UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) ___ |_X_| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 OR ___ |___|TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-13883 CALIFORNIA WATER SERVICE GROUP (Exact name of registrant as specified in its charter) California 77-0448994 (State or other jurisdiction (I.R.S. Employer identification No.) of incorporation or organization) 1720 North First Street, San Jose, CA. 95112 (Address of principal executive offices) (Zip Code) 1-408-367-8200 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common shares outstanding as of October 30, 1998 - 12,619,140. This Form 10-Q contains a total of 21 pages. CALIFORNIA WATER SERVICE GROUP CONSOLIDATED BALANCE SHEET SEPT 30, 1998 DEC 31, 1997 (In Thousands) ASSETS Utility plant $670,021 $647,648 Less depreciation and amortization 198,838 187,241 Net utility plant 471,183 460,407 Current assets: Cash and cash equivalents 1,616 1,742 Receivables 18,341 14,862 Unbilled revenue 8,286 5,136 Materials and supplies 2,193 2,105 Taxes and other prepaid expenses 5,986 4,423 Total current assets 36,422 28,268 Regulatory assets 38,748 38,345 Other deferred assets 4,136 4,277 $550,489 $531,297 CAPITALIZATION AND LIABILITIES Capitalization: Common stock $44,941 $44,941 Retained earnings 123,174 119,124 Total common shareholders' equity 168,115 164,065 Preferred stock 3,475 3,475 Long term debt 139,205 139,205 Total capitalization 310,795 306,745 Current liabilities: Short-term borrowings 13,000 14,500 Accounts payable 20,923 15,499 Accrued expenses and other liabilities 23,890 13,145 Total current liabilities 57,813 43,144 Unamortized investment tax credits 3,006 3,006 Deferred income taxes 26,694 25,761 Advances for construction 95,474 95,878 Contributions in aid of construction 44,215 44,270 Regulatory liabilities 12,492 12,493 $550,489 $531,297 See accompanying notes on page 5 2 CALIFORNIA WATER SERVICE GROUP CONSOLIDATED STATEMENT OF INCOME FOR THE THREE MONTHS ENDED: Sept 30 1998 1997 In Thousands Operating revenue $62,263 $59,551 Operating expenses: Operation 36,610 35,971 Maintenance 2,253 2,560 Depreciation and amortization 3,641 3,435 Income taxes 5,662 5,025 Property and other taxes 2,094 2,020 Total operating expenses 50,260 49,011 Net operating income 12,003 10,540 Other income and expenses, net 279 257 12,282 10,797 Interest on long term debt 2,836 2,889 Other interest 305 48 3,141 2,937 Net income 9,141 7,860 Preferred dividends 38 38 Net income available for common stock $9,103 $7,822 Weighted average common shares outstanding 12,619 12,619 Basic earnings per share of common stock $0.72 $0.62 Dividends per share of common stock $0.2675 $0.2638 FOR THE NINE MONTHS ENDED: In Thousands Operating revenue $141,943 $152,192 Operating expenses: Operation 86,964 89,005 Maintenance 6,655 6,782 Depreciation and amortization 10,922 10,211 Income taxes 8,449 12,372 Property and other taxes 5,890 5,783 Total operating expenses 118,880 124,153 Net operating income 23,063 28,039 Other income and expenses, net 632 613 23,695 28,652 Interest on long term debt 8,508 8,668 Other interest 896 324 9,404 8,992 Net income 14,291 19,660 Preferred dividends 114 114 Net income available for common stock $14,177 $19,546 Weighted average common shares outstanding 12,619 12,619 Basic earnings per share of common stock $1.12 $1.55 Dividends per share of common stock $0.8025 $0.7913 See accompanying notes on page 5 3 CALIFORNIA WATER SERVICE GROUP CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE NINE MONTHS ENDED In Thousands SEPTEMBER 30 1998 1997 Operating activities: Net Income $14,291 $19,660 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 10,922 10,211 Regulatory assets and liabilities, net (404) (153) Deferred income taxes and investment tax credits, net 933 708 Change in operating assets and liabilities: Receivables (3,478) (3,471) Unbilled revenue (3,150) (2,405) Materials and supplies (43) 233 Taxes and other prepaid expenses (1,562) (1,898) Accounts payable 5,424 4,309 Accrued expenses and other liabilities 10,743 6,915 Other changes, net 473 714 Net adjustments 19,858 15,163 Net cash provided by operating activities 34,149 34,823 Investing activities: Utility plant expenditures (23,210) (21,795) Financing activities: Net short-term borrowings (1,500) (5,500) Advances for construction 2,628 3,562 Contributions in aid of construction 948 1,343 Refunds of advances for construction (2,899) (2,767) Dividends paid (10,242) (10,100) Net cash used in financing activities (11,065) (13,462) Change in cash and cash equivalents (126) (434) Cash and cash equivalents at beginning of period 1,742 1,368 Cash and cash equivalents at end of period $1,616 $934 See accompanying notes on page 5 4 Notes: 1.Due to the seasonal nature of the water business, the results for interim periods are not indicative of the results for a twelve month period. 2.The interim financial information is unaudited. In the opinion of management, the accompanying financial statements reflect all adjustments which are necessary to provide a fair statement of the results for the periods covered. The adjustments consist only of normal recurring adjustments. 3.Basic earnings per share are calculated on the weighted average number of common shares outstanding during the period and net income available for common stock as shown on the Consolidated Statement of Income. The Group has no dilutive securities, accordingly, dilutive earnings per share is not shown. 4.Refer to 1997 Annual Report on Form 10-K for a summary of significant accounting policies and detailed information regarding the financial statements. 5 PART I FINANCIAL INFORMATION Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS This 10-Q filing of California Water Service Group ("Group") contains forward looking statements. Readers are directed to review the comments regarding forward looking statements contained in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the 1997 Annual Report to shareholders. The 1997 Annual Report to shareholders was incorporated by reference in Group's 1997 Form 10-K filing. RESULTS OF THIRD QUARTER OPERATIONS Third quarter net income was $9,141,000, equivalent to $0.72 per common share. This represents a $0.10 or 16% increase from the $0.62 earned in last year's third quarter. Operating revenue increased $2,712,000 to $62,263,000. The revenue increase was primarily due to the passage of "El Nino" which had negatively impacted revenue and constrained earnings during the first half of 1998. The return of normal weather resulted in an increase in customer water consumption by 2%, adding $1,753,000 to revenue. Usage by 3,100 new customers added in the last twelve months added $494,000 and increased customer rates added $465,000. Average revenue per customer increased $6.60 or 4%. A breakdown of the net increase in operating revenue is accounted for in the following table: General rate increases $51,000 Step rate increases 414,000 Total rate increases 465,000 Increased consumption 1,753,000 Usage by 3,100 new customers 494,000 Net revenue increase $2,712,000 Total operating expenses increased 2% this quarter: Water production for the quarter was 1% more than last year's level. Well production provided 54% of the supply with 46% purchased from wholesale suppliers. Water production costs, which include purchased water, purchased power and pump taxes, increased $564,000. The purchased water increase was modest because wholesale supplier rate increases in eight districts ranged between 1% and 5%, while three districts experienced a 13% rate decrease. The components of water production expense and the changes from last year are shown in the table below: Third Quarter 1998 Cost Change Purchased water $17,764,000 $573,000 Purchased power 4,794,000 (36,000) Pump taxes 1,746,000 27,000 Total $24,304,000 $564,000 Other operations expense categories increased $75,000. The impact of the 3.0% general wage increase, which was effective at the start of the year, additional hours worked and increases in related employee benefits increased expenses. However, there were decreases in other expense categories including chemicals, telephone expense, general corporate and employee relocations, which offset the increased payroll. Maintenance expense was lower this year due to reduced expenditures required for tank maintenance and pump equipment maintenance and repair. Depreciation and amortization expense increased $206,000 due to increased depreciation expense authorized by the Commission in the rate case decisions and a greater depreciable plant investment. The additional expense is reflected in customer rates. Federal and state income taxes increased $637,000 because of greater taxable income. Other income and expense, reported on a pretax basis, was $279,000. Other income included $318,000 from nonregulated operations. Netted against other income was $39,000 of other expenses, which included contributions and costs of maintaining nonregulated properties. RESULTS FOR THE NINE MONTHS Net income for the nine months ending September 30, 1998 was $14,291,000, equivalent to $1.12 per common share. This represents a $0.43 or 28% decrease from the $1.55 earned for the same period last year. Part of the decline in earnings was attributable to one-time purchased water refunds received in May 1997 from wholesale water suppliers totaling $2,512,000 or $0.12 per share. Operating revenue declined $10,249,000 to $141,943,000. The revenue decrease was primarily due to the impact of "El Nino" which negatively impacted revenue and constrained earnings during the first two 1998 quarters. As reported above, the return of normal weather resulted in an increase in customer water consumption during the third quarter. Since January 1, 1998, 2,800 new customers have been added. Average consumption per metered customer declined 12% from last year and average revenue per customer decreased $30.08 or 7%, both indications of the negative impact of "El Nino" weather during the first half of the year. A breakdown of the net decrease in operating revenue is accounted for in the following table: General rate increases $502,000 Step rate increases 1,028,000 Offset rate increases 217,000 Total rate increases 1,747,000 Decreased consumption (13,075,000) Usage by 2,800 new customers 1,079,000 Net revenue decrease $(10,249,000) Total operating expenses decreased 4%. Water production was 13% less than last year. Well production provided 51% of the supply with 48% purchased from wholesale suppliers and 1% produced through a local watershed. Because of the decline in water production, purchased water, purchased power and pump taxes each declined. Water production costs, which include purchased water, purchased power and pump taxes, decreased $3,231,000. The decline in purchased water cost would have been greater except that in May 1997 one-time refunds were received from wholesale water suppliers totaling $2,512,000. The components of water production expense and the changes from last year are shown in the table below: Year to Date 1998 Cost Change Purchased water $39,004,000 $(1,294,000) Purchased power 8,759,000 (1,410,000) Pump taxes 3,118,000 (527,000) Total $50,881,000 $(3,231,000) Besides water production costs, other operation expense categories decreased $2,042,000. The impact of the 3.0% general wage increase, which was effective at the start of the year, additional hours worked and increases in related employee benefits increased operating expenses. However, there were decreases in other expense categories including chemicals, CPUC reimbursement fee, telephone expense, general corporate and employee relocations which offset the increased payroll. Maintenance expense was lower this year due to reduced expenditures required for tank maintenance, water treatment equipment maintenance and pump equipment maintenance and repair. Depreciation and amortization expense increased $711,000 due to increased depreciation expense authorized by the Commission in the rate case decisions and a greater depreciable plant investment. The additional expense is reflected in customer rates. The largest decrease in operating expense was Federal and state income taxes which declined due to lower taxable income. Other income and expense, reported on a pretax basis, was $632,000. Other income included $856,000 from nonregulated operations. Netted against other income was $224,000 of other expenses, which included contributions and costs of operating and maintaining nonregulated properties. REGULATORY MATTERS 1998 rate case applications were filed with the California Public Utilities Commission ("Commission") on July 31 for rate increases in four districts (Bear Gulch, East Los Angeles, Hermosa Redondo and Visalia) representing 25% of total regulated customers. The applications request additional annual revenue of about $7,000,000 with a return on equity of 11.85%. Based on the Commission's processing schedule, a decision regarding the applications is expected from the full Commission in the second quarter of 1999. An application to increase rates in the Hawthorne district which is operated under a long-term lease was also filed. In accordance with the lease agreement, this application will be processed by the Hawthorne city council. Decisions were received in July 1998 from the Commission on the applications filed in July 1997. These decisions affect four districts (Marysville, Oroville, Selma and South San Francisco) representing 7% of the regulated customers. The decisions are expected to provide $299,000 during 1998, $267,000 in 1999 and $121,000 in the years 2000 and 2001. Rate increases in the Selma and Oroville districts will be tied to future changes in a price index. LIQUIDITY Interest expense on long-term debt decreased by $53,000 as a result of the retirement of Series L first mortgage bonds and annual first mortgage bond sinking fund payments made in the fourth quarter of 1997. Short-term interest expense increased $257,000 due to additional borrowings under the bank line of credit. At September 30, 1998, $13 million was borrowed under the credit line at an effective interest rate of 7.05%. At September 30, 1997, $2 million was outstanding under the credit line. The Group plans to issue long-term debt during the fourth quarter of 1998 or early in 1999 to replace outstanding short-term bank borrowings. The third quarter common dividend was paid on August 15, 1998, at $0.2675 per share. The $0.2675 represents a $0.00375 or 1.4% increase in the quarterly dividend rate from last year as approved by the Board of Directors at their January meeting. Annualized, the dividend rate is $1.07 per common share compared to $1.055 in 1997. Based on the 12-month earnings per share at September 30, 1998, the dividend payout ratio is 76%. About 11% of the outstanding shares participate in the reinvestment program under Group's Dividend Reinvestment and Stock Purchase Plan ("Plan"). No new common shares were issued under the Plan during the quarter. Shares required for the dividend reinvestment and stock purchase options were purchased on the open market and distributed to Plan participants. Shares are also purchased on the open market to fulfill the requirements of the Company sponsored Employee Savings Plan (401(k)). Purchases are made on a biweekly basis. Book value per common share was $13.32 at September 30, 1998, compared to $12.98 a year earlier. During the quarter, utility plant expenditures totaled $6,959,000 for additions to and replacements of utility plant. Of that amount, $6,696,000 was funded through Group's construction budget with the balance consisting of funds received from developers as contributions in aid of construction and refundable advances for construction. The 1998 Group construction budget is $31,000,000. WATER SUPPLY The Group believes that its various sources of water supply are sufficient to meet customer demand for the remainder of the year. Historically, approximately half of the water source is purchased from wholesale suppliers with the other half pumped from wells. Storage in state reservoirs was 136% of historic average as of September 30, 1998, and groundwater levels remain adequate. Because the first part of the summer was relatively cool with no sustained hot weather until mid-July, melting of the very large mountain snowpack was slow. The abundant snowpack provides runoff to streams and reservoirs as it melts during the remaining summer months. YEAR 2000 UPDATE Group continues to modify and implement its Year 2000 readiness program as described in the 10Q filed for the quarter ended June 30, 1998. In the second quarter 10Q filing, Group indicated that it was considering using an outside consultant to review and assess the Year 2000 readiness plan. An independent consultant was retained and a risk assessment completed on October 23, 1998. While the consultants report was positive, it did identify several areas which require additional attention. Attention is being given to implement the consultant's recommendations. Installation of the PeopleSoft accounting and human resources software packages continues on schedule. Both systems are scheduled to be in place before mid year 1999. The $300,000 estimated remediation cost for Year 2000 readiness has not changed. Operating units continue to work with suppliers to assure availability of necessary products or services. This work will continually be updated through the remainder of 1998 and throughout 1999. One objective of continued updating is to learn of any changes in a supplier's ability to provide necessary products and services. It is also designed to allow time for alternative plans should circumstances warrant. ACCOUNTING PRONOUNCEMENTS There were no accounting pronouncements issued during the period that would have a significant impact on Group. BUSINESS OPPORTUNITIES In the 1997 Annual Report to shareholders, Group indicated that it would be carefully evaluating the potential risk and return of business opportunities in Central and South America. That assessment has been completed. Group concluded that the risks and potential returns do not warrant pursuing business opportunities in Central or South America. In accordance with its growth strategy, Group will continue to investigate opportunities in the western United States. REAL ESTATE PROGRAM Group's subsidiary, California Water Service Company ("Company") owns more than 850 real estate parcels. Certain parcels are not necessary for or used in water utility operations. A program has been developed to realize the value of the surplus properties. The program will be ongoing over a period of several years. Over the next four years, Group estimates that gross property transactions totaling several million could be completed. SHAREHOLDER PROPOSALS The Board of Directors amended Group's bylaws to require that shareholder proposals for consideration at an annual shareholders' meeting or nomination of a candidate for director (other than a nomination by the Board's nominating committee) must be submitted to Group at least 150 days before the anniversary date of the previous year's annual meeting. The advance notice requirement is intended to allow management sufficient time to review and consider any shareholder proposal or nomination. Proposals and nominations will no longer be accepted from the floor at the annual shareholders' meeting. Because of the timing of this action, the deadline for the shareholders' meeting scheduled for April 21, 1999 will be approximately 30 days later or December 14. The December 14 date will be about 120 days before the anniversary date of the 1998 annual meeting. The 150 day requirement will be effective for the year 2000 annual meeting. Consistent with Securities and Exchange Commission rules, the deadline for any proposal to be eligible for inclusion in Group's 1999 proxy statement was November 11, 1998, as announced in the 1998 proxy statement. The full text of the bylaw amendment is included as an exhibit with this filing. PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits required to be filed by Item 601 of Regulation S-K. Sequential Exhibit Page Numbers Number Description in this Report 10.18 Amendment to bylaws regarding timing for 11 submission of shareholder proposals for consideration at annual shareholder meetings and shareholder nominations of directors 10.19 Certificate of Determination filed with state 14 of California regarding Series D Participating Preferred Shares. These shares are relative to Shareholder Rights Plan and would be issued if the rights plan were triggered. The certificate was adopted earlier this year as part of the rights plan and was refiled in a revised form at the Secretary of State's request. (b) No reports on Form 8-K have been filed during the quarter ended September 30, 1998. SIGNATURES Pursuant to the requirement of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the authorized undersigned. CALIFORNIA WATER SERVICE GROUP Registrant October 27, 1998 /s/ Gerald F. Feeney GERALD F. FEENEY Vice President, Chief Financial Officer and Treasurer