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CWT > SEC Filings for CWT > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for CALIFORNIA WATER SERVICE GROUP

Form 10-Q for CALIFORNIA WATER SERVICE GROUP


7-Nov-2012

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(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;

litigation that may result in damages or costs not recoverable from third parties;

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 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 Act and other regulations on internal controls; and

the risks set forth in "Risk Factors" included elsewhere in this quarterly report.

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 regulatory commissions to which we are subject. The process of preparing financial statements in accordance with GAAP requires the use of estimates and assumptions on the part of management. The estimates and assumptions used by management are based on historical experience and our 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 and financial condition. 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;

expense balancing and memorandum accounts;

modified cost balancing 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 nine month periods ended September 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 THIRD QUARTER 2012 OPERATIONS COMPARED TO

THIRD QUARTER 2011 OPERATIONS

Amounts in thousands except share data

Overview

Third quarter of 2012 net income was $29.8 million equivalent to $0.71 per diluted common share compared to net income of $20.9 million or $0.50 per diluted common share in the third quarter of 2011. The increase in net income was primarily attributable to rate increases, a nonrecurring income tax benefit of $0.15 per diluted common share, and an unrealized gain on our benefit plan insurance investments.

Operating Revenue

Operating revenue increased $8.9 million or 5% to $178.1 million in the third 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 third quarter of 2012 compared to 2011 are:

Rate increases (includes a 2012 $1.1 million water cost of
capital mechanism revenue reduction)                                 $      8,377
Usage (includes WRAM and MCBA deferral adjustment)                          7,492
Net change due to actual versus adopted results, and other                 (6,988 )
Net operating revenue increase                                       $      8,881

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     $ 4,107
Step rate increases                   2,781
General rate case (GRC) increases     1,137
Other                                   352
Total increase in rates             $ 8,377

Total Operating Expenses

Total operating expenses were $141.8 million for the third quarter of 2012, versus $139.2 million for the same period in 2011, a 2% 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 47% of total operating expenses in the third quarter of 2012. Water production expenses increased $4.9 million, or 8%, during the third quarter of 2012 compared to the same period last year due to purchased water and power price increases. These cost increases were partially offset by reductions in customer usage. Our wholly-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 September 30

                       2012                2011
Well production               50 %                50 %
Purchased                     44 %                45 %
Surface                        6 %                 5 %
Total                        100 %               100 %


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The components of water production costs are shown in the table below:

Three Months Ended September 30

                      2012            2011       Change
Purchased water   $     51,428    $     47,652   $ 3,776
Purchased power         11,440          10,866       574
Pump taxes               3,621           3,075       546
Total             $     66,489    $     61,593   $ 4,896

Purchased water costs increased due to price increases from water wholesalers. Total water production, measured in acre feet, increased 3% during the third quarter of 2012 as compared with the third quarter of 2011 due to an increase in customer usage.

Administrative and general expense and other operations expense increased 6% to $41.6 million. The primary reasons for the increase were increases in employee benefits and wage costs, and conservation program expenses during the third quarter of 2012. At September 30, 2012, there were 1,129 employees and at September 30, 2011, there were 1,141 employees.

Maintenance expenses decreased by 6% to $4.4 million in the third quarter of 2012 compared to $4.7 million in the third quarter of 2011, due to a decrease in main and service repairs. Depreciation and amortization expense increased $1.0 million, or 8%, due to 2011 capital additions.

Federal and state income taxes charged to operating expenses and other income and expenses decreased $3.8 million, from a provision of $14.6 million in the third quarter of 2011 to $10.8 million in the third quarter of 2012. The decrease was due to new corporate tax regulations, effective January 1, 2012, that require the Company to deduct costs previously capitalized for book and tax purposes and resulted in a nonrecurring income tax benefit related to 2011 and prior years which reduced income tax expense $6.2 million during the third quarter of 2012. We expect the effective tax rate to be between 31% and 35% for fiscal year 2012.

Other Income and Expense

Other income, net of income taxes, increased $2.4 million during the third quarter of 2012 mostly due to a $0.6 million unrealized gain on our benefit plan insurance investments during the third quarter of 2012 compared to an unrealized loss of $2.9 million during the third quarter of 2011.

Interest Expense

Total interest expense, net of interest capitalized, decreased $0.1 million to $7.2 million for the third quarter of 2012 compared to the same period last year. This decrease was attributable to lower borrowing costs on the short-term lines of credit and an increase in capitalized interest charged to construction projects.

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 NINE MONTHS ENDED SEPTEMBER 2012 COMPARED TO

THE NINE MONTHS ENDED SEPTEMBER 2011 OPERATIONS

Amounts in thousands except per share data

Overview

Net income for the nine-month period ended September 30, 2012, was $43.8 million, or $1.05 per diluted common share compared to net income of $35.8 million or $0.86 per diluted common share for the nine months ended September 30, 2011. The increase in net income is primarily attributable to rate increases, a nonrecurring income tax benefit of $0.15 per diluted common share, and an unrealized gain on our benefit plan insurance investments.

Operating Revenue

Operating revenue increased $39.6 million or 10% to $438.4 million in the nine month period ended September 30, 2012. As disclosed in the following table, the increase was due to increases in usage (includes an additional $11.4 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 third quarter of 2012 compared to 2011 are as follows:

Usage (includes WRAM and MCBA deferral adjustment)                     $   26,978
Rate increases (includes a 2012 $2.7 million water cost of capital
mechanism revenue reduction)                                               23,278
Net change due to actual versus adopted results and other                 (10,620 )
Net operating revenue increase                                         $   39,636

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    $ 13,870
Step rate increases                    6,351
General rate case (GRC) increases      2,090
Other                                    967
Total increase in rates             $ 23,278

Total Operating Expenses

Total operating expenses were $375.8 million for the nine months ended September 30, 2012, versus $339.2 million for the same period in 2011, an 11% increase.

Water production expense consists of purchased water, purchased power and pump taxes. Water production expense represents the largest component of total operating expenses, accounting for approximately 42% of total operating expenses. Water production expenses increased $19.8 million in the nine months ended September 30, 2012, or 14% compared to the same period last year due to increased cost of purchased water and pump taxes. Our wholly-owned operating subsidiaries, Washington Water, New Mexico Water, and Hawaii Water obtain all of their water supply from wells.

Sources of water production as a percent of total water production are listed on the following table:

Nine Months Ended September 30

                       2012                2011
Well production               47 %                48 %
Purchased                     47 %                46 %
Surface                        6 %                 6 %
Total                        100 %               100 %


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The components of water production costs are shown in the table below:

Nine Months Ended September 30

                      2012           2011       Change
Purchased water   $    125,218    $  108,121   $ 17,097
Purchased power         24,577        23,198      1,379
Pump taxes               8,324         6,977      1,347
Total             $    158,119    $  138,296   $ 19,823

Purchased water costs increased due to higher prices from wholesalers. Pump taxes were higher due to increased production from wells subject to pump taxes. Total water production, measured in acre feet, increased 5% for the first nine months of 2012 compared to the same period last year due to an increase in customer usage.

Administration and general and other operations expenses were $128.3 million, increasing $17.7 million, or 16%, for the nine months ended September 30, 2012. The increase was primarily attributable to increases in employee benefits and wage costs, and conservation program expenses during the nine months ended September 30, 2012.

Maintenance expense decreased $0.4 million, or 3%, for the nine months ended September 30, 2012, to $14.7 million due to less repairs of mains, water treatment facilities, and wells. Depreciation and amortization expense increased $3.7 million, or 10%, due to 2011 capital additions.

Federal and state income taxes charged to operating expenses and other income and expenses decreased $1.6 million, or 7%, for the nine months ended September 30, 2012. The decrease was due to new tax regulations, effective January 1, 2012, that require the Company to deduct costs previously capitalized for book and tax purposes and resulted in a nonrecurring income tax benefit related to 2011 and prior years which reduced income tax expense $6.2 million during the nine months ended September 30, 2012. We expect the effective tax rate to be between 31% and 35% for fiscal year 2012.

Other Income and Expense

Other income, net of income taxes, was $2.1 million for the nine months ended September 30, 2012, compared to a loss of $1.1 million in the same period last year, which was an increase of $3.2 million. The increase was mostly due to a $2.2 million unrealized gain on our benefit plan insurance investments during the nine months ended September 30, 2012 compared to an unrealized loss of $2.8 million during the same period last year

Interest Expense

Net interest expense decreased $1.8 million to $20.8 million for the nine month period ended September 30, 2012 compared to the nine month period ended September 30, 2011. This decrease was attributable to lower borrowing costs on the short-term lines of credit, the TIRBA balancing account interest charges ending on December 31, 2011, and an increase in capitalized interest charged to construction projects during the first nine months of 2012.

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.

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 September 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. Cal Water . . .

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