Business context and reporting period
California Water Service Group filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. It provides regulated water and related utility services in California, Washington, New Mexico, and Hawaii, alongside non-regulated services. The company reports one segment. Results are seasonal, with water use and earnings generally higher in warm, dry months.
Financial performance and position
Amounts below are in millions of dollars except per-share data. Comparisons are with the corresponding 2016 period.
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Operating revenue | $211.7 | $184.3 | $504.9 | $458.4 |
| Net operating income | $41.2 | $30.1 | $74.5 | $54.9 |
| Net income | $33.8 | $22.9 | $53.5 | $33.6 |
| Diluted EPS | $0.70 | $0.48 | $1.11 | $0.70 |
| Net interest expense | $8.6 | $7.7 | $25.3 | $22.6 |
- Operating margin was approximately 19.5% in Q3 2017 versus 16.3% in Q3 2016, and 14.8% for the first nine months versus 12.0%.
- For the first nine months, operating cash flow was $109.8 million, compared with $123.8 million in the cash flow statement. Utility plant expenditures were $180.4 million; cash and cash equivalents ended the period at $28.3 million. Cash flow did not cover reported utility plant spending.
- At September 30, total assets were $2.60 billion, common equity $687.7 million, long-term debt including current maturities $555.7 million, and short-term borrowings $195.1 million. Short-term borrowings were $97.1 million at December 31, 2016.
- Revolving credit facilities totaled $450 million; $94.9 million of the parent company facility and $160.0 million of Cal Water’s facility remained available. The company reported compliance with credit covenants.
- Capital expenditures were $180.4 million in the first nine months. The 2017 company-funded utility plant expenditure budget was $200–$220 million. The quarterly dividend declared was $0.18 per share, versus $0.1725 in 2016.
Material changes and management commentary
Q3 revenue increased 14.9% and net income rose $10.9 million year over year. Nine-month revenue increased 10.1% and net income rose $19.9 million. Management attributed the gains principally to California rate increases under the 2015 General Rate Case, with additional contributions from higher unbilled revenue, equity allowance for funds used during construction (AFUDC), and lower drought-related costs. For the nine-month period, lower maintenance and unrealized gains on certain benefit-plan investments also supported results.
Higher operating costs partly offset growth: water production costs increased 7.3% in Q3 and 7.5% year to date; nine-month depreciation and amortization increased 20.7%, mainly reflecting utility plant additions. Net interest expense rose 11.8% year to date, primarily from greater short-term borrowing for capital investment and higher short-term rates. Equity AFUDC was newly recorded in 2017 following regulatory authorization.
Outlook, regulation, risks, and contingencies
- The California CPUC-approved GRC authorized gross revenue increases of approximately $45 million beginning in 2017, with further increases in 2018 and 2019 subject to an earnings test, and authorized $658.8 million of California system improvements over 2016–2018.
- A cost-of-capital application for 2018 sought a 10.75% return on equity and a 53.4% equity capital structure; a CPUC decision was anticipated by year-end 2017. Management also expected to seek recovery of 2016 and 2017 incremental drought costs.
- Management expected water supplies to be adequate for 2017 and beyond. California’s governor ended the drought emergency in most counties in April 2017, although two company districts remained under declared drought conditions.
- Management said long-term financing would be needed to support planned utility investment and anticipated a relatively balanced approach between long-term debt and equity. A $20 million First Mortgage Bond maturity was due in Q4 2017.
- Risks include regulatory decisions and rate relief timing, cost recovery, water availability and quality, conservation and weather, purchased water and power costs, interest rates and financing access, labor matters, and legal or environmental issues. Known legal-matter liabilities were $6.1 million; management did not expect existing disputes, net of reserves, to materially affect financial position, results, or cash flows.
- The company reported no material changes to its stated risk factors, no material change in contractual obligations outside the ordinary course, effective disclosure controls, and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile the cash flow comparison: the cash flow statement reports nine-month 2016 operating cash flow of $123.8 million, while MD&A cites $123.2 million.
- Track recovery and collection timing for the $61.6 million of under-collected net WRAM/MCBA receivables, which management said were partly financed with debt.
- Monitor regulatory outcomes, including the 2018 cost-of-capital case, GRC earnings-test conditions, and recovery of drought-related costs.
- Assess execution and financing needs for the $200–$220 million 2017 company-funded capital expenditure budget, rising short-term borrowings, and the Q4 $20 million bond maturity.
- Consider the seasonal, unbilled-revenue contribution to Q3 results and the sensitivity of operating costs and water supply to usage, weather, purchased-water prices, and conservation.