California Water Service Group — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited consolidated results; amounts below are in millions of dollars except per-share data. The company provides regulated and non-regulated water and related services across California, Washington, New Mexico, and Hawaii, and reports one operating segment. Water demand and earnings are typically higher in warm, dry months.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Operating revenue | $219.0 | $211.7 | $523.9 | $504.9 |
| Operating expenses | $173.4 | $169.3 | $445.2 | $425.2 |
| Net operating income | $45.5 | $42.5 | $78.7 | $79.7 |
| Net income | $34.4 | $33.8 | $44.9 | $53.5 |
| Diluted EPS | $0.72 | $0.70 | $0.93 | $1.11 |
| Net operating margin | 20.8% | 20.1% | 15.0% | 15.8% |
Q3 revenue increased 3.4% and net income increased 1.6% year over year. For the first nine months, revenue rose 3.8%, while net income fell 16.2%. Dividends declared were $0.1875 per share in Q3 and $0.5625 per share year to date, versus $0.1800 and $0.5400 in the comparable 2017 periods.
Cash flow, debt, and liquidity
- Nine-month operating cash flow was $119.5, up from $109.8. Utility-plant expenditures were $212.9, compared with $180.4, leaving substantial investment needs beyond internally generated cash.
- Cash and cash equivalents were $66.4 at September 30, 2018, down from $94.8 at year-end 2017. Cash, cash equivalents, and restricted cash totaled $67.1 for cash-flow reporting.
- Total debt, including current maturities, was approximately $819.1 at September 30, versus $531.7 at December 31, 2017. Long-term debt excluding current maturities was $714.3; current maturities were $104.8; short-term borrowings were $75.1.
- Cal Water issued $300.0 of floating-rate First Mortgage Bonds in September, due September 2020, at three-month LIBOR plus 70 basis points. Proceeds were primarily used to repay Cal Water revolving-credit borrowings.
- Revolving-credit availability at September 30 was $74.9 under the company facility and $300.0 under Cal Water’s facility. The company reported compliance with debt covenants and access to the full facilities.
- Management estimated 2018 utility-plant expenditures of $240–$260. Long-term funding is expected to use a relatively balanced mix of debt and equity.
Material changes and management commentary
- Q3: Net income increased $0.6, supported mainly by $4.4 of aggregate rate increases, lower write-offs of unrecoverable capital costs, and increased tax benefits. Offsets included higher depreciation, wages, new-business costs, and interest expense.
- Nine months: Net income declined $8.6. Management cited higher new-business expenses ($5.1), depreciation and amortization ($5.0), wages ($4.0), and interest expense ($3.5), along with lower unbilled-revenue accruals and benefit-investment valuation effects. Aggregate rate increases of $10.8 partially offset these items.
- Water-production costs rose 4.7% in Q3 and 5.7% year to date, primarily from higher water production and wholesaler rates. Administrative and other operating costs also increased, including employee, pension, health-care, consulting, and deferred-cost items.
- Interest expense increased as capital investment financing grew and short-term rates rose. The federal tax-rate reduction lowered income-tax expense; the company estimated a 2018 effective tax rate of 22%–25% before discrete items.
Outlook, regulation, and risks
- Cal Water’s July 2018 general-rate-case filing requested $828.5 of infrastructure investment for 2019–2021. Proposed revenue increases versus last authorized revenue were $50.7 (7.6%) for 2020, $31.5 (4.4%) for 2021, and $33.0 (4.4%) for 2022. The review was expected to take about 18 months, with rate changes anticipated in 2020; these are requests, not approved increases.
- The CPUC’s revised cost-of-capital decision lowered Cal Water’s authorized return on equity to 9.20% and return on rate base to 7.48%; new rates took effect July 1, 2018. The company recorded a $2.8 regulatory liability related to the cost-of-capital memorandum account.
- Tax-law customer rate reductions and related regulatory accounting remained subject to finalization. The company was working with regulators on an estimated $108.0 customer net refund; TCJA transition balances were provisional and final impacts could differ materially.
- Management believed water supplies would be adequate to meet demand in 2018 and beyond. California snowpack water content was 79% of long-term averages as of September 30; two Cal Water districts remained under declared drought conditions. New California water-use standards and groundwater sustainability requirements may affect future operations and costs.
- Risks include regulatory decisions and timing of rate relief or cost recovery, water availability and quality, weather and climate, conservation-related demand changes, purchased-water and power costs, infrastructure needs, interest rates and financing access, and litigation. Management reported no material change to the risk factors in the 2017 Form 10-K.
- The company renewed its 15-year lease to operate the City of Commerce water system effective April 3, 2018. It terminated its $68.25-per-share tender offer for San Jose Water Group in August; a subsequent $70-per-share proposal was rejected. No acquisition was reported as completed.
- Known legal-matter liabilities were $3.8 at September 30, down from $6.1 at year-end. Management did not expect resolution of existing matters, after reserves, to materially affect financial position, results, or cash flows.
Important facts for investors to verify
- Progress and decisions in the California and Washington rate cases, including timing and final customer-rate effects.
- Whether TCJA-related customer refunds and regulatory balances are finalized, and how the estimated $108.0 refund is allocated.
- Funding and execution of the $240–$260 2018 capital program and the company’s longer-term infrastructure plan.
- Debt maturity, floating-rate exposure, refinancing needs, and continued compliance with credit-facility covenants.
- Water-supply conditions, groundwater regulation, drought exposure, and the extent to which rising production costs can be recovered through rates.
- Whether earnings comparisons are affected by seasonal demand, deferred regulatory balances, unbilled revenue, and unusual or non-recurring expenses.