to financing, interest rates, water quality and environmental requirements, labor, healthcare costs, and operational execution. The company said new federal healthcare laws eliminated approximately $11.4 million of future federal and state income tax deductions, but were not expected to significantly increase 2010 healthcare and other costs.
- No material change in contractual obligations outside the normal course of business was reported. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the expected decision date and status of the California general rate case, given the inconsistent timing statements in the filing.
- Track CPUC decisions on WRAM/MCBA recovery periods, pending rate relief, and the regulatory treatment of MTBE and TCP proceeds.
- Assess whether operating cash generation can support the planned $120–$140 million 2010 capital budget and dividend, given first-half capital spending exceeded operating cash flow.
- Monitor rising short-term borrowings, financing plans, interest costs, and covenant headroom as capital requirements continue.
- Evaluate continued usage declines and conservation effects, as well as purchased-water and power cost changes and their recovery through rates.