CALIFORNIA WATER SERVICE GROUP annual report, FY2019

Business context and reporting period

California Water Service Group filed this Form 10-K for the fiscal year ended December 31, 2019. It operates regulated water and wastewater utilities in California, Hawaii, Washington, and New Mexico, plus non-regulated water-related services. The company served 520,600 customer connections at year-end, up from 517,500 in 2018. California accounted for 93.8% of consolidated revenue.

Financial performance and condition

Revenue increased 2.3%, while net income fell 3.8%. Operating margin was approximately 13.9% versus 15.8%; net margin was approximately 8.8% versus 9.4%. The $2.5 million net income decline reflected higher administrative and general, other operating, depreciation, maintenance, property tax, and interest costs, partly offset by rate increases and lower business development expenses. A $7.4 million unrealized gain on benefit-plan investments contributed to other income in 2019.

Cash and cash equivalents were $42.7 million at year-end, and current liabilities exceeded current assets: $358.7 million versus $184.7 million. The company had $550 million of revolving credit facilities, with $175.1 million drawn at year-end; it reported compliance with financial covenants. Equity was $779.9 million, and capitalization was 49.1% equity and 50.9% long-term debt. The 2019 dividend was $0.79 per share; the board subsequently declared a quarterly dividend of $0.2125 per share.

Fourth-quarter 2019 revenue was $176.9 million, net income was $11.3 million, and diluted EPS was $0.24, compared with $167.4 million, $15.4 million, and $0.32, respectively, in fourth-quarter 2018.

Material changes versus the prior comparable period

• Operating revenue rose $16.4 million, including $25.4 million of estimated impact from rate changes, partly offset by lower MCBA revenue and increased deferred revenue.
• Operating expenses rose $27.5 million. Other operations expense increased $10.2 million, administrative and general expense increased $7.8 million, and depreciation and amortization increased $5.4 million.
• Operating cash flow decreased $10.2 million, primarily due to increased net WRAM and MCBA receivables as actual usage was below adopted levels. Those receivables totaled $62.6 million at year-end, up from $56.1 million.
• Debt financing changed substantially: the company issued $400 million of long-term bonds and repaid $405.6 million of long-term debt, while year-end revolving-credit borrowings increased by $110 million.
• Water production declined 2.7% to 104.7 billion gallons. Purchased water represented 51.3% of production, while well and surface supply represented 43.5% and 5.2%.

Outlook, risks, contingencies, and unusual items

• Rates and investment: The California 2018 General Rate Case remained pending at year-end. A settlement proposed $609 million to $628 million of new projects for 2019–2021, plus about $200 million for earlier projects; the company anticipated total capital investment of about $809 million to $828 million if adopted. The CPUC extended its decision deadline to July 1, 2020. Interim rates and a memorandum account provide for later customer-bill adjustments back to January 1, 2020, but adverse or delayed decisions could affect interim results. The filing gives no earnings guidance.
• Capital needs: Management estimated 2020 capital expenditures of $260 million to $290 million and expected annual investment to rise over the following five years. Funding is expected from operating cash flow, debt, equity, and developer contributions.
• Water supply: Management believed supplies would be adequate to meet demand in 2020 and beyond, while noting possible future rationing, rising wholesale-water prices, climate-related uncertainty, and groundwater sustainability requirements. California snowpack was 81% of long-term average in the Northern Sierra as of December 31, 2019.
• Operational and regulatory risks: Wildfires and public-safety power shutoffs may disrupt power and water service and increase backup-power costs; 2019 incremental PSPS costs were $1.6 million. Other material risks include water quality rules and contamination, environmental compliance costs, drought and climate impacts, inverse-condemnation claims, cybersecurity and IT disruption, and dependence on regulatory recovery of costs.
• Contingencies and unusual items: The company had received $56.0 million net of legal fees from a TCP contamination settlement and had used $47.6 million for remediation by year-end. It recorded a $2.5 million liability for known legal matters and stated that other pending matters were not expected to materially affect results. The TCJA-related ratepayer refund process remained under review; the filing reported $121.0 million of excess deferred tax liability before a gross-up, with total related regulatory liabilities of $168.0 million.
• Growth and transactions: Cal Water began serving Travis Air Force Base in July 2019 under a 50-year agreement, subject to unresolved rehearing and stay requests. Proposed acquisitions in Hawaii and Washington remained subject to conditions and regulatory approval. A new at-the-market equity program authorized up to $300 million of stock sales over three years; $19.3 million net proceeds had been raised by year-end.
• Audit: Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting. Rate regulation and management’s judgments about regulatory asset recovery were identified as a critical audit matter.

Important facts investors should verify

1. Final CPUC 2018 GRC decision, treatment of litigated issues, and resulting authorized rates and capital program.
2. Timing and collection of WRAM/MCBA balances, which affect cash flow and short-term financing needs.
3. 2020 capital spending, funding mix, revolving-credit utilization, and compliance with debt covenants.
4. Progress on TCP remediation and ratepayer refunds associated with the TCJA.
5. Outcome of the Travis Air Force Base rehearing matter and approvals for proposed water-system acquisitions.
6. Exposure to pension funding requirements, wildfire/PSPS costs, water-quality compliance, and water-supply constraints.