California Water Service Group — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. The unaudited company provides regulated water and related services in California, Washington, New Mexico and Hawaii, alongside non-regulated services. Results are seasonal, with water use and revenue generally higher in warm, dry months.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Operating revenue | $172.6 million | $171.1 million | $304.9 million | $293.2 million |
| Net operating income | $25.1 million | $26.7 million | $33.1 million | $37.2 million |
| Net income | $13.0 million | $18.5 million | $10.5 million | $19.7 million |
| Diluted EPS | $0.27 | $0.39 | $0.22 | $0.41 |
| Operating cash flow | — | — | $49.6 million | $35.7 million |
| Utility plant expenditures | — | — | $133.9 million | $108.7 million |
Q2 operating margin was approximately 14.5%, versus 15.6% a year earlier; six-month operating margin was approximately 10.9%, versus 12.7%. Revenue rose 0.9% in Q2 and 4.0% for the half, but net income fell in both periods. The company attributed the six-month earnings decline primarily to new-business development costs, lower revenue associated with the cost-of-capital decision, higher depreciation, wages and interest, and lower unbilled-revenue accruals. Rate increases partly offset these pressures.
At June 30, cash and cash equivalents were $33.7 million, down from $94.8 million at December 31, 2017. Short-term borrowings were $325.1 million, compared with $275.1 million at year-end; long-term debt, including current maturities, totaled $519.6 million. The company reported $49.6 million of operating cash flow, $133.9 million of investing outflow and $23.2 million of financing inflow for the first half. Available capacity on its revolving credit lines was $94.9 million at the parent and $30.0 million at Cal Water. It reported compliance with credit covenants. Dividends declared were $0.1875 per share for Q2 and $0.3750 for the first half.
Material changes and management commentary
- Revenue and costs: Q2 revenue increased $1.5 million, while operating expenses rose $3.1 million. Management cited rate increases, including escalation and purchased-water offsets, alongside a $1.7 million revenue reduction related to the cost-of-capital decision and lower unbilled revenue. Water production costs increased with higher production and wholesaler rates.
- Six-month earnings: Revenue increased $11.7 million, but operating expenses rose $15.8 million and net income declined $9.2 million. Higher water production costs, administrative and other operating costs, depreciation, and interest weighed on results.
- Interest and taxes: Net interest expense increased 15.4% in Q2 and 10.8% for the first half, mainly due to short-term financing for capital projects and higher short-term rates. The federal tax-rate reduction from 35% to 21% lowered tax expense; management estimated a 2018 effective tax rate of 23%–25%.
- Accounting: ASC 606 was adopted January 1, 2018 using the modified retrospective method; management said it had no significant financial-statement impact. The company also adopted updated pension-cost and restricted-cash presentation rules.
Outlook, regulatory matters and risks
- Capital program: The 2018 budget estimated company-funded utility plant expenditures of $200–$220 million. Management expects utility plant needs to require long-term financing and anticipates a relatively balanced debt-and-equity approach. Construction work in progress was $210.4 million at June 30.
- California rate case: On July 2, 2018, Cal Water filed a general rate case seeking $828.5 million of infrastructure investment for 2019–2021 and proposed revenue increases of $50.7 million in 2020, $31.5 million in 2021 and $33.0 million in 2022. These are requests, not approved rates.
- Regulatory rates and recoveries: New cost-of-capital and federal-tax rates became effective July 1, 2018. The company recorded revenue reductions and regulatory liabilities for these matters. It was seeking recovery of $3.2 million of 2016–2017 drought expenses; the filing said recovery could be lower and a decision was expected by year-end 2018. A $50.1 million net under-collection of 2017 WRAM/MCBA balances was being recovered through customer surcharges.
- Water supply and operating risks: Management believed supplies would be adequate through 2018 and beyond. California snowpack was 79% of long-term averages at June 30, and two Cal Water districts remained under declared drought status. Risks include regulatory decisions and cost recovery, water availability and quality, weather and conservation, purchased-water and power costs, financing rates, and infrastructure needs.
- Acquisition activity: The company reported a $68.25-per-share all-cash proposal and tender offer for San Jose Water Group, valued at approximately $1.9 billion including assumed debt. SJW’s board had rejected the proposal; California Water Service Group was soliciting proxies in opposition to resolutions related to SJW’s pending merger with Connecticut Water Service. The tender offer was scheduled to expire September 28, 2018.
- Other items: The City of Commerce renewed Cal Water’s operating lease for 15 years. The company had $3.2 million in recognized liabilities for known legal matters at June 30 and said existing disputes were not expected to materially affect its financial position, results or cash flows. The filing also describes groundwater-contamination litigation and regulatory rules for the use of any proceeds.
Important facts for investors to verify
- Whether the proposed San Jose Water Group acquisition or tender offer proceeds, and its funding, regulatory and integration implications.
- Outcomes and timing of the California general rate case, cost-of-capital and tax-related rate adjustments, and requested drought-cost recovery.
- Whether planned capital spending, rate recovery and financing availability support liquidity while short-term borrowing and interest costs rise.
- How water production costs, usage, conservation, drought conditions and customer surcharges affect future revenue, margins and cash flow.
- Final customer refund and regulatory treatment of the estimated $108.0 million tax-related refund, which the company said was still being finalized with regulators.