(Dollar amounts in thousands, except where otherwise noted and per share
amounts)
FORWARD LOOKING STATEMENTS
This quarterly report, including all documents incorporated by reference,
contains forward-looking statements within the meaning established by the
Private Securities Litigation Reform Act of 1995 (Act). Forward-looking
statements in this quarterly report are based on currently available
information, expectations, estimates, assumptions and projections, and our
management's beliefs, assumptions, judgments and expectations about us, the
water utility industry and general economic conditions. These statements are not
statements of historical fact. When used in our documents, statements that are
not historical in nature, including words like "expects," "intends," "plans,"
"believes," "may," "estimates," "assumes," "anticipates," "projects,"
"predicts," "forecasts," "should," "seeks," or variations of these words or
similar expressions are intended to identify forward-looking statements. The
forward-looking statements are not guarantees of future performance. They are
based on numerous assumptions that we believe are reasonable, but they are open
to a wide range of uncertainties and business risks. Consequently, actual
results may vary materially from what is contained in a forward-looking
statement.
Factors which may cause actual results to be different than those expected or
anticipated include, but are not limited to:
† governmental and regulatory commissions' decisions, including
decisions on proper disposition of property;
† changes in regulatory commissions' policies and procedures;
† the timeliness of regulatory commissions' actions concerning rate
relief;
† changes in the capital markets and access to sufficient capital on
satisfactory terms;
† new legislation;
† changes in accounting valuations and estimates;
† changes in accounting treatment for regulated companies, including
adoption of International Financial Reporting Standards, if required;
† electric power interruptions;
† increases in suppliers' prices and the availability of supplies
including water and power;
† fluctuations in interest rates;
† changes in environmental compliance and water quality requirements;
† acquisitions and the ability to successfully integrate acquired
companies;
† the ability to successfully implement business plans;
† civil disturbances or terrorist threats or acts, or apprehension
about the possible future occurrences of acts of this type;
† the involvement of the United States in war or other hostilities;
† our ability to attract and retain qualified employees;
† labor relations matters as we negotiate with the unions;
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† federal health care law changes that could result in increases to
Company health care costs and additional income tax expenses in future years;
† changes in federal and state income tax regulations and treatment
of such by regulatory commissions;
† implementation of new information technology systems;
† changes in operations that result in an impairment to acquisition
goodwill;
† restrictive covenants in or changes to the credit ratings on
current or future debt that could increase financing costs or affect the ability
to borrow, make payments on debt, or pay dividends;
† general economic conditions, including changes in customer growth
patterns and our ability to collect billed revenue from customers;
† changes in customer water use patterns and the effects of
conservation;
† the impact of weather on water sales and operating results;
† the ability to satisfy requirements related to the Sarbanes-Oxley
and Dodd Frank Acts and other regulations on internal controls; and
† the risks set forth in "Risk Factors" included in the Company's
Annual Report on Form 10-K.
In light of these risks, uncertainties and assumptions, investors are cautioned
not to place undue reliance on forward-looking statements, which speak only as
of the date of this quarterly report or as of the date of any document
incorporated by reference in this report, as applicable. When considering
forward-looking statements, investors should keep in mind the cautionary
statements in this quarterly report and the documents incorporated by reference.
We are not under any obligation, and we expressly disclaim any obligation, to
update or alter any forward-looking statements, whether as a result of new
information, future events or otherwise.
CRITICAL ACCOUNTING POLICIES
We maintain our accounting records in accordance with accounting principles
generally accepted in the United States of America (GAAP) and as directed by the
Commissions to which our operations are subject. The process of preparing
financial statements in accordance with GAAP requires the use of estimates on
the part of management. The estimates used by management are based on historic
experience and an understanding of current facts and circumstances. Management
believes that the following accounting policies are critical because they
involve a higher degree of complexity and judgment, and can have a material
impact on our results of operations, financial condition, and cash flows of the
business. These policies and their key characteristics are discussed in detail
in the 2011 Form 10-K. They include:
† revenue recognition and the water revenue adjustment mechanism;
† modified cost balancing accounts;
† expense balancing and memorandum accounts;
† regulatory utility accounting;
† income taxes;
† pension benefits;
† workers' compensation and other claims;
† goodwill accounting and evaluation for impairment; and
† contingencies.
For the three and six month periods ended June 30, 2012, there were no changes
in the methodology for computing critical accounting estimates, no additional
accounting estimates met the standards for critical accounting policies, and
there were no material changes to the important assumptions underlying the
critical accounting estimates.
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RESULTS OF SECOND QUARTER 2012 OPERATIONS COMPARED TO
SECOND QUARTER 2011 OPERATIONS
Amounts in thousands except share data
Overview
Second quarter of 2012 net income was $13.0 million or $0.31 per diluted common
share compared to net income of $12.2 million or $0.29 per diluted common share
in the second quarter of 2011. The increase in net income is primarily
attributable to 2011 rate increases from the General Rate Case (GRC) and a
decrease in net interest expense, which was partially offset by higher operating
expenses.
Operating Revenue
Operating revenue increased $12.2 million or 9% to $143.6 million in the second
quarter of 2012. As disclosed in the following table, the increase was primarily
due to rate increases.
The factors that primarily impacted the operating revenue for the second quarter
of 2012 compared to 2011 are:
Rate increases $ 8,873
Net change due to actual versus adopted results, usage, and other 3,282
Net operating revenue increase
$ 12,155
The net change due to actual versus adopted results, usage, and other in the
above table refers primarily to the revenue impact year over year of the change
in revenue recognized by the WRAM and MCBA. The WRAM is impacted by changes in
consumption patterns from our historical trends as well as an increase in
conservation efforts. The MCBA, which records the differences in production
costs from the adopted costs, is recorded as an element of revenue as it
represents pass through costs which are billed to customers. The MCBA is
impacted by changes in total production quantities, the production mix of the
source of water, the price paid for purchased water and power, and the amount of
pump taxes paid.
The components of the rate increases are listed in the following table:
Purchase water offset increases $ 5,929
Step rate increases 2,184
General rate case (GRC) increases 681
Other 79
Total increase in rates $ 8,873
Total Operating Expenses
Total operating expenses were $123.9 million for the second quarter of 2012,
compared to $111.8 million for the same period in 2011, an 11% increase.
Water production expense consists of purchased water, purchased power, and pump
taxes. It represents the largest component of total operating expenses,
accounting for approximately 43% of total operating expenses in the second
quarter of 2012. Water production expenses increased $7.9 million, or 18%,
during the second quarter of 2012 compared to the same period last year due to
purchased water and power price increases, and pump taxes were higher due to
increased usage of wells subject to pump taxes during the second quarter of
2012. These cost increases were partially offset by reductions in customer
usage. Our 100% owned operating subsidiaries, Washington Water, New Mexico
Water, and Hawaii Water obtain all of their water supply from wells.
Sources of water as a percent of total water production are listed in the
following table:
Three months Ended June 30
2012 2011
Well production 47 % 46 %
Purchased 47 % 47 %
Surface 6 % 7 %
Total 100 % 100 %
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The components of water production costs are shown in the table below:
Three months Ended June 30
2012 2011 Change
Purchased water $ 41,935 $ 34,938 $ 6,997
Purchased power 7,995 7,482 513
Pump taxes 2,748 2,325 423
Total $ 52,678 $ 44,745 $ 7,933
Purchased water costs increased due to price increases from water wholesalers.
Total water production, measured in acre feet, increased by 4% during the second
quarter of 2012 as compared with the second quarter of 2011 due to higher
customer usage.
Administrative and general expense and other operations expense increased 10% to
$39.9 million. The primary reasons for the increase were increases in employee
benefits and wage costs, and conservation program expenses during the second
quarter of 2012. Wage increases became effective January 1, 2012. At June 30,
2012, there were 1,114 employees and at June 30, 2011, there were 1,132
employees.
Maintenance expenses decreased by 13% to $4.6 million in the second quarter of
2012 compared to $5.3 million in the second quarter of 2011, due to a decrease
in main and service repairs.
Depreciation and amortization expense increased $1.3 million, or 11%, mostly due
to 2011 capital additions.
Federal and state income taxes charged to operating expenses and other income
and expenses increased $0.4 million, from a provision of $8.8 million in the
second quarter of 2011 to $9.2 million in the second quarter of 2012, due to an
increase in pretax income and a higher effective tax rate in 2012. We expect the
effective tax rate to be between 38% and 42% for fiscal year 2012.
Other Income and Expense
Other income, net of income taxes, increased less than $0.1 million during the
second quarter of 2012 mostly due to a decrease in the unrealized loss on our
benefit plan insurance investments during 2012.
Interest Expense
Total interest expense, net of interest capitalized, decreased $0.7 million to
$6.9 million for the second quarter of 2012 compared to the same period last
year. This decrease was attributable to an increase in capitalized interest
charged to construction projects and a reduction in line-of-credit interest
rates and fees during the second quarter of 2012 compared to the same period
last year.
Company Health Care Benefits
In March 2010, both the federal "Patient Protection and Affordable Care Act"
(P.L. 111-148) and "Health Care and Education Reconciliation Act" (H.R. 4872)
were enacted. We have not determined the impact of this legislation on the
Company's health care costs during 2012 and in future years. However, we
anticipate that the Company's health care and other costs will increase as a
result of the new federal health care laws and based on available information.
A new memorandum account was established for Cal Water, effective January 1,
2011, to account for health care cost changes due to federal legislation, as
these costs were not included in the 2009 GRC decision.
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RESULTS OF THE SIX MONTHS ENDED JUNE 2012 COMPARED TO
THE SIX MONTHS ENDED JUNE 2011 OPERATIONS
Amounts in thousands except per share data
Overview
Overview
Net income for the six-month period ended June 30, 2012 was $14.1 million or
$0.34 per diluted common share compared to net income of $14.9 million or $0.36
per diluted common share for the six month period ended June 30, 2011. The
decrease in net income during the six month period ended June 30, 2012 was
mostly due to a nonrecurring income tax adjustment recorded during the first
quarter of 2011 that reduced income taxes by $1.6 million. Other income
increased $0.7 million mostly due to an increase in the amount of unrealized
gains on our benefit plan insurance investments during the six month period
ended June 30, 2012 compared to the same period last year.
Operating Revenue
Operating revenue increased $30.8 million or 13% to $260.3 million in the six
month period ended June 30, 2012. As disclosed in the following table, the
increase was due to increases in usage (includes an additional $9.5 million of
net WRAM and MCBA operating revenues that were deferred as of December 31, 2011)
and rates.
The factors that impacted the operating revenue for the second quarter of 2012
compared to 2011 are as follows:
Usage (includes WRAM and MCBA deferral adjustment) $ 19,823
Rate increases
14,564
Net change due to actual versus adopted results and other (3,632 )
Net operating revenue increase
$ 30,755
The net change due to actual versus adopted results, usage, and other in the
above table refers primarily to the revenue impact year over year of the change
in revenue recognized by the WRAM and MCBA. The WRAM is impacted by changes in
consumption patterns from our historical trends as well as an increase in
conservation efforts. The MCBA, which records the differences in production
costs from the adopted costs, is recorded as an element of revenue as it
represents pass through costs which are billed to customers. The MCBA is
impacted by changes in total production quantities, the production mix of the
source of water, the price paid for purchased water and power, and the amount of
pump taxes paid.
The components of the rate increases are as follows:
Purchased water offset increases $ 9,762
Step rate increases 3,570
General rate case (GRC) increases 953
Other 279
Total increase in rates $ 14,564
Total Operating Expenses
Total operating expenses were $234.1 million for the six month period ended
June 30, 2012, compared to $200.0 million for the same period in 2011, a 17%
increase.
Water production expense consists of purchased water, purchased power, and pump
taxes. It represents the largest component of total operating expenses,
accounting for approximately 39% of total operating expenses in the six month
period ended June 30, 2012. Water production expenses increased 20% compared to
the same period last year mostly due to increased costs for purchased water. Our
100% owned operating subsidiaries, Washington Water, New Mexico Water, and
Hawaii Water obtain all of their water supply from wells.
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Sources of water as a percent of total water production are listed in the
following table:
Six months Ended June 30
2012 2011
Well production 46 % 45 %
Purchased 49 % 48 %
Surface 5 % 7 %
Total 100 % 100 %
The components of water production costs are shown in the table below:
Six months Ended June 30
2012 2011 Change
Purchased water $ 73,791 $ 60,469 $ 13,322
Purchased power 13,137 12,332 805
Pump taxes 4,702 3,902 800
Total $ 91,630 $ 76,703 $ 14,927
Purchased water costs increased primarily due to price increases from water
wholesalers. Total water production measured in acre feet increased by 11,935
acre feet for the six month period ended June 30, 2012, or 7% over the six month
period ended June 30, 2011.
Administrative and general expense and other operations expense increased 21% to
$86.7 million. The primary reason for the increase was an additional $7.7
million of net WRAM and MCBA expenses resulting from the reversal of amounts
deferred as of December 31, 2011, increases in employee benefits and wage costs,
and increases in conservation program expenses during the six month period ended
June 30, 2012. Wage increases became effective January 1, 2012.
Maintenance expense decreased by 1% to $10.4 million during the six month period
ended June 30, 2012 compared to $10.5 million during the six month period ended
June 30, 2011, due to a decrease in transmission and distribution mains repairs.
Depreciation and amortization expense increased $2.7 million, or 11%, mostly due
to 2011 capital additions.
Federal and state income taxes charged to operating expenses and other income
and expenses increased $2.2 million, during the six month period ended June 30,
2012 mostly because of a 2011 nonrecurring income tax adjustment which reduced
income taxes $1.6 million during the first quarter of 2011. We expect the
effective tax rate to be between 38% and 42% for fiscal year 2012.
Other Income and Expense
Other income, net of income taxes, increased $0.7 million mostly due to an
unrealized gain on our benefit plan insurance investments of $1.6 million for
the six month period ended June 30, 2012, compared to an unrealized gain of less
than $0.1 million in the same period last year.
Interest Expense
Net interest expense, net of interest capitalized, decreased $1.7 million, or
11%, to $13.6 million for the six month period ended June 30, 2012 compared to
the same period last year. The decrease was mostly due to an increase in
capitalized interest charged to construction projects, a reduction in
line-of-credit interest rates and fees, and the end of temporary interest rate
balancing account (TIRBA) interest expenses as of December 31, 2011.
REGULATORY MATTERS
The state regulatory commissions have plenary powers setting rates and operating
standards. As such, state commission decisions significantly impact Cal Water's
revenues, earnings, and cash flows. The amounts discussed herein are generally
annual amounts, unless specifically stated, and the financial impact to recorded
revenue is expected to occur over a 12-month period from the effective date of
the decision. In California, water utilities are required to make several
different types of filings. Most filings result in rate changes that remain in
place until the next General Rate Case (GRC). As explained below, surcharges and
surcredits are used to recover balancing and memorandum accounts as well as
general rate case interim rate catch-up. Surcharges and surcredits are temporary
rate changes, which have specific time frames for recovery.
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GRCs, escalation rate increase filings, and offset filings change rates to
amounts that will remain in effect until the next GRC. The CPUC follows a rate
case plan, which requires Cal Water to file a GRC for each of its regulated
operating districts every three years. In a GRC proceeding, the CPUC not only
considers the utility's rate setting requests, but may also consider other
issues that affect the utility's rates and operations. The CPUC is generally
required to issue its GRC decision prior to the first day of the test year or
authorize interim rates. In accordance with the rate case plan, the Commission
issued a decision on Cal Water's 2009 general rate case filing in the fourth
quarter of 2010 with rates effective on January 1, 2011. Cal Water filed its
2012 GRC on July 5, 2012, which will be applicable to all of its California
Districts. Any rate change as a result of this filing is expected to be
effective on January 1, 2014.
Between GRC filings utilities may file escalation rate increases, which allow
the utility to recover cost increases, primarily from inflation and incremental
investment, during the second and third years of the rate case cycle. However,
escalation rate increases are subject to a weather-normalized earnings test on a
district-by-district basis. Under the earnings test, the CPUC may reduce the
escalation rate increase if, in the most recent 12-month period, this earnings
test reflects earnings in excess of authorized for that district.
In addition, California water utilities are entitled to make offset filings.
Offset filings may be filed to adjust revenues for construction projects
authorized in GRCs when the plant is placed in service or for rate changes
charged to the Company for purchased water, purchased power, and pump taxes
(referred to as "offsettable expenses"). Such rate changes approved in offset
filings remain in effect until the next GRC is approved.
The Water Revenue Adjustment Mechanism (WRAM) and Modified Cost Balancing
Account (MCBA) are required by the CPUC to encourage Cal Water to promote lower
water consumption levels with water conservation programs. In order to maintain
revenue neutrality, the CPUC de-coupled Cal Water's revenue requirement from
ratepayer usage with the WRAM/MCBA. Under the WRAM/MCBA, Cal Water recovers the
full quantity revenue amounts authorized by the CPUC by using advice letter
filings for any unbilled quantity revenue amounts or refunds for overcollection,
regardless of customer usage volumes.
Surcharge and surcredit advice letters to amortize balances in the WRAM and MCBA
accounts are filed between February and April of each year based on the district
balances for the last calendar year. Based on current CPUC interpretations,
surcharges are generally amortized over 12 or 18 months. The WRAM and MCBA
amounts are cumulative, so if they are not amortized in a given calendar year,
the balance will be carried forward and included with the following year
balance.
2012 Regulatory Activity
Changes in CPUC's Procedures for WRAM Amortization
Cal Water, along with four other investor-owned water utilities filed a joint
application to change the amortization periods to 24 months or less. The CPUC
issued a proposed decision regarding the amortization periods on March 23, 2012
and a final decision on April 19, 2012. The final decision shortened the
amortization for undercollected balances for calendar years 2011, 2012, and
2013. Also, the decision authorized Cal Water to bill and collect all year-end
undercollected balances. Cal Water anticipates most of the undercollected
balances during calendar years 2011, 2012, and 2013 will be collected using 12
and 18- month amortization periods. The collection periods for calendar year
2014 and future years will be determined during the 2012 GRC.
Remaining Balances from Previously Authorized Balancing Accounts
Recoveries/Refunds
Prior to the adoption of the MCBA on July 1, 2008, the CPUC required incremental
cost balancing accounts (ICBA) memorandum and balancing accounts. The ICBA
refunds and billings will be completed during calendar year 2012. As of June 30,
2012, a $0.7 million regulatory asset and a $0.3 million regulatory liability
were recorded for the remaining unbilled or un-refunded balances.
California Cost of Capital Applications
Cal Water, along with the three other large water utilities in California, filed
an application with the CPUC in May of 2011 to review its cost of capital for
2012 through 2014. The Company and the other applicants reached a settlement
with the Division of Ratepayer Advocates that was approved by the CPUC in
Decision D.12.07.009. The decision required Cal Water to adopt a 9.99% return on
equity and 53.4% equity capital structure for rate setting purposes. It also
continues the Water Cost of Capital Mechanism, which would adjust allowed equity
returns if there is a large change in the Moody AA utility bond index. The
decision also discontinued the Temporary Interest Rate Balancing Account (TIRBA)
and required Cal Water to refund the balance of $1.1 million to customers via a
12-month surcredit. Because this proceeding was scheduled to set the authorized
rate of return for the Company's investment starting on January 1, 2012 and a
decision had not been issued, the CPUC required Cal Water to file an advice
letter to establish a Cost of Capital interim rate memorandum account. This will
serve as a mechanism to true up rates to reflect the final decision in this
proceeding.
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2012 California GRC filing
On July 5, 2012, Cal Water filed its 2012 GRC application covering all district
and general office revenue requirements. The GRC application requested an
increase of $92.7 million or 19.4% in rates for 2014, $17.2 million or 3.0% in
rates for 2015 and $16.9 million or 2.9% in rates for 2016. The GRC also asks
the CPUC consider a number of special requests. Any rate change as a result of
this filing is expected to be effective on January 1, 2014
2009 California GRC Decision
On July 2, 2009, Cal Water filed its 2009 GRC application covering all district
and general office revenue requirements. The GRC application requested an
increase of $70.6 million or 16.75% in rates for 2011, $24.8 million or 5.04% in
rates for 2012 and $24.8 million or 4.79% in rates for 2013. On December 2,
2010, the CPUC issued decision 10-12-017, which approved a settlement between
Cal Water, the Division of Ratepayer Advocates, and several intervenors
representing the interests of individual district customers. This decision
allows for revenue increases of $25.4 million or 5.6% in 2011. Cal Water is also
allowed to file for increases of $9.6 million or 2.0% for 2012, and $9.0 million
or 2.0% for 2013 subject to adjustment for indexed inflation and contingent upon
passing a weather normalized earnings test. This decision also allows for offset
increases after construction of 77 large capital projects in various operating
districts.
In addition, the Company was authorized to make a deviation from its escalation
expense and exclude employee health care, retiree health insurance, and
conservation expenses from it escalation filings in 2012 and 2013. Instead for
these three significant expense items, the CPUC has enumerated fixed three-year
budgets for these expenses. It is anticipated that the budgets for these areas
will more closely align with the actual expenses now that this change has been
initiated.
The CPUC also authorized a Pension Balancing Account to track the difference
between authorized pension contributions included in rates and the costs
actually incurred. It is anticipated that this account will allow Cal Water to
reduce some of the volatility it experiences in regard to the recovery of these
costs from customers.
The Company was also authorized to combine the rates and tariffs of the South
San Francisco and the Mid Peninsula Districts, located on the San Francisco
peninsula, into a single ratemaking area in 2011. This new ratemaking area is
known as the Bayshore District. Previously, the two separate districts had been
operated out of a combined location.
Due to the transition between a phased rate case and a total company filing, the
CPUC delayed the rate cases of 16 Cal Water districts. However, to compensate
for this delay, the CPUC authorized interim rates from the authorized effective
date under the old rate case plan. The difference between revenue requirements
that were effective in the interim period and those calculated based on a final
determination in the 2009 general rate case filing totaled $6.7 million and is
being recovered as customer surcharges over a three-year period. During 2011,
$3.8 million was billed and recorded as revenue. The remaining balance of $2.9
million is expected to be recovered during 2012 and 2013, and will be recorded
as revenue when billed. Overcollected amounts from ratepayers will be recorded
as regulatory liability during the reporting period in which it occurs. As of
June 30, 2012, the overcollected amount of $0.5 million was recorded as a
regulatory liability.
In January 2012, Cal Water implemented escalation rate increases in 17
districts. The annual revenue associated with these increases is $8.7 million.
Low Income Ratepayer Assistance Program
Cal Water currently administers a Low Income Ratepayer Assistance Program in
accordance with decision D.06-11-053. This program provides qualifying low
income customers with a 50% discount on their service charge (up to a maximum of
$12 per month). It imposes a surcharge on non-qualifying customers of $0.01 per
hundred cubic feet of monthly water consumption for metered customers and
between $0.24 and $0.41 per flat rate service per month. Due to a successful
enrollment of over 47,000 customers, this account had accumulated an under
collection of approximately $6.8 million as of June 30, 2012, and is recorded in
non-current regulatory assets. During the second quarter of 2012, Cal Water
filed a petition to modify D.06-11-053 to 1) increase surcharges to balance
program expenses and revenues, 2) amortize the current balance in the program,
and 3) establish an annual adjustment mechanism to reduce the potential for
large balances in the future. On May 25, 2012, Cal Water and the Division of
Ratepayer Advocates (DRA) filed a full settlement of the application with the
Commission. The settlement would allow Cal Water to 1) raise its LIRA surcharge
to account for more eligible customers in the program; 2) adjust surcharges on
an annual basis; and 3) put in place a temporary surcharge to recover the
accumulated balance in the program account. Cal Water anticipates that the
unopposed settlement will be approved by the Commission, but the timing and
resolution of the matter are subject to normal regulatory uncertainty.
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2010 Ka'anapali (Hawaii) GRC Filing
On December 30, 2010, Hawaii Water filed its 2010 GRC application for the
Ka'anapali Service Area. The Hawaii Public Utilities Commission (HPUC) requires
a separate rate application for all service areas and uses a limited future test
year. The Ka'anapali GRC requested additional revenue of $1.5 million or an
increase of 38.2% over the prior year. Hawaii Water and the Consumer Advocate of
the HPUC reached a tentative settlement on this rate increase. On January 11,
2012, the HPUC issued a Decision and Order approving the stipulated settlement.
This resulted in a $1.2 million, or 30.8%, annual revenue increase that was
effective March 2012.
2011 Pukalani (Hawaii) GRC Filing
In August 2011, Hawaii Water filed a general rate case for the Pukalani
wastewater system requesting $1.3 million in additional annual revenues. Hawaii
Water began settlement negotiations with the Consumer Advocate in early 2012. At
this time, Hawaii Water cannot determine timing or final amount of rate relief
this filing will generate.
2011 Washington Water GRC Filing
In 2011, Washington Water filed a general rate case for its operations. It
requested a $1.7 million, or 21.8%, increase in revenue. On January 26, 2012,
the Washington Utilities and Transportation Commission approved a $1.6 million,
or 20.0%, increase effective February 2012.
Federal Income Tax Bonus Depreciation
In 2011, Cal Water filed for and received approval to track the benefits from
federal income tax accelerated depreciation in a memorandum account due to the
Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of
2010. Additional federal income tax deductions for assets placed in service
after September 8, 2010 and before December 31, 2011 was $6.6 million for 2010
and estimated at $10.5 million for 2011. The CPUC will determine the disposition
of amounts recorded in the memorandum account in Cal Water's next GRC.
Request for MTBE regulatory treatment
The CPUC in its Decision (D.) 10-10-018 issued rules for treating contamination
proceeds generally. Subsequently, the CPUC's D.11-03-043 resolved Cal Water's
separate application for treatment of MTBE proceeds by ordering continued
tracking of the proceeds and expenditures until litigation and remediation are
both complete. The new rules allow Cal Water to file an advice letter to move
proceeds from this tracking account into Contributions in Aid of Construction
("CIAC") when remediation or replacement projects are complete. Cal Water has
completed several such projects totaling $16.7 million. While the advice letters
have not been filed for some of these projects, Cal Water believes it is
probable the CPUC will treat the invested amounts as CIAC when the advice
letters are filed. The Company reclassified $16.7 million from regulatory and
other liabilities to CIAC during 2011. Project costs totaling $9.1 million were
treated as CIAC in setting rates in the 2009 General Rate Case effective
January 1, 2011, so there is no rate impact for this reclassification. For
projects not identified in the 2009 General Rate Case, as projects to remediate
or replace MTBE-contaminated plant are completed, the Company will book a
reclassification from other long-term liabilities to CIAC and adjust rate base
during the next GRC. The CPUC's adopted rules would require all contamination
proceeds to be used first to pay transactional expenses, then to make ratepayers
whole for costs to ensure the water system complies with the CPUC's water
quality standards. The rules allow for a risk-based consideration of proceeds
which exceed the costs of the remediation described above and may result in some
sharing of excess, or "net" proceeds. Because treatment or replacement of Cal
Water's MTBE contaminated wells will occur over a number of years, a final
disposition of Cal Water's memorandum account will occur at an unknown future
date. Cal Water will continue to monitor proceeds and remediation and will
report to the CPUC in its next GRC. Because of uncertainty surrounding eventual
remediation capital and operating costs and the eventual ratemaking treatment of
"net proceeds" as defined by the CPUC, Cal Water cannot predict the future
disposition of its partial MTBE settlement proceeds at this time.
Service Line Insurance Billing
As a consequence of D.07-12-055 which resolved Cal Water's 2006 GRC, Cal Water
was required to demonstrate that its non-regulated Extended Service Protection
(ESP) business or its successor complies with CPUC rules. Cal Water made an
administrative compliance filing in 2008 which was rejected. Cal Water
subsequently filed A.08-05-019 requesting Commission confirmation that the
interaction between Cal Water, CWS Utility Services, and Home Service USA
complied with all applicable rules. During the proceeding, the CPUC established
a memorandum account to record Cal Water's revenues and expenses related to the
non-regulated service line insurance business. The application is being
processed in 2011 and 2012 after the CPUC adopted comprehensive rules for the
relationships between regulated utilities and their unregulated affiliates and
the rules for offering non-tariffed products and services. These rules went into
effect on June 30, 2011 as a result of D.10-10-019. The CPUC's ratepayer
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advocate testified that Cal Water's customers should receive some of the
proceeds from the sale of the non-regulated ESP business as well as other
program revenues. While Cal Water challenged these claims and presented its own
testimony, the parties were able to reach a settlement on all issues in the
case. The proposed settlement, which was filed in October 2011, describes the
accounting and revenue sharing applicable to the non-regulated service line
business after June 30, 2011 and proposes a monetary settlement of $2.1 million
to ratepayers to resolve all issues related to non-regulated service line
business activity from 2007 through June 30, 2011. The settlement is still
subject to approval by the CPUC. Cal Water anticipates that the CPUC will
approve the settlement in the fourth quarter of 2012. A $2.1 million regulatory
liability and reduction to revenues was recorded during the third quarter of
2011. The amount is expected to be refunded on ratepayer bills over a 12-month
period.
2012 Expense Offset filings
In 2012, Cal Water filed advice letters to offset increased purchased water and
pump tax rates in nine of its regulated districts totaling $13.2 million in
annual revenue. Expense offsets are dollar-for-dollar increases in revenue to
match increased expenses and interact with the WRAM and MCBA mechanisms so that
net operating income is not affected by an offset increase.
In May, Cal Water filed an advice letter to recover the cost relating to the
expense of hiring 6 additional Cross Connection Control Inspectors. These
positions were approved in the 2009 GRC and Cal Water was allowed to file for
the recovery of the positions and associated equipment after the positions were
hired. The annual revenue increase from this filing is $0.6 million. In the
future, Cal Water plans to file advice letters to offset expected increases in
purchased water and pump tax charges in some districts. Cal Water cannot predict
the exact timing or dollar amount of the changes.
2012 Ratebase Offset filings
In 2012, Cal Water filed advice letters to offset several infrastructure
improvement projects in seven districts totaling $2.0 million in annual revenue.
For some of these offsets, Cal Water also filed 12 month surcredits to the
customers to account for the use of internal labor to complete the flat to meter
projects. These surcredits total $1.2 million. Companies are allowed to file
rate base offsets to increase revenues for construction projects authorized in
GRCs when the plant is placed in service. The project for this filing was
authorized in the 2009 GRC. The remaining advice letter projects from the 2009
GRC are scheduled to be completed during 2012 and 2013.
LIQUIDITY
Cash flow from Operations
Cash flow from operations were $32.1 million during the six months ended
June 30, 2012, compared to $47.7 million for the same period of 2011. In
general, cash flow from operations is primarily generated by net income,
non-cash expense for depreciation and amortization, deferred income taxes,
regulatory liabilities, and other current liabilities. Cash generated by
operations varies during the year due to customer billings, timing of
contributions to our benefit plans, and timing of vendor and tax payments.
Effective January 1, 2012, the federal income tax repairs deduction for
qualified tangible property is mandatory. The repairs deduction is estimated to
reduce the Company's 2012 estimated federal and state income tax payments and
increase cash flow from operations. The new deduction accelerates qualified
tangible property deductions for property placed into service during 2012 and
prior years.
On April 19, 2012, the CPUC issued a decision to shorten the amortization
periods for Cal Water's undercollected net WRAM and MCBA receivable balances for
calendar years 2011, 2012, and 2013. This change is estimated to significantly
increase cash collections during 2012.
During the six months ended June 30, 2012, we made contributions of $15.8
million to our pension and retiree health care plans compared to $8.1 million
for the same period of 2011. The net WRAM and MCBA undercollected balances
increased $4.1 million to $53.7 million during the six months ended June 30,
2012 compared to December 31, 2011.
The water business is seasonal. Billed revenue is lower in the cool, wet winter
months when less water is used compared to the warm, dry summer months when
water use is highest. This seasonality results in the possible need for
short-term borrowings under the bank lines of credit in the event cash is not
available to cover operating and capital costs during the winter period. The
increase in cash flows during the summer allows short-term borrowings to be paid
down. Customer water usage can be lower than normal in years when more than
normal precipitation falls in our service areas or temperatures are lower than
normal, especially in the
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summer months. The reduction in water usage reduces cash flows from operations
and increases the need for short-term bank borrowings. In addition, short-term
borrowings are used to finance capital expenditures until long-term financing is
arranged.
Investing Activities
During the six months ended June 30, 2012 and 2011, we used $62.0 million and
$52.3 million, respectively, of cash for both company-funded and
developer-funded capital expenditures. For 2012, our capital budget is
approximately $100 to $125 million. Annual expenditures fluctuate each year due
to the availability of construction resources and our ability to obtain
construction permits in a timely manner.
Financing Activities
During the six months ended June 30, 2012, there were no equity or debt
offerings; however, we borrowed $40.6 million on our unsecured revolving credit
facilities mostly to finance company-funded capital expenditures.
The undercollected net WRAM and MCBA receivable balances were $53.7 million as
of June 30, 2012 and $49.6 million as of December 31, 2011, respectively. The
CPUC shortened the amortization periods for undercollected net WRAM and MCBA
balances such that most balances will be collected within 18-month. This change
is expected to improve cash flows during 2012. The undercollected balances were
primarily financed by Cal Water and negatively affected cash flows for the six
months ended June 30, 2012. Cal Water used short-term and long-term financing
arrangements to meet operational cash requirements. Interest on the
undercollected balances, the interest recoverable from ratepayers, is limited to
the current 90-day commercial paper rates which is significantly lower than Cal
Water's short and long-term financing rates.
Short-Term and Long-Term Debt
Short-term liquidity is provided by our unsecured revolving credit facilities,
which were amended and replaced on June 29, 2011, and internally generated
funds. Long-term financing is accomplished through the use of both debt and
equity. As of June 30, 2012, there were short-term borrowings of $87.8 million
outstanding on the unsecured revolving credit facilities compared to $47.1
million as of December 31, 2011.
Given our ability to access our lines of credit on a daily basis, cash balances
are managed to levels required for daily cash needs and excess cash is invested
in short-term or cash equivalent instruments. Minimal operating levels of cash
are maintained for Washington Water, New Mexico Water, and Hawaii Water.
Both short-term credit agreements contain affirmative and negative covenants and
events of default customary for credit facilities of this type including, among
other things, limitations and prohibitions relating to additional indebtedness,
liens, mergers, and asset sales. Also, these unsecured credit agreements contain
financial covenants governing the Company and its subsidiaries' consolidated
total capitalization ratio not to exceed 66.7% and an interest coverage ratio of
three or more. As of June 30, 2012, the Company's total capitalization ratio was
58.4% (trade payable is included as debt for this calculation) and interest
ratio slightly exceeds five. As of June 30, 2012, we have met all of the
covenant requirements and are eligible to use the full amount of the commitment.
Bond principal and other long-term debt payments were $1.6 million during the
six months ended June 30, 2012, compared to $1.3 million during the same period
of 2011.
Long-term financing, which includes senior notes, other debt securities, and
common stock, has typically been used to replace short-term borrowings and fund
capital expenditures. Internally generated funds, after making dividend
payments, provide positive cash flow, but have not been at a level to meet the
needs of our capital expenditure requirements. Management expects this trend to
continue given our capital expenditures plan for the next five years. Some
capital expenditures are funded by payments received from developers for
contributions in aid of construction or advances for construction. Funds
received for contributions in aid of construction are non-refundable, whereas
funds classified as advances in construction are refundable. Management believes
long-term financing is available to meet our cash flow needs through issuances
in both debt and equity instruments.
On September 23, 2010, the CPUC authorized Cal Water to issue $350 million of
debt and common stock to finance capital projects and operations. During the six
months ended June 30, 2012, we utilized cash generated from operations,
borrowings on the unsecured revolving credit facilities, and the first mortgage
bond offerings. We did not issue any significant common stock in 2011. In future
periods, management anticipates funding our capital needs through a relatively
balanced approach between long term debt and equity.
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Dividends, Book Value and Shareholders
The second quarter of 2012 common stock dividend of $0.1575 per share was paid
on May 18, 2012, compared to a quarterly dividend in the second quarter of 2011
of $0.15375. This was our 269th consecutive quarterly dividend. Annualized, the
2012 dividend rate is $0.63 per common share, compared to $0.615 in 2011. For
the full year 2011, the payout ratio was 68% of net income. On a long-term
basis, our goal is to achieve a dividend payout ratio of 60% of net income
accomplished through future earnings growth.
At its July 25, 2012 meeting, the Board declared the third quarter dividend of
$0.1575 per share payable on August 17, 2012, to stockholders of record on
August 6, 2012. This was our 270th consecutive quarterly dividend.
2012 Financing Plan
We intend to fund our capital needs in future periods through a relatively
balanced approach between long-term debt and equity. The Company and Cal Water
have a three-year syndicated unsecured revolving line of credit of $100 million
and $300 million, respectively for short-term borrowings. As of June 30, 2012,
the Company's availability on these unsecured revolving lines of credit was
$312.2 million.
Book Value and Stockholders of Record
Book value per common share was $10.77 at June 30, 2012 compared to $10.76 at
December 31, 2011.
There were approximately 2,383 stockholders of record for our common stock as of
July 23, 2012.
Utility Plant Expenditures
During the second quarter of 2012, capital expenditures totaled $62.0 million
for company-funded and developer-funded projects. The planned 2012
company-funded capital expenditure budget is approximately $120 to $125 million.
The actual amount may vary from the budget number due to timing of actual
payments related to current year and prior year projects. We do not control
third-party-funded capital expenditures and therefore are unable to estimate the
amount of such projects for 2012.
At June 30, 2012, construction work in progress was $131.6 million compared to
$98.6 million at December 31, 2011. Work in progress includes projects that are
under construction but not yet complete and placed in service.
WATER SUPPLY
Our source of supply varies among our operating districts. Certain districts
obtain all of their supply from wells; some districts purchase all of their
supply from wholesale suppliers; and other districts obtain supply from a
combination of wells and wholesale suppliers. A small portion of supply comes
from surface sources and is processed through Company-owned water treatment
plants. To the best of management's knowledge, we are meeting water quality,
environmental, and other regulatory standards for all company-owned systems.
California's normal weather pattern yields little precipitation between
mid-spring and mid-fall. The Washington Water service areas receive
precipitation in all seasons, with the heaviest amounts during the winter. New
Mexico Water's rainfall is heaviest in the summer monsoon season. Hawaii Water
receives precipitation throughout the year, with the largest amounts in the
winter months. Water usage in all service areas is highest during the warm and
dry summers and declines in the cool winter months. Rain and snow during the
winter months replenish underground water aquifers and fill reservoirs,
providing the water supply for subsequent delivery to customers. As of July 1,
2012, the State of California snowpack water content and rainfall accumulation
during the 2011 - 2012 water year is 85% of normal (per the California
Department of Water Resources, Northern Sierra Precipitation Accumulation
report). Precipitation during the six months ended June 30, 2012 was below
average. Management believes that supply pumped from underground aquifers and
purchased from wholesale suppliers will be adequate to meet customer demand
during 2012 and beyond. Long-term water supply plans are developed for each of
our districts to help assure an adequate water supply under various operating
and supply conditions. Some districts have unique challenges in meeting water
quality standards, but management believes that supplies will meet current
standards using current treatment processes.
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CONTRACTUAL OBLIGATIONS
During the six months ended June 30, 2012, there were no material changes in
contractual obligations outside the normal course of business.
Item 3.
