CALIFORNIA WATER SERVICE GROUP annual report, FY2017

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California Water Service Group — 2017 Form 10-K

Business context and reporting period. This annual report covers the year ended December 31, 2017; it is not a standalone fourth-quarter filing. The company provides regulated water and wastewater services and related nonregulated services in California, Hawaii, New Mexico, and Washington, serving approximately 514,300 customer connections. California generated about 93.9% of consolidated operating revenue.

Financial performance and position

  • Revenue: $666.9 million, up 9.4% from $609.4 million in 2016. Rate changes were the main driver; reported revenue also reflects regulatory balancing accounts and unbilled revenue estimates.
  • Profit and margins: Net income was $67.2 million versus $48.7 million; diluted EPS was $1.40 versus $1.01. Net operating income was $94.6 million versus $76.2 million. Calculated operating margin was approximately 14.2% versus 12.5%, and net margin approximately 10.1% versus 8.0%.
  • Fourth quarter: Revenue was $162.0 million and net income $13.7 million, compared with $150.9 million and $15.1 million, respectively, in fourth-quarter 2016; diluted EPS was $0.29 versus $0.31.
  • Cash flow and investment: Operating cash flow was $147.8 million, down from $160.4 million. Utility-plant expenditures were $259.2 million, up from $228.9 million; operating cash flow less plant expenditures was negative $111.4 million. Cash and cash equivalents ended the year at $94.8 million.
  • Debt and liquidity: Long-term debt, including current maturities, was $531.7 million; short-term revolving borrowings rose to $275.1 million from $97.1 million. Combined borrowings were approximately $806.8 million. The company reported compliance with credit covenants, a 56.5% consolidated capitalization ratio, and interest coverage above five times.
  • Other metrics: Total assets were $2.74 billion, net utility plant $2.05 billion, and common equity $693.5 million. The 2017 dividend was $0.72 per share; the board subsequently declared a quarterly dividend of $0.1875 per share.

Material changes versus 2016

  • Net income increased $18.5 million, primarily reflecting California rate increases, lower other operating expense, and a $2.5 million increase in estimated unbilled revenue. Higher depreciation, wages, property taxes, and interest expense partly offset the gains.
  • Water production expenses increased 9.9% to $241.9 million, including purchased water expense up 9.7% and pump taxes up 23.2%. Total estimated water production rose 6.0%.
  • Depreciation and amortization increased $13.2 million, or 20.7%, reflecting capital additions and a higher depreciation provision.
  • Short-term borrowings increased substantially as the company financed capital spending and general corporate needs. Capital expenditures exceeded the 2017 budget’s stated high end of $230 million.
  • The 2017 tax-law change reduced the federal corporate tax rate from 35% to 21%. The company recorded provisional tax remeasurement amounts and a related $108 million estimated net refund obligation to customers; final allocation and regulatory treatment remained subject to review.

Outlook, commentary, risks, and unusual items

  • Management expected water supplies to be adequate for 2018 and beyond, while acknowledging that rationing could be required in future periods. California’s 2017–2018 water-year snowpack was below long-term averages in the reported regions, and two districts remained under drought declarations.
  • Management estimated 2018 capital expenditures of $200 million to $220 million and anticipated higher annual infrastructure investment over the following five years. The company expects to fund long-term needs through operating cash flow, debt, and common-stock issuance.
  • A CPUC administrative law judge’s proposed cost-of-capital decision would reduce Cal Water’s authorized return on equity from 9.43% to 8.22%. If adopted unchanged, management estimated an approximately $13 million reduction in California customer rates, 2018 net income, and operating cash flow. The full Commission had not yet acted.
  • The 2015 California rate-case decision authorized $658.8 million of system improvements over 2016–2018. Cal Water also sought approval to serve Travis Air Force Base under a 50-year agreement, with initial improvements estimated at $12.7 million and anticipated investment of about $52 million over the term.
  • Cal Water settled TCP contamination claims for $85 million gross; net proceeds after legal fees were $56 million and were received in 2017. The proceeds are intended to reimburse a portion of remediation-related capital costs. The settlement releases claims concerning specified wells subject to stated treatment or replacement conditions for other wells.
  • The City of Commerce system lease was due to expire in June 2018; the company had bid to continue operating the system, with the outcome expected in 2018.
  • Key risks include regulatory rate-setting and cost-recovery delays, water availability and quality, weather and drought, wholesale water-price changes and supply-contract commitments, high capital needs and financing costs, pension obligations, environmental compliance and litigation, labor matters, and cybersecurity or operational disruption. The company reported a $6.1 million liability for known legal matters; management did not expect their resolution to materially affect consolidated results.

Important facts for investors to verify

  • Final CPUC action on the proposed cost of capital and the resulting customer-rate, earnings, and cash-flow effects.
  • Final regulatory treatment and customer refund schedule for the estimated $108 million tax-related amount, and any subsequent adjustments to provisional tax accounting.
  • Timing and collectability of the $71.6 million year-end net WRAM/MCBA receivable, which increased from $39.2 million and contributed to lower operating cash flow.
  • Whether the $56 million TCP settlement proceeds adequately cover the relevant remediation investment and how remaining well-treatment obligations develop.
  • Availability and cost of financing for the planned capital program, given higher revolving-credit borrowings and capital spending above the 2017 budget range.
  • Approval and execution of the Travis Air Force Base service application, the City of Commerce lease outcome, and progress on planned 2018 capital expenditures.