California Water Service Group — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; financial statements are unaudited. The company provides regulated water and related services in California, Washington, New Mexico, and Hawaii, alongside nonregulated services, and reports one operating segment. Water demand and results are seasonal, generally strongest in warm, dry months.
Financial performance and liquidity
Amounts below are in millions of dollars, except per-share data and percentages. Margins are calculated from reported figures.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenue | $184.3 | $183.5 | $458.4 | $449.9 |
| Net operating income | $30.1 | $32.2 | $54.9 | $56.2 |
| Net operating margin | 16.3% | 17.5% | 12.0% | 12.5% |
| Net income | $22.9 | $25.1 | $33.6 | $36.5 |
| Diluted EPS | $0.48 | $0.52 | $0.70 | $0.76 |
| Net interest expense | $7.7 | $6.7 | $22.6 | $19.9 |
- Revenue rose 0.4% in Q3 and 1.9% year to date, while net income declined 8.9% and 8.1%, respectively. Q3 net margin was 12.4% versus 13.7%; nine-month net margin was 7.3% versus 8.1%.
- Operating cash flow for the first nine months was $123.2 million, versus $116.5 million. Utility-plant expenditures were $166.4 million, versus $118.3 million, so operating cash flow did not cover investment outlays.
- Cash at September 30 was $21.4 million. Current assets were $151.1 million and current liabilities $204.0 million. Short-term borrowings were $57.1 million, up from $33.6 million at December 31, 2015.
- Long-term debt, including current maturities, totaled $561.7 million; adding short-term borrowings gives approximately $618.8 million of reported debt. Total capitalization was $1.21 billion, including $652.0 million of equity. The company reported compliance with credit-facility covenants and $392.9 million of unused revolving capacity.
- Utility plant expenditures for 2016 were budgeted at $180–$210 million. Dividends declared were $0.1725 per share quarterly in 2016, versus $0.1675 in 2015; the board declared the same $0.1725 fourth-quarter dividend.
Material changes and drivers
- Q3 water production costs increased $9.7 million (16.1%), primarily from higher purchased-water rates and production. For the first nine months, water production costs rose $10.2 million (6.4%); lower California consumption related to drought reduced associated MCBA revenue.
- Q3 net income included a $3.2 million write-off of engineering costs for a canceled water-treatment project that management did not expect to recover in the California general rate case. Higher depreciation and interest expense also weighed on results.
- Net interest expense increased 15.0% in Q3 and 14.0% year to date, mainly following $150 million of First Mortgage Bond issuances across late 2015 and March 2016. The March issuance was $50 million, with net proceeds of about $49.7 million.
- Year-to-date maintenance expense increased $1.8 million, while administrative and other operating expenses declined, mainly due to lower pension and uninsured-loss costs. An unrealized gain on benefit-plan insurance investments contributed to higher other income.
Outlook, regulation, and risks
- A September 2016 settlement proposed $658.8 million of California system investment for 2016–2018 and specified potential revenue increases of about $45.0 million in 2017, $17.2 million in 2018, and $16.3 million in 2019, plus up to $30.0 million for approved advice-letter projects. CPUC approval was pending; the company expected a decision by year-end 2016 and anticipated any resulting rate change to take effect January 1, 2017.
- Management estimated a 38% effective tax rate for 2016. It expected water supplies to be adequate for customer demand in 2016 and beyond, while noting below-average precipitation in central and southern California despite statewide snowpack and rainfall at 116% of normal for the 2015–2016 water year.
- California drought surcharges were ended effective July 29, 2016. The company revised its request for recovery of prior-year incremental drought costs to $2.9 million; recovery remained subject to CPUC approval. Year-to-date 2016 drought-related incremental expenses and capital totaled $4.6 million.
- Management expects to fund future utility-plant needs with a relatively balanced mix of long-term debt and equity. Seasonal cash needs, capital spending, conservation and weather-related water demand, purchased-water and power costs, regulatory decisions and rate-case timing, water quality and environmental requirements, and groundwater regulation are key risks.
- A settlement resolved claims concerning a water-main leak that discharged drinking water into Polhemus Creek. Cal Water paid $0.52 million and must replace 2,000 feet of main and perform streambed restoration; the settlement includes no admission of wrongdoing. Management said other litigation was not expected to materially affect results, subject to uncertainty.
Most important facts for investors to verify
- Whether and when the CPUC approved the California GRC settlement, and the final authorized investment and rate increases.
- Whether the $3.2 million canceled-project cost write-off or other GRC-related items receive any regulatory recovery.
- Actual 2016 capital expenditures, funding mix, and resulting debt and interest-cost trajectory.
- Collection timing and regulatory treatment of WRAM/MCBA balances, drought-cost recovery, and the effects of conservation and weather on water sales and cash flow.
- Progress and costs of the Polhemus Creek settlement projects, and developments in other legal or environmental matters.