Published on March 26, 1998
Management's Discussion and Analysis
of Financial Condition and Results of Operations
In April 1997, shareholders of California Water Service Company
("Company") voted to approve a holding company structure. After
receiving final regulatory approval required to complete the process,
on December 31, 1997, California Water Service Group ("Group") was
formed. Through the holding company formation procedure, the Company
became one of the Group's two operating subsidiaries. The Company will
continue to operate as a regulated utility. Its assets and operating
revenues currently comprise virtually all of the Group's assets and
revenues. The other subsidiary, CWS Utility Services, is a new entity
that will provide non-regulated water operations and related services.
The following discussion and analysis provides information regarding
the Group, its assets and operations.
In conjunction with formation of the holding company structure, each
common share of Company stock was exchanged on a two-for-one basis for
common shares of Group. Per share data has been restated where
necessary to reflect the effective two-for-one stock split.
FORWARD LOOKING STATEMENTS
The Management's Discussion and Analysis section and other sections of
this annual report contain forward looking statements. Such statements
are inherently based on currently available information and
expectations, estimates, assumptions and projections, and management's
judgment about the Group, the water utility industry and general
economic conditions. Such words as expects, intends, plans, believes,
estimates, anticipates or variations of such words or similar
expressions are intended to identify forward looking statements. The
forward looking statements are not guarantees of future performance.
Actual results may vary materially from what is contained in a forward
looking statement. Factors which may cause a result different than
expected include regulatory decisions, legislation and the impact of
weather on operating results. The Group assumes no obligation to
provide public updates of forward looking statements.
BUSINESS
The Company is a public utility supplying water service to 379,500
customers in 57 California communities through 21 separate water
systems or districts. In the Company's 20 regulated systems, which
serve 373,500 customers as shown on the map on page 7, rates and
operations are subject to the jurisdiction of the California Public
Utilities Commission ("CPUC"). An additional 6,000 customers receive
service through a long-term lease of the City of Hawthorne water
system, which is not subject to CPUC regulations. The Company also has
contracts with various municipalities to operate water systems and
provide billing services to an additional 29,500 customers. The
Company also operates two reclaimed water systems under contract.
The CPUC requires that water rates for each regulated district be
determined independently. Rates for the City of Hawthorne system are
established in accordance with an operating agreement and are subject
to ratification by the City council. Fees for other operating
agreements are based on contracts negotiated among the parties.
RESULTS OF OPERATIONS
Earnings and Dividends. 1997 net income was $23,305,000 compared to
$19,067,000 in 1996 and $14,698,000 in 1995. Earnings per common share
were $1.83 in 1997, $1.50 in 1996 and $1.16 in 1995. 1997 revenue, net
income and earnings per share represent the highest levels ever
achieved by the Group. The weighted average number of common shares
outstanding in each of the three years was 12,619,000, 12,580,000 and
12,506,000, respectively.
At its January 1997 meeting, the Board of Directors increased the
common stock dividend rate for the 30th consecutive year. 1997 also
marked the 53rd consecutive year that a dividend had been paid on the
Company's common stock. The annual dividend rate paid in 1997 was
$1.055, an increase of 1.4% over the 1996 rate of $1.04 per share
which was an increase of 2.0% compared with the 1995 dividend of $1.02
per share. The dividend increases were based on projections that the
higher dividend could be sustained while still providing the Group
with adequate financial flexibility. Earnings not paid as dividends
are reinvested in the business. The dividend payout ratio was 58% in
1997, 69% in 1996 and 88% in 1995, an average of 72% for the three-
year period. The variation in payout ratios among the three years is
primarily attributable to earnings per share fluctuations.
Operating Revenue. Operating revenue, including revenue from City of
Hawthorne customers, was a record $195.3 million, exceeding the record
set the previous year of $182.8 million, a $12.6 million or 7%
increase. 1995 revenue was $165.1 million. General and step rate
increases contributed $6.4 million, while offset rate adjustments,
primarily for purchased water cost increases, added $0.2 million.
Increased customer usage added $3.9 million. Average revenue per
customer for each of the three years ended December 31, 1997 and was
$515, $486 and $450, respectively. The revenue changes were mainly
driven by consumption levels and rate increases. Rainfall for the
1996-97 season was concentrated in December 1996 and January 1997,
then virtually ceased. The summer months were dry and warm, resulting
in the highest average recorded consumption level for metered accounts
at 315 ccf., a 4% increase for the year. The increase in average
consumption followed a very strong consumption year in 1996. The
increase in revenue during the first half of 1997 benefited from the
June, 1996 rate case decision affecting 47% of customers. The CPUC
decision for the applications filed in 1996 became effective in April
1997, affecting 11% of the customers. The customer count increased
0.9% to 379,500. Sales to 3,352 new customers increased revenue $2.1
million. The City of Hawthorne system was operated for the full year
in 1997, while the 1996 operation was for a ten-month period.
Operating revenue in 1996 increased $17.7 million, or 11% greater than
1995's operating revenue. Offset rate adjustments, primarily for
purchased water cost increases, added $2.2 million to revenue, while
general and step rate increases contributed $7.8 million. Increased
customer usage added $3.1 million. Average billed water consumption
per metered customer was 303 ccf, a 6% increase for the year.
Following a wet first quarter, during which heavy rainfall assured an
adequate supply for the year, warm, dry spring and summer weather
caused an increase in consumption. In June, rate increases in five
districts, covering 47% of customers, became effective and added
significantly to revenue in the second half of the year. The number of
customers increased 2.4% for the year due to the addition of the 6,000
City of Hawthorne customers in March and other customers added in
existing service areas. Sales to a total of 9,000 new accounts provided
$4.6 million in additional revenue.
The 1995 revenue increase was $7.8 million, or 5% greater than 1994.
Offset rate adjustments, mainly for purchased water cost increases, added
$3.8 million while general and step rate increases contributed $2.2
million. Increased customer usage added $1.1 million. Average billed
water consumption per metered customer was 286 ccf., an increase of 1
ccf for the year. Only consumption in the fourth quarter exceeded that
of the prior year, the first three 1995 quarters recorded usage which
was less than 1994's. The consumption pattern reflects 1995's weather.
The winter was unusually wet. Rain and cool weather continued through
the spring and negatively influenced summer usage. With the exception
of August, which showed a slight increase in consumption, all months
through the third quarter recorded a sales decline from the prior
year. Lack of rain and mild weather in the fourth quarter resulted in
increased average customer usage of 14%. Sales to 1,600 new customers
during the year accounted for $0.7 million in additional revenue.
Operating and Interest Expenses. Operating expenses, including those
for the Hawthorne operation, increased $8.6 million in 1997, $12.7
million in 1996 and $7.9 million in 1995.
Well production supplied 51.2% of the water delivered to all systems
in 1997, while 48.4% was purchased from wholesale suppliers and 0.4%
came from the Company's Bear Gulch district watershed. Water
production was 110 billion gallons, up 5% from 1996's 105 billion
gallons. Production in 1995 was 99 billion gallons. The production
levels in 1997 and 1996 reflect increased customer usage. Total cost
of water production, including purchased water, purchased power and
pump taxes, was $68.9 million in 1997, $67.3 million in 1996 and $62.2
million in 1995. Purchased water expense was the largest component of
operating expense in each year. This year purchased water expense was
$52.2 million, an increase of $0.6 million. The overall purchased
water expense was reduced by $2.5 million due to refunds received from
two wholesale suppliers in May 1997. Well production, which increased
6% in 1997 because of increased demand, caused a $0.9 million increase
in pump taxes and purchased power costs. In 1996, well production was
up 8%, however, purchased power decreased $0.6 million due to the
availability of less expensive power in several districts. In 1997,
the Bear Gulch watershed yielded 0.5 billion gallons, the same
production as in 1996.
Employee payroll and benefits charged to operations and maintenance
expense was $32.9 million this past year, $31.2 million in 1996 and
$29.9 million in 1995. The increases in payroll and related benefits
are attributable to general wage increases effective at the start of
each year and additional hours worked. At year-end 1997, 1996 and
1995, there were 649, 633 and 630 employees, respectively.
Income taxes were $14.0 million in 1997, $12.2 million in 1996 and
$9.9 million in 1995. The changes in taxes are generally due to
increased taxable income.
Long-term debt interest expense decreased $0.3 million due to the
retirement of Series K bonds in November 1996 and Series L bonds in
November 1997, and annual sinking fund payments each year. Interest on
long-term debt increased $0.7 million in 1996 because of the sale, in
August, 1995, of $20 million of senior notes which were outstanding
for the full year. In 1995, bond interest expense increased $0.4
million, also because of the senior note sale.
Interest on short-term bank borrowings in 1997 was $0.3 million more
than in 1996 which was $0.2 million less than 1995's expense. The
additional interest expense this year reflects increased short-term
borrowings, especially during the latter part of the year. 1996's
expense reduction reflects a reduced requirement for short-term
borrowings due to increased water sales which resulted in improved
cash flow and funds available in 1996 from the 1995 senior note sale.
Interest on short-term bank borrowings decreased $0.3 million in 1995,
despite higher short-term rates during 1995 compared to 1994. The
reduction in the expense reflects the payoff of outstanding short-term
bank borrowings upon the issuance of senior notes and reduced short-
term borrowing needs. Due to improved earnings, interest coverage of
long-term debt before income taxes was 4.2 in 1997, 3.6 in 1996 and
3.2 in 1995.
Other Income. Other income is derived from management contracts under
which the Company operates three municipally owned water systems,
contracts for operation of five privately owned water systems,
agreements for operation of two reclaimed water systems, provides
billing services to various cities, leases certain facilities, other
nonutility sources and interest on short-term investments. Total other
income was $1.1 million in 1997, $0.8 million in 1996 and $0.9 million
in 1995. Income from the various operating and billing contracts
excluding short-term interest income was $1 million this year, $0.7
million in 1996 and 1995.
Following the August 1995 senior note issue, available funds generated
significant interest income. This source for temporary investments was
not available in 1997 or 1996. There was $14.5 million in temporary
borrowings at the end of 1997, $7.5 million at the end of 1996 and
none at the end of 1995.
RATES AND REGULATION
General rate case applications were filed for four districts
representing 7% of total accounts in July 1997. The applications
request additional revenue of about $650,000 for 1998. Future step
rate increases for two of the districts of about $110,000 for each
year 1999 through 2001 were also requested. In the other two
districts, proposed step rate increases would be based on a hybrid -
CPI each year through the year 2003.
During 1996, general rate case applications were filed with the CPUC
for two districts, Livermore and Palos Verdes, which represent about
11% of the Company's customers. In April, the CPUC granted the Company
a return on common equity (ROE) of 10.35%. Additional 1997 revenue,
including memorandum and balancing account adjustments, was $2.4
million. The decision included provisions for future step rate
increases to become effective in the next three years of $1.7 million
in 1998 and $0.1 million in 1999 and 2000. The CPUC also authorized
step rate increases for 1997 in various districts totaling $1.5
million and $1.4 million for undercollection of expense balancing
accounts.
The CPUC's decision on the Company's 1995 rate case filing was
effective in June 1996. The decision, which involved five districts
representing 47% of the Company's customers, authorized an ROE of
10.3%. It added $5.4 million of revenue during the first full year,
including $1.2 million of step rate increases effective at the start
of 1996. Over a four-year period, the decision is expected to provide
about $10.6 million in new revenue. The decision includes a provision
to accelerate recovery of the Company's utility plant investment,
resulting in an annualized depreciation rate of about 2.6% for the
five districts. Historically, the Company's annual depreciation rate
has been 2.4% of utility plant.
During 1998, 14 districts, representing about 80% of all customers,
are eligible for rate increase filings. The Company will review
earnings levels in those districts and file for additional rate
consideration as it deems appropriate. The filings are expected to be
made in July.
WATER SUPPLY
The Company's source of supply varies among its 21 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 their supply from both sources. The Company
operates two treatment plants which process surface water supplies. In
each of the past three years, approximately half of the total Company
supply has been pumped from Company owned wells and half purchased
from wholesale suppliers. Total water production for 1997, 1996 and
1995 was 109,802, 105,072 and 98,823 million gallons, respectively.
Generally, between mid-spring and mid-fall little precipitation falls
in the Company's service areas. Water demand is highest during the
warm, dry summer period and less in the cool, wet winter. Rain and
snow during the winter months replenish underground water basins and
fill reservoirs providing the water supply for subsequent delivery to
customers. To date, snow and rainfall accumulation during the 1997-98
winter has exceeded normal levels for the third year in a row. Water
storage in state reservoirs exceeds historic levels. The Company
believes that its source of supply from both underground aquifers and
purchased sources is adequate to meet customer demands for 1998 in all
service areas.
ENVIRONMENTAL MATTERS
The Company is subject to regulations of the United States
Environmental Protection Agency (EPA), the California Department of
Health Services and various county health departments concerning water
quality matters. It is also subject to the jurisdiction of various
state and local regulatory agencies relating to environmental matters,
including handling and disposal of hazardous materials.
The Company believes it is in compliance with all monitoring and
treatment requirements set forth by the various agencies. In the past
several years, substantially all of the Company's wells have been
equipped with chlorinators, providing disinfection of water extracted
from underground sources. The cost of the new treatment is being
recovered in customer rates as authorized by the CPUC. Water purchased
from wholesale suppliers is treated before delivery to the Company.
During 1996, Congress approved amendments to the Safe Drinking Water
Act. The revised law provides improvements in establishing regulations
for potential contaminants. Among the considerations by EPA in
determining whether to regulate a particular substance are potential
impact on public health, the likelihood of the contaminants'
occurrence and a cost/benefit analysis. The Company believes the
amended law provides a prudent approach to safeguarding potable water
supplies.
Various regulatory agencies could require increased monitoring and
possibly additional treatment of water supplies. The Company intends
to request recovery for any additional treatment costs through the
ratemaking process.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The Company's liquidity is provided by utilization of a
$50 million short-term bank line of credit which is split evenly
between Group and Company, and by internally generated funds. Prior to
1997, the line of credit was $30 million. The Group's $25 million
portion of the bank credit line may be drawn upon for use by the
Group, including funding operations of either of its two operating
subsidiaries. The Company's $25 million portion of the credit line may
be used solely for purposes of regulated water operations. Additional
information regarding the bank line of credit is presented in Note 4
to the financial statements. Internally generated funds come from
retention of a portion of earnings, depreciation and deferred income
taxes.
Because of the seasonal nature of the water business, the need for
short-term borrowings under the line of credit generally increases
during the first six months of the year. Due to greater summer usage,
cash flow from operations increases and bank borrowings can be repaid.
The Company believes that long-term financing is available to it
through equity and debt markets. Standard & Poor's and Moody's have
maintained their ratings of the Company's first mortgage bonds at AA-
and Aa3, respectively. Long-term financing, which includes issuance of
common stock, first mortgage bonds, senior notes and other debt
securities is used to replace short-term borrowings and fund
construction. Developer contributions in aid of construction and
refundable advances for construction are also sources of funds for
various construction projects.
Additional long-term financing was not necessary in either 1997 or
1996. Operating and capital requirements were met by borrowings under
the bank short-term line of credit and by internally generated funds.
During August, 1995, Series A, 7.28%, 30-year senior notes were
issued. The proceeds from the issue were used to repay outstanding
bank borrowings, redeem upon maturity the outstanding $2,565,000
Series J first mortgage bonds and fund the 1995 and a portion of the
1996 construction programs.
During the first quarter of 1998, the Group plans to implement a new
Dividend Reinvestment and Stock Purchase Plan (Plan). The Plan will
replace the Company's former Dividend Reinvestment Plan. Under the new
Plan, shareholders may reinvest dividends to purchase additional Group
common stock. Another feature of the Plan allows existing shareholders
and other interested investors to purchase Group common shares. Shares
required for the Plan may be purchased on the open market or newly
issued shares. Therefore, the Plan will provide the Group with an
alternative means of developing additional equity if new shares were
to be issued. Initially, the intention is to purchase shares required
for the Plan on the open market. If new shares are issued to satisfy
future Plan requirements, the impact on earnings per share could be
dilutive because of the added shares outstanding. Also, shareholders
not participating in the Plan would experience dilution of their
ownership percentage.
In 1996, under the Company's former Dividend Reinvestment Plan, 80,438
new common shares were issued to shareholders who elected to reinvest
their dividends, providing the Company with $1.4 million in additional
equity. In 1995, 44,634 new shares were issued under the Plan during
the third and fourth quarters providing equity of $0.7 million.
Reinvestment shares required for the 1995 first and second quarter
dividends were purchased on the open market and redistributed to Plan
participants. Currently, about 10% of outstanding shares participate
in the Company's dividend reinvestment program.
Capital Requirements. Capital requirements consist primarily of new
construction expenditures for expanding and replacing the Company's
utility plant facilities, and the acquisition of new water properties.
They also include refunds of advances for construction and retirement
of bonds.
During 1997, utility plant expenditures totaled $32.9 million compared
to $35.7 million in 1996. This year's expenditures included $25.5
million provided by Company funding and $7.4 million received from
developers through contributions in aid of construction and refundable
advances. Company funded expenditures were in the following areas:
wells, pumping and water treatment equipment and storage facilities,
$6.9 million; distribution systems, $9.7 million; services and meters,
$5.2 million; equipment, $3.7 million. Company projects were funded by
internally generated funds and the short-term bank line of credit. In
1996, expenditures included the $6.5 million up-front City of
Hawthorne lease payment. The system is being leased for 15 years. A
portion of the proceeds from the August 1995 senior notes issue was
also available to fund a portion of the 1996 Company construction
program.
The 1998 Company construction program has been authorized by the Board
of Directors for $31.0 million. Expenditures are expected to be in the
following areas: wells, pumping and water treatment equipment and
storage facilities, $11.9 million; distribution systems, $8.7 million;
services and meters, $5.4 million; and equipment, $5.0 million. The
funds for this program are expected to be provided by cash from
operations, bank borrowings and long-term debt financing. New
subdivision construction generally will be financed by developers'
contributions and refundable advances. Company funded construction
budgets over the next five years are projected to be $125 million.
Since 1986, proceeds received from developers for installation of new
facilities were subject to income tax. During 1996, Congress enacted
legislation which exempted from taxable income the majority of
proceeds received from developers to fund advances for construction
and contributions in aid of construction. As part of the legislation,
future water utility plant additions will generally be depreciated for
federal tax purposes on a straight-line, 25-year life basis. The
federal tax exemption of developer funds will reduce the Company's
cash flow requirement for income taxes. In 1997, California adopted
similar legislation regarding the taxability of payments received from
developers.
Capital Structure. The Company's total capitalization at December 31,
1997 and 1996 was $306.7 million and $299.9 million, respectively.
Capital ratios were:
1997 1996
Common equity 53.5% 51.4%
Preferred stock 1.1% 1.2%
Long-term debt 45.4% 47.4%
The increase in the common equity percentage from 1996 to 1997 and
the corresponding decrease in the long-term debt percentage were
primarily caused by strong 1997 earnings which contributed to
shareholders' equity. During the year, no new debt was sold or equity
issued. Also contributing to the change was the retirement of Series
L, first mortgage bonds in November 1997 along with the annual bond
sinking fund payments which were also made in November.
The 1997 return on average common equity was 14.6% compared with 12.7%
in 1996 and 10.2% in 1995. The most recent CPUC authorized rate of
return on common equity is 10.35%.
Shareholder Rights Plan. As explained in Note 3 to the Consolidated
Financial Statements, in January 1998, the Board of Directors adopted
a Shareholder Rights Plan (Plan). In connection with the Plan, a
dividend distribution of one's right to purchase preferred stock under
certain circumstances was also authorized. The Plan is designed to
protect shareholders and maximize shareholder value in the event of an
unsolicited takeover proposal by encouraging a prospective acquirer to
negotiate with the Board.
NEW ACCOUNTING STANDARDS
During 1997, the Financial Accounting Standards Board issued two
statements which will be effective for the Group in 1998. Statement
No. 130, "Reporting Comprehensive Income," requires comprehensive
income items be classified separately and the accumulated balance be
reported in the equity section of the financial statements. Statement
No. 131, "Disclosures about Segments of an Enterprise and Related
Information," establishes disclosure requirements concerning operating
business segments, products and services, geographic areas and major
customers. The Group, which will adopt both statements during 1998,
does not anticipate that either statement will have a material impact
on its financial position or operating results.
YEAR 2000
The Group is familiar with the concerns and technological complexities
associated with achieving Year 2000 compliance of computer based
systems. A program is in place with a goal to assure that Group's
systems achieve Year 2000 compliance by the end of 1998. In addition,
the program includes attaining comfort that our business partners will
also achieve Year 2000 compliance without a disruption of our business
processes. The Group believes that the Year 2000 transition will be
completed without a material adverse effect on its operations or
financial position.
CONSOLIDATED BALANCE SHEET
(In thousands)
December 31,
1997 1996
ASSETS
Utility plant:
Land $7,860 $7,536
Depreciable plant and equipment 627,584 600,329
Construction work in progress 4,026 3,300
Intangible assets 8,178 7,267
Total utility plant 647,648 618,432
Less depreciation and amortization 187,241 174,844
Net utility plant 460,407 443,588
Current assets:
Cash and cash equivalents 1,742 1,368
Receivables:
Customers 10,890 11,437
Other 3,972 1,528
Unbilled revenue 5,136 5,577
Materials and supplies at average cost 2,105 2,324
Taxes and other prepaid expenses 4,423 4,537
Total current assets 28,268 26,771
Other assets:
Regulatory assets 38,345 37,556
Unamortized debt premium and expense 3,748 3,943
Other 529 532
Total other assets 42,622 42,031
$531,297 $512,390
See accompanying notes to consolidated financial statements.
December 31, 1997 1996
(In thousands)
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock $44,941 $44,941
Retained earnings 119,124 109,285
Total common shareholders' equity 164,065 154,226
Preferred stock without mandatory
redemption provision 3,475 3,475
Long-term debt 139,205 142,153
Total capitalization 306,745 299,854
Current liabilities:
Short-term borrowings 14,500 7,500
Accounts payable 15,499 14,692
Accrued taxes 2,985 3,002
Accrued interest 1,919 1,947
Other accrued liabilities 8,241 7,653
Total current liabilities 43,144 34,794
Unamortized investment tax credits 3,006 3,086
Deferred income taxes 25,761 23,736
Regulatory liabilities 12,493 12,627
Advances for construction 95,878 95,226
Contributions in aid of construction 44,270 43,067
$531,297 $512,390
CONSOLIDATED STATEMENT OF INCOME
For the years ended December 31, 1997 1996 1995
(In thousands, except per share data)
Operating revenue $195,324 $182,764 $165,086
Operating expenses:
Operations:
Purchased water 52,155 51,514 46,370
Purchased power 12,462 12,075 12,689
Pump taxes 4,302 3,753 3,151
Administrative and general 23,521 21,664 19,989
Other 24,019 23,000 21,635
Maintenance 9,319 8,317 7,722
Depreciation and amortization 13,670 12,665 11,436
Income taxes 13,950 12,150 9,850
Property and other taxes 7,577 7,259 6,852
Total operating expenses 160,975 152,397 139,694
Net operating income 34,349 30,367 25,392
Other income and expenses, net 858 607 768
Income before interest expense 35,207 30,974 26,160
Interest expense:
Long-term debt interest 11,405 11,663 10,984
Other interest 497 244 478
Total interest expense 11,902 11,907 11,462
Net income $23,305 $19,067 $14,698
Earnings per share of common stock $1.83 $1.50 $1.16
Average number of common
shares outstanding 12,619 12,580 12,506
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS' EQUITY
Common
Shares Common Retained
Outstanding Stock Earnings Total
(In thousands, except shares)
Balance at December 31, 1994 12,494,068 $42,800 $ 101,647 $144,447
Net income 14,698 14,698
Dividends paid:
Preferred stock 153 153
Common stock 12,750 12,750
Total dividends paid 12,903 12,903
Income reinvested in business 1,795 1,795
Dividend reinvestment 44,634 707 707
Balance at December 31, 1995
12,538,702 43,507 103,442 146,949
Net income 19,067 19,067
Dividends paid:
Preferred stock 153 153
Common stock 13,071 13,071
Total dividends paid 13,224 13,224
Income reinvested in business 5,843 5,843
Dividend reinvestment 80,438 1,434 1,434
Balance at December 31, 1996
12,619,140 44,941 109,285 154,226
Net income 23,305 23,305
Dividends paid:
Preferred stock 153 153
Common stock 13,313 13,313
Total dividends paid 13,466 13,466
Income reinvested in business 9,839 9,839
Balance at December 31, 1997
12,619,140 $44,941 $119,124 $164,065
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENT OF CASH FLOWS
For the years ended December 31, 1997 1996 1995
(In thousands)
Operating activities:
Net income $23,305 $19,067 $14,698
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 13,670 12,665 11,436
Deferred income taxes and investment
tax credits, net 1,945 (2,169) 1,698
Regulatory assets and liabilities, net (923) 503 (1,181)
Changes in operating assets and liabilities:
Receivables (1,897) 698 (1,936)
Unbilled revenue 441 729 (314)
Accounts payable 807 (115) 2,576
Other current liabilities 543 1,579 1,560
Other changes, net 1,510 235 1,258
Net adjustments 16,096 14,125 15,097
Net cash provided by operating activities 39,401 33,192 29,795
Investing activities:
Utility plant expenditures:
Company funded (25,491) (27,631) (20,039)
Developer advances and contributions
in aid of construction (7,416) (8,052) (7,211)
Net cash used in investing activities (32,907) (35,683) (27,250)
Financing activities:
Net short-term borrowings $7,000 $7,500 $(7,000)
Proceeds from issuance of long-term debt 20,000
Proceeds from issuance of common stock 1,434 707
Advances for construction 4,536 4,998 5,368
Refunds of advances for construction (3,685) (3,631) (3,524)
Contributions in aid of construction 2,443 3,896 3,183
Retirements of first mortgage bonds
including premiums (2,948) (3,387) (3,404)
Dividends paid (13,466) (13,224) (12,903)
Net cash provided by (used in)
financing activities (6,120) (2,414) 2,427
Change in cash and cash equivalents 374 (4,905) 4,972
Cash and cash equivalents at
beginning of year 1,368 6,273 1,301
Cash and cash equivalents at end of year $1,742 $1,368 $6,273
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest (net of amounts capitalized) $11,734 $11,721 $11,050
Income taxes $14,525 $12,775 $8,258
See accompanying notes to consolidated financial statements
Notes to Consolidated Financial Statements
December 31, 1997, 1996 and 1995
In April 1997, shareholders of California Water Service Company
("Company") voted to approve a holding company structure. The
formation process was completed on December 31, 1997 at which time
California Water Service Group ("Group") became the parent company. As
a result of the holding company formation, the Company became one of
Group's two operating subsidiaries. The Company will continue to
operate as a utility regulated by the California Public Utilities
Commission (CPUC). The other subsidiary, CWS Utility Services, is a
new entity which will perform non-regulated water related services and
operations. The consolidated financial statements include the accounts
of the Company which comprise virtually all of the Group's assets and
revenues.
In conjunction with formation of the holding company structure, common
shares of Company stock were exchanged on a two-for-one basis for
common shares of Group. Prior years' share data has been restated to
reflect the effects of the exchange which is equivalent to a stock
split.
NOTE 1. Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of
California Water Service Group and its wholly-owned subsidiaries,
California Water Service Company and CWS Utility Services,
collectively referred to as the Group. Intercompany transactions and
balances have been eliminated.
The accounting records of the Company are maintained in accordance
with the uniform system of accounts prescribed by the CPUC. Certain
prior years' amounts have been reclassified, where necessary, to
conform to the current presentation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
Revenue. Revenue consists of monthly cycle customer billings for
regulated water service at rates authorized by the CPUC and billings
to City of Hawthorne customers. Revenue from metered accounts includes
unbilled amounts based on the estimated usage from the latest meter
reading to the end of the accounting period. Flat rate accounts which
are billed at the beginning of the service period are included in
revenue on a pro rata basis for the portion applicable to the current
accounting period.
Utility Plant. Utility plant is carried at original cost when first
constructed or purchased, except for certain minor units of property
recorded at estimated fair values at dates of acquisition. Cost of
depreciable plant retired is eliminated from utility plant accounts
and such costs are charged against accumulated depreciation.
Maintenance of utility plant, other than transportation equipment, is
charged to operation expenses. Maintenance and depreciation of
transportation equipment are charged to a clearing account and
subsequently distributed primarily to operations. Interest is
capitalized on plant expenditures during the construction period and
amounted to $267,000 in 1997, $261,000 in 1996, and $207,000 in 1995.
Intangible assets acquired as part of water systems purchased are
stated at amounts as prescribed by the CPUC. All other intangibles
have been recorded at cost. Included in intangible assets is
$6,500,000 paid to the City of Hawthorne to lease the city's water
system and associated water rights. The lease payment is being
amortized on a straight-line basis over the 15-year life of the lease.
The Group continually evaluates the recoverability of utility plant by
assessing whether the amortization of the balance over the remaining
life can be recovered through the expected and undiscounted future
cash flows.
Long-Term Debt Premium, Discount and Expense. The discount and
expense on long-term debt is being amortized over the original lives
of the related debt issues. Premiums paid on the early redemption of
certain debt issues and unamortized original issue discount and
expense of such issues are amortized over the life of new debt issued
in conjunction with the early redemption.
Cash Equivalents. Cash equivalents include highly liquid investments,
primarily U.S. Treasury and U.S. Government agency interest bearing
securities, stated at cost with original maturities of three months or
less.
Depreciation. Depreciation of utility plant for financial statement
purposes is computed on the straight-line remaining life method at
rates based on the estimated useful lives of the assets, ranging from
5 to 65 years. The provision for depreciation expressed as a
percentage of the aggregate depreciable asset balances was 2.5% in
1997 and 1996, and 2.4% in 1995. For income tax purposes, as
applicable, the Company computes depreciation using the accelerated
methods allowed by the respective taxing authorities. Plant additions
since June 1996, are depreciated on a straight-line basis for tax
purposes.
Advances for Construction. Advances for Construction consist of
payments received from developers for installation of water production
and distribution facilities to serve new developments. Advances are
excluded from rate base. Such payments are refundable to the developer
without interest over a 20-year or 40-year period. Refund amounts
under the 20-year contracts are based on annual revenues from each
extension. Unrefunded balances at the end of the contract period are
credited to Contributions in Aid of Construction and are no longer
refundable. Refunds on contracts entered into since 1982 are made in
equal annual amounts over 40 years. At December 31, 1997, the amounts
refundable under the 20-year contracts were $9,547,000 and under the
40-year contracts $86,331,000. Estimated refunds for 1998 for all
water main extension contracts are $3,800,000.
Contributions in Aid of Construction. Contributions in Aid of
Construction represent payments received from developers, primarily
for fire protection purposes, which are not subject to refunds.
Facilities funded by contributions are included in utility plant, but
excluded from rate base. Depreciation related to contributions is
charged to Contributions in Aid of Construction.
Income Taxes. The Group accounts for income taxes using the asset and
liability method. Deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Measurement of the
deferred tax assets and liabilities is at enacted tax rates expected
to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in the period that includes the enactment date.
It is anticipated that future rate action by the CPUC will reflect
revenue requirements for the tax effects of temporary differences
recognized which have previously been flowed through to customers.
The CPUC has granted the Company customer rate increases to reflect
the normalization of the tax benefits of the federal accelerated
methods and available investment tax credits (ITC) for all assets
placed in service after 1980. ITC are deferred and amortized over the
lives of the related properties.
Advances for Construction and Contributions in Aid of Construction
received from developers subsequent to 1986 were taxable for federal
income tax purposes and subsequent to 1991 subject to state income
tax. In 1996 the federal tax law, and in 1997 the state tax law,
changed and a major portion of subsequent advances and contributions
are non-taxable.
Earnings per Share. In 1997, the Group adopted Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings per Share", issued by
the Financial Accounting Standards Board. SFAS No. 128 changes the
standard for computing earnings per share (EPS) by replacing the
presentation of primary EPS with basic EPS for all periods presented.
Per share data is calculated using income available to common
shareholders divided by the weighted average number of shares
outstanding during the year. The adoption of SFAS No. 128 had no
effect on the Group's EPS amounts. The Group has no dilutive
securities, accordingly, diluted EPS is not shown.
NOTE 2. Preferred Stock
As of December 31, 1997 and 1996, 380,000 shares of preferred stock
were authorized. Dividends on outstanding shares are payable quarterly
at a fixed rate before any dividends can be paid on common stock.
Preferred shares are entitled to sixteen votes each with the right to
cumulative votes at any elections of directors.
The outstanding 139,000 shares of $25 par value cumulative, 4.4%
Series C preferred shares are not convertible to common stock. A
premium of $243,250 would be due upon voluntary liquidation of Series
C. There is no premium in the event of an involuntary liquidation.
NOTE 3. Common Shareholders' Equity
The Group is authorized to issue 25,000,000 shares of no par value
common stock. All share data has been restated to reflect the two-for-
one stock split effective December 31, 1997. As of December 31, 1997
and 1996, 12,619,140 shares of common stock were issued and
outstanding. All shares of common stock are eligible to participate in
the Group's dividend reinvestment plan. Approximately 10% of
shareholders participate in the plan. In 1996 and 1995, 80,438 and
44,634, respectively, new shares were issued under the
reinvestment plan.
Shareholder Rights Plan. In January 1998, the Board of Directors
adopted a Shareholder Rights Plan (Rights Plan) and authorized a
dividend distribution of one right (Right) to purchase 1/100th share
of Series D Preferred Stock for each outstanding share of Common
Stock. The Rights will become effective in February 1998 and expire in
February 2008. The Rights Plan is designed to provide shareholders
protection and to maximize shareholder value by encouraging a
prospective acquirer to negotiate with the Board.
Each Right represents a right to purchase 1/100th share of Series D
Preferred Stock at the price of $120, subject to adjustment ("the
Purchase Price"). Each share of Series D Preferred Stock is entitled
to receive a dividend equal to 100 times any dividend paid on common
stock and 100 votes per share in any shareholder election. The Rights
become exercisable upon occurrence of a Distribution Date. A
Distribution Date event occurs if (a) any person accumulated 15% of
the then outstanding Common Stock, (b) any person presents a tender
offer which caused the person's ownership level to exceed 15% and the
Board determined the tender offer not to be fair to Group's
shareholders, or (c) the Board determines that a shareholder
maintaining a 10% interest in the Common Stock could have an adverse
impact on the Group or could attempt to pressure Group to repurchase
the holder's shares at a premium.
Until the occurrence of a Distribution Date, each Right trades with
the Common Stock and is not separately transferable. When a
Distribution Date occurs: (a) Group would distribute separate Rights
Certificates to Common Shareholders and the Rights would subsequently
trade separate from the Common Stock; and (b) each holder of a Right,
other than the Acquiring Person (whose Rights will thereafter be
void), will have the right to receive upon exercise at its then
current Purchase Price that number of shares of Common Stock having a
market value of two times the Purchase Price of the Right. If Group
merges into the acquiring person, transfers a significant portion of
its assets to the acquiring person or enters into any transaction that
unfairly favors the acquiring person or disfavors Group's other
shareholders, the Right becomes a right to purchase Common Stock of
the acquiring person having a market value of two times the Purchase
Price.
The Board may determine that in certain circumstances a proposal which
would cause a distribution date is in the Group shareholders' best
interest. Therefore, the Board may, at its option, redeem the Rights
at a redemption price of $.001 per Right.
NOTE 4. Short-Term Borrowings
As of December 31, 1997, the Group maintained a bank line of credit
providing unsecured borrowings of up to $50,000,000 at the prime
lending rate or lower rates as quoted by the bank. Subsequent to
December 31, 1997, $25,000,000 of the bank line was transferred to
California Water Service Group, with the remaining line of $25,000,000
available solely to the Company. The agreement does not require
minimum or specific compensating balances. The following table
represents borrowings under the bank line of credit.
Dollars in Thousands
1997 1996 1995
Maximum short-term borrowings $14,500 $9,500 $13,000
Average amount outstanding 5,164 1,662 5,142
Weighted average interest rate 7.22% 6.94% 7.26%
Interest rate at December 31 7.29% 6.98%
NOTE 5. Long-Term Debt
As of December 31, 1997 and 1996 long-term debt outstanding was:
In Thousands
1997 1996
First Mortgage Bonds:
Series L 6.75% due 1997 $ $2,138
Series P 7.875% due 2002 2,625 2,640
Series S 8.50% due 2003 2,640 2,655
Series BB 9.48% due 2008 16,740 16,920
Series CC 9.86% due 2020 18,900 19,100
Series DD 8.63% due 2022 19,500 19,600
Series EE 7.90% due 2023 19,600 19,700
Series FF 6.95% due 2023 19,600 19,700
Series GG 6.98% due 2023 19,600 19,700
119,205 122,153
Senior Notes:
Series A 7.28% due 2025 20,000 20,000
Total long-term debt $139,205 $142,153
The first mortgage bonds are held by institutional investors and
secured by substantially all of the Company's utility plant. Aggregate
maturities and sinking fund requirements for each of the succeeding
five years 1998 through 2002 are $620,000, $2,240,000, $2,240,000,
$2,240,000 and $4,790,000, respectively.
The senior notes are held by institutional investors and are unsecured
and require interest only payments until maturity.
NOTE 6. Income Taxes
Income tax expense consists of the following:
In Thousands
Federal State Total
1997
Current $8,970 $2,894 $11,864
Deferred 2,280 (194) 2,086
Total $11,250 $2,700 $13,950
1996
Current $9,356 $3,274 $12,630
Deferred 444 (924) (480)
Total $9,800 $2,350 $12,150
1995
Current $6,839 $2,729 $9,568
Deferred 1,161 (879) 282
Total $8,000 $1,850 $9,850
Income tax expense computed by applying the current federal tax rate
of 35% to pretax book income differs from the amount shown in the
Consolidated Statement of Income. The difference is reconciled in the
table below:
In Thousands
1997 1996 1995
Computed "expected" tax expense $13,039 $10,926 $8,592
Increase (reduction) in taxes due to:
State income taxes net of
federal tax benefit 1,755 1,528 1,203
Investment tax credits (152) (119) (132)
Other (692) (185) 187
Total income tax $13,950 $12,150 $9,850
The components of deferred income tax expense in 1997, 1996 and 1995
were:
In Thousands
1997 1996 1995
Depreciation $2,457 $3,544 $3,854
Developer advances and contributions (334) (3,749) (3,455)
Bond redemption premiums (62) (73) (75)
Investment tax credits (93) (93) (90)
Other 118 (109) 48
Total deferred income tax expense $2,086 $(480) $282
The tax effects of differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December
31, 1997 and 1996 are presented in the following table:
In Thousands
1997 1996
Deferred tax assets:
Developer deposits for extension agreements
and contributions in aid of construction $43,980 $45,901
Federal benefit of state tax deductions 2,998 4,177
Book plant cost reduction for future
deferred ITC amortization 1,776 1,832
Insurance loss provisions 334 286
Total deferred tax assets 49,088 52,196
Deferred tax liabilities:
Utility plant, principally due to
depreciation differences 74,029 74,407
Premium on early retirement of bonds 1,215 1,290
Other (395) 235
Total deferred tax liabilities 74,849 75,932
Net deferred tax liabilities $25,761 $23,736
A valuation allowance was not required during 1997 and 1996. Based on
historical taxable income and future taxable income projections over
the periods in which the deferred assets are deductible, management
believes it is more likely than not the Group will realize the
benefits of the deductible differences.
NOTE 7. Employee Benefit Plans
Pension Plan. The Company provides a qualified defined benefit, non-
contributory, pension plan for substantially all employees. The cost
of the plan was charged to expense and utility plant. The Company
makes annual contributions to fund the amounts accrued for pension
cost. Plan assets are invested in mutual funds, pooled equity, bond
and short-term investment accounts. The data below includes the
unfunded, non-qualified, supplemental executive retirement plan.
Net pension cost for the years ending December 31, 1997, 1996 and 1995
included the following components:
In Thousands
1997 1996 1995
Service cost-benefits earned during the year $1,545 $1,543 $1,265
Interest cost on projected obligation 2,805 2,583 2,360
Actual return on plan assets (6,023) (4,784) (5,817)
Net amortization and deferral 3,915 2,789 4,220
Net pension cost $2,242 $2,131 $2,028
The following table sets forth the plan's funded status and the plan's
accrued assets (liabilities) as of December 31, 1997 and 1996:
In Thousands
1997 1996
Accumulated benefit obligation, including vested
benefits of $31,519 in 1997 and $28,059 in 1996 $(32,242) $(28,679)
Projected benefit obligation (44,576) (39,296)
Plan assets at fair value 42,390 38,293
Projected benefit obligation in excess of
plan assets (2,186) (1,003)
Unrecognized net gain (5,203) (6,120)
Prior service cost not yet recognized
in net periodic pension cost 5,370 4,991
Remaining net transition obligation at
adoption date January 1, 1987 1,144 1,430
Accrued pension liability recognized
in the balance sheet $(875) $(702)
The projected long-term rate of return on plan assets used in
determining pension cost was 8.0% for the years 1997, 1996 and 1995. A
discount rate of 7.0% in 1997, 7.4% in 1996 and 7.0% in 1995, and
future compensation increases of 4.5% in 1997, 1996 and 1995 were used
to calculate the projected benefit obligations as of the end of the
respective years.
Savings Plan. The Company sponsors a 401(k) qualified, defined
contribution savings plan that allows participants to contribute up to
15% of pre-tax compensation. The Company matched fifty cents for each
dollar contributed by the employee up to a maximum Company match of
4.0%, 3.5% and 3.0% of the employees' compensation in 1997, 1996 and
1995, respectively. Company contributions were $1,045,000, $858,000
and $711,000 for the years 1997, 1996 and 1995, respectively.
Other Postretirement Plans. The Company provides substantially all
active employees with medical, dental and vision benefits through a
self-insured plan. Employees retiring at or after age 58 with 10 or
more years of service are offered, along with their spouses and
dependents, continued participation in the plan by payment of a
premium. Retired employees are also provided with a $5,000 life
insurance benefit.
The Company records the costs of postretirement benefits during the
employees' years of active service. The CPUC has issued a decision
which authorizes rate recovery of tax deductible funding of
postretirement benefits and permits recording of a regulatory asset
for the portion of costs that will be recoverable in future rates.
Net postretirement benefit cost for the years ending December 31,
1997, 1996 and 1995 included the following components:
In Thousands
1997 1996 1995
Service cost - benefits earned $280 $166 $131
Interest cost on accumulated
postretirement benefit obligation 549 383 391
Actual return on plan assets (424) (63) (30)
Net amortization of transition obligation 710 278 260
Net periodic postretirement benefit cost $1,115 $764 $752
Postretirement benefit expense recorded in 1997, 1996 and 1995, was
$581,000, $523,000 and $507,000, respectively. $1,441,000, which is
recoverable through future customer rates, is recorded as a regulatory
asset. The Company intends to make annual contributions to the plan up
to the amount deductible for tax purposes. Plan assets are invested in
mutual funds, short-term money market instruments and commercial
paper.
The following table sets forth the plan's funded status and the plan's
accrued assets (liabilities) as of December 31, 1997 and 1996:
In Thousands
1997 1996
Accumulated postretirement benefit obligation $(3,982) $(2,959)
Other fully eligible participants (818) (604)
Other active participants (3,430) (2,310)
Total (8,230) (5,873)
Plan assets at fair value 936 582
Accumulated postretirement benefit
obligation in excess of plan assets (7,294) (5,291)
Unrecognized net loss 2,129 407
Remaining unrecognized transition obligation 3,724 3,972
Net postretirement benefit liability
included in current liabilities $(1,441) $(912)
For 1997 measurement purposes, a 6.0% annual rate of increase in the
per capita cost of covered benefits was assumed; the rate was assumed
to decrease gradually to 5% in the year 2000 and remain at that level
thereafter. The health care cost trend rate assumption has a
significant effect on the amounts reported. Increasing the assumed
health care cost trend rates by one percentage point in each year
would increase the accumulated postretirement benefit obligation as of
December 31, 1997, by $1,226,000 and the aggregate of the service and
interest cost components of the net periodic postretirement benefit
cost for the year ended December 31, 1997, by $144,000.
The discount rate used in determining the accumulated postretirement
benefit obligation was 7% at December 31, 1997, 7.4% at December 31,
1996, and 7% at December 31, 1995. The long-term rate of return on
plan assets was 8% for 1997, 1996 and 1995.
NOTE 8. Fair Value of Financial Instruments
For those financial instruments for which it is practicable to
estimate a fair value the following methods and assumptions were used:
Cash Equivalents. The carrying amount of cash equivalents
approximates fair value because of the short-term maturity of the
instruments.
Long-term Debt. The fair value of the Group's long-term debt is
estimated at $155,000,000 as of December 31, 1997 and $159,000,000 as
of December 31, 1996, using a discounted cash flow analysis, based on
the current rates available to the Group for debt of similar
maturities.
Advances for Construction. The fair value of advances for
construction contracts is estimated at $21,000,000 as of December 31,
1997 and 1996, based on data provided by brokers.
NOTE 9. Quarterly Financial and Common Stock Market Data
(Unaudited)
The Group's common stock is traded on the New York Stock Exchange
under the symbol "CWT". There were approximately 11,000 common stock
shareholders at December 31, 1997. Quarterly dividends have been paid
on common stock for 212 consecutive quarters and the quarterly rate
has been increased during each year since 1968. The stock quotations
presented, adjusted for the two-for-one split, are those of the
Company which traded on the New York Stock Exchange prior to its
December 31, 1997 merger with the Group.
1997
First Second Third Fourth
(In thousands, except per share amounts)
Operating revenue $37,558 $55,083 $59,551 $43,132
Net operating income 5,712 11,788 10,540 6,309
Net income 2,921 8,878 7,860 3,646
Earnings per share .23 .70 .62 .28
Common stock market price range:
High 22.63 23.88 25.22 29.59
Low 19.50 18.63 21.13 23.44
Dividends paid .264 .264 .264 .264
1996
First Second Third Fourth
Operating revenue $32,298 $49,048 $59,230 $42,188
Net operating income 4,028 8,698 11,488 6,153
Net income 1,177 5,836 8,673 3,381
Earnings per share .09 .46 .68 .27
Common stock market price range:
High 18.63 17.81 19.13 21.88
Low 16.25 16.75 16.25 17.94
Dividends paid .26 .26 .26 .26
Independent Auditors' Report
Shareholders and Board of Directors
California Water Service Group:
We have audited the accompanying consolidated balance sheet of
California Water Service Group and subsidiaries as of December 31,
1997 and 1996, and the related consolidated statements of income,
common shareholders' equity and cash flows for each of the years in
the three-year period ended December 31, 1997. These consolidated
financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position
of California Water Service Group and subsidiaries as of December 31,
1997 and 1996, and the results of their operations and their cash
flows for each of the years in the three-year period ended December
31, 1997, in conformity with generally accepted accounting principles.
San Jose, California
January 23, 1998