REGULATED AND NON-REGULATED CUSTOMERS
Published on March 24, 2000
Page 16
Management's Discussion and Analysis of Financial Condition and Results of
Operations
California Water Service Group (Company) is a holding company with three
operating subsidiaries, California Water Service Company (Cal Water), CWS
Utility Services (Services) and Washington Water Service Company (Washington
Water). Cal Water and Washington Water are regulated public utilities. Their
assets and operating revenues currently make up the majority of the Company's
assets and revenues. Services provides non-regulated water operations and
related services to other private companies and municipalities. The following
discussion and analysis provides information regarding the Company and its
assets, operations and financial condition.
Forward-Looking Statements
This annual report, including the Letter to Stockholders, Management's
Discussion and Analysis and other sections, contains forward-looking statements
within the meaning of the federal securities laws. Such statements are based on
currently available information, expectations, estimates, assumptions and
projections, and management's judgment about the Company, 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 or
anticipated include regulatory commission decisions, new legislation, increases
in suppliers' prices, changes in environmental compliance requirements,
acquisitions, changes in customer water use patterns and the impact of weather
on operating results. The Company assumes no obligation to provide public
updates on forward-looking statements.
Business
Cal Water is a public utility supplying water service to 387,600 customers in 60
California communities through 21 separate water systems or districts. Cal
Water's 20 regulated systems, which are subject to regulation by the California
Public Utilities Commission (CPUC), serve 381,500 customers as shown on the
enclosed map. An additional 6,100 customers receive service through a lease of
the City of Hawthorne's water system, which is not subject to CPUC regulation.
Cal Water derives non-regulated income from contracts with other private
companies and municipalities to operate water systems and provide billing
services to 33,400 customers. It also leases communication antenna sites and
operates two reclaimed water systems.
Washington Water's utility operations are regulated by the Washington
Utilities and Transportation Commission (WUTC). Washington Water provides
domestic water service to 12,000 customers through two operating districts near
Tacoma and Olympia. An additional 2,800 customers are served under operating
agreements with private
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owners. Refer to the separate section titled "Washington Acquisitions" for
further information concerning Washington Water.
Rates and operations for regulated customers are subject to the
jurisdiction of the respective state's regulatory commission. The commissions
require that water rates for each regulated district be independently
determined. 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 Operation
Restatement During 1999, the Company issued 316,472 shares of common stock in
exchange for all of the outstanding shares of Harbor Water Company and South
Sound Utility Company. Both acquisitions were accounted for as poolings of
interests. Financial statements for the current and prior periods have been
restated to include the accounts of both companies.
Earnings and Dividends Net income in 1999 was $19,919,000, compared to
$18,936,000 in 1998 and $23,736,000 in 1997. Earnings per common share were
$1.53 in 1999, $1.45 in 1998 and $1.82 in 1997. Net income and earnings per
share in 1997 were the highest levels ever achieved by the Company. The weighted
average number of common shares outstanding in each of the three years was
12,936,000.
At its January 1999 meeting, the Board of Directors increased the common
stock dividend rate for the 32nd consecutive year. 1999 also marked the
55th consecutive year that a dividend had been paid on the Company's common
stock. The annual dividend paid in 1999 was $1.085, an increase of 1.4%
over the 1998 rate of $1.07 per share, which in turn was an increase of
1.4% from the 1997 dividend of $1.055 per share. The dividend increases
were based on projections that the higher dividend could be sustained while
still providing the Company with adequate financial flexibility. Earnings
not paid as dividends are reinvested in the business. The dividend payout
ratio was 71% in 1999, 74% in 1998 and 58% in 1997, an average of 67% for
the three-year period.
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Operating Revenue Operating revenue, including revenue from City of Hawthorne
customers, was $206.4 million, $16.8 million or 9% more than the $189.7 million
recorded last year. Revenue in 1997 was $198.3 million. Operating revenue
exceeded $200 million for the first time in 1999. The source of changes in
operating revenue were:
dollars in millions 1999 1998 1997
Customer water usage $11.8 $(12.6) $ 3.9
General and step rate increases 3.0 1.9 6.4
Offset rate increases - water production costs 0.2 0.2 0.2
Usage by new customers 1.8 1.9 2.3
Net change $16.8 $ (8.6) $12.8
Average revenue per customer $ 517 $ 481 $ 508
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Average metered customer usage (ccf) 305 284 315
New customers added 5,000 4,100 4,000
Weather in the first half of 1999 was normal, while in the prior year it was
cool and wet; as a result, customer usage and revenue were higher this year.
Third-quarter weather in both years was normal. Fourth-quarter 1999 weather was
mild and drier than 1998, causing an increase in customer usage and an increase
in revenue. The year-end customer count was 399,600, an increase of 1.3%.
During the first half of 1998, weather in our service areas was wet and
cool, very much the reverse of 1997's favorable weather pattern. Weather in the
second half of 1998 returned to a more normal pattern. However, the wet, cool
weather in the early part of the year resulted in an overall 9% decrease in 1998
water usage, negatively impacting revenue. The year-end customer count in 1998
was 394,500, a 1.1% increase.
Rainfall for the 1996-97 season was concentrated in December 1996 and
January 1997, then virtually ceased. Average consumption per metered account
reached a record level due to dry and warm summer months. The customer count in
1997 increased 1.0% to 390,400.
Operating and Interest Expenses Operating expenses, including those for the
Hawthorne operation, were $175.8 million in 1999, $159.1 million in 1998 and
$163.4 million in 1997.
Wells provided 52.4% of water requirements in 1999 and purchased water
provided 47.2%, with 0.4% obtained from a surface supply. In 1998, the
corresponding percentages were 50.6%, 48.9% and 0.5%, and in 1997, 51.8%,
47.8% and 0.4%. The table below provides information regarding water
production costs, which includes purchased water, purchased power and pump
taxes:
dollars in millions 1999 1998 1997
Purchased water $58.1 $50.4 $52.2
Purchased power 13.0 11.4 12.7
Pump taxes 4.5 3.8 4.3
Total water production costs $75.6 $65.6 $69.2
Change from prior year 15% (5)% 2%
Water production (billion gallons) 110 101 111
Change from prior year 10% (9)% 5%
The year-to-year water production cost changes were influenced by each
year's predominant weather pattern. In each of the three years, purchased water
expense, the largest component of annual operating expense, was affected by
wholesale suppliers' rate increases. Water production costs in 1999 reflect an
increase in customer usage and significant purchased water price increases for
the San Francisco Peninsula districts, where the wholesale supplier's rates
increased 37%.
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Production levels in 1998 decreased from 1997 due to lower customer
usage in response to weather conditions. Despite some wholesaler price
increases, overall water
37
production expenses declined. Well production decreased due to the decline in
water sales and because several wells were out of service for maintenance. With
reduced well production, purchased power and pump tax expenses declined.
In 1997, nonrecurring refunds totaling $2.5 million received from two
wholesale water suppliers reduced purchased water expense. Well production
increased 6% in 1997 because of increased demand, causing an increase in pump
taxes and purchased power costs.
Employee payroll and benefits charged to operations and maintenance
expense was $38.4 million in 1999, $34.9 million in 1998 and $34.1 million in
1997. The increases in payroll and related benefits are attributable to wage
increases effective at the start of each year and additional hours worked. At
year-end 1999, 1998 and 1997, there were 708, 689 and 679 employees.
Income tax expense was $12.2 million in 1999, $10.8 million in 1998 and
$14.1 million in 1997. The changes in taxes are generally due to variations in
taxable income. There is no state income tax in Washington.
Long-term debt interest expense increased $1.0 million in 1999 because
of the issuance of Series B, 6.77% senior notes in March. Long-term interest
costs decreased $0.4 million in 1998 and $0.3 million in 1997 due to the
retirement of Series K bonds in November 1996 and Series L bonds in November
1997, annual sinking fund payments each year and the absence of new long-term
financing.
Interest expense from short-term bank borrowings in 1999 decreased $0.4
million. Short-term borrowings were reduced after the issue of the Series B
senior notes and by strong cash flow from operations. In 1998, short-term
interest expense was $0.7 million greater than in 1997. In 1997, short-term
interest expense was $0.3 million more than in the prior year. Interest coverage
of long-term debt before income taxes was 3.5 times in 1999 and 1998, and 4.1
times in 1997. There was $13.5 million in short-term borrowings at the end of
1999, and $22.5 million at the end of 1998.
Other Income Other income is derived from management contracts by which the
Company operates private and municipally-owned water systems, agreements for
operation of two reclaimed water systems, contracts for meter reading and
billing services to various cities, leases of communication antenna sites,
surplus property sales, other nonutility sources and interest on short-term
investments. Total other income was $2.7 million in 1999, $1.3 million in 1998
and $1.4 million in 1997. During 1999, $1.3 million in pretax revenues were
realized as part of the Real Estate Program that is described in more detail in
"Liquidity and Capital Resources." Income from the various operating and billing
contracts, excluding short-term interest income, was $2.5 million in 1999 and
$1.3 million in 1998 and 1997.
Rates and Regulation
The Company's regulatory staff completed a review of 14 Cal Water districts that
were eligible for general rate application filings in 1999. Based on current
earnings levels, projected expense increases and expected capital expenditures,
a determination was made that no general rate increase applications were
necessary. During 2000, eligible districts will again be reviewed. It is
anticipated that general rate application filings will be made in mid-year with
CPUC decisions expected in late spring 2001.
In May 1999, the CPUC authorized rate increases in four districts
serving about 25% of Cal Water's total customers. The applications were filed in
July 1998.
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Subsequently, the Company and CPUC staff agreed to a stipulated settlement. The
decision is estimated to generate $4,095,000 in new revenue during the twelve
months following its mid-June effective date. The decision authorized a 9.55%
return on equity, providing $1.9 million in additional revenue. In addition, the
decision provided another $2.2 million in revenue for environmental compliance,
specific capital budget expenditures and recovery of General Office expenses.
The $2.2 million is not reflected in the 9.55% return on equity calculation.
CPUC decisions were received in July 1998 for the general rate
applications filed in July 1997. Additional annual revenue from these decisions
is expected to total $299,000 in 1998, $267,000 in 1999 and $121,000 in the
years 2000 and 2001. In a variance from its past practice, future rate increases
for operating costs and capital requirements over the next five years in the
Oroville and Selma districts are tied to changes in a price index. The decision
maintained the ROE at 10.35%.
In 1997, the CPUC's general rate application decisions granted an ROE
of 10.35% and additional revenue of $2.4 million.
No rate applications were filed for the Washington operations during
1999. The most recent authorized rate of return was 11.1%, granted in a 1998
decision. General rate application filings for both districts are expected in
2000.
Water Supply Page 19
The Company's source of supply varies among its 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 a combination of wells and purchased sources. Historically, about half of
the water is provided from wells and about half is purchased.
Generally, between mid-spring and mid-fall, little precipitation falls
in the California service areas. The Washington service areas receive
precipitation in all seasons. Water demand is highest during the warm summers
and lowest in the cool winters. 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 1999-2000 water year has been less than normal, but the prior four years
exceeded normal levels. Water storage in state reservoirs at the end of 1999
exceeds historic amounts. The Company believes that its supply from both
underground aquifers and purchased sources should be adequate to meet customer
demand during 2000.
Environmental Matters
The Company is subject to regulations of the United States Environmental
Protection Agency (EPA), state health service departments and various local
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 requirements set forth by the
various agencies.
The Safe Drinking Water Act was amended in 1996 to provide a new
process for the EPA to select and regulate waterborne contaminants. The EPA can
now regulate only contaminants that are known or likely to occur at levels that
would pose a risk to public
39
health when such regulation would provide a meaningful opportunity to reduce a
health risk. New drinking water regulations will be based primarily on risk
assessment and measurement of cost/benefit considerations for minimizing overall
health risk. Over 90 contaminants for possible regulation have been listed by
the EPA and the list must be updated every five years. Also, every five years
the EPA must select at least five listed contaminants and determine if they
should be regulated.
The Company has an established water supply monitoring program to test
for contaminants as mandated by the EPA. As necessary or required, water
treatment is added to provide disinfection for water extracted from underground
sources. The Company also owns and operates three surface water treatment
plants. The cost of treatment is being recovered in customer rates as authorized
by the regulatory authorities. Water purchased from wholesale suppliers is
treated before delivery to the Company's systems.
Enforcement of the EPA standards is the responsibility of individual
states, which could impose more stringent regulation. In addition to the EPA's
requirements, 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 bank lines of credit and
internally generated funds. The Company and Cal Water have a $50 million bank
line of credit. The Company's portion is $20 million and Cal Water's portion is
$30 million. The Company's $20 million portion may be drawn on for use by the
Company, including funding operations of either of its two California
subsidiaries. Cal Water's $30 million portion can be used solely for purposes of
the regulated utility. Washington Water has loan commitments from two banks to
meet its operating and capital equipment purchase requirements. Generally,
short-term borrowings under the commitments are converted annually to long-term
borrowings with repayment terms tied to system and equipment acquisitions.
Additional information regarding the bank borrowings is presented in Note 6 to
the Consolidated Financial Statements. Internally generated funds come from
retention of earnings not paid out as dividends, 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 when water sales are lower. With greater summer
usage and increased billings comes increased cash flow from operations, allowing
bank borrowings to 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 Cal Water's first mortgage bonds at AA- and Aa3. Long-term
financing, which includes common stock, first mortgage bonds, senior notes and
other debt securities, has been 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.
Page 20
In March 1999, Cal Water completed its first long-term financing in
four years when Series B, 6.77%, 30-year senior notes were issued. Prior to the
Series B issue,
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operating and capital requirements were met by borrowings under the bank
short-term line of credit and by internally generated funds.
In 1998, the Company introduced a Dividend Reinvestment and Stock
Purchase Plan (Plan), replacing the existing plan. Under the Plan, stockholders
may reinvest dividends to purchase additional Company common stock. The Plan
also allows existing stockholders and other interested investors to purchase
Company common stock through the transfer agent. Shares required for the Plan
may be purchased on the open market or newly issued shares. Therefore, the Plan
will provide the Company with an alternative means of developing additional
equity if new shares are issued. During 1999 and 1998, shares required by the
Plan were purchased on the open market. At this time, the Company intends to
continue purchasing shares required for the Plan on the open market. However, if
new shares were issued to satisfy future Plan requirements, the impact on
earnings per share could be dilutive because of the added shares outstanding.
Also, stockholders not participating in the Plan may experience dilution of
their ownership percentage.
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 1999, total utility plant expenditures were $44.5 million. For
1998, utility plant expenditures totaled $35.9 million, compared to $33.9
million in 1997. Expenditures in 1999 included $31.5 million provided by Company
funds and $13.0 million received from developers through contributions in aid of
construction and refundable advances for construction. Company projects were
funded by internally generated funds, borrowings under bank credit lines and
commitments, and issuance of the $20 million Series B senior notes.
The Company's 2000 construction program is authorized for $35.7
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 about $175 million.
Capital Structure Common stockholders' equity increased by the amount of
earnings not paid out for dividends. No new equity was issued in the past three
years. The long-term debt portion of the capital structure increased due to the
issuance of Series B senior notes. It was reduced by first mortgage bond sinking
fund payments.
The Company's total capitalization at December 31, 1999 was $337.2
million, compared to $313.9 million at the end of 1998.
Capital ratios were: 1999 1998
Common equity 52.1% 54.2%
Preferred stock 1.0% 1.1%
Long-term debt 46.9% 44.7%
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The 1999 return on average common equity was 11.4%, compared with 11.3%
in 1998 and 14.7% in 1997. Refer to the discussion of authorized return on
equity in the "Rates and Regulation" section.
Real Estate Program The Company's subsidiaries own more than 900 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 certain surplus
properties through sale or lease of those properties. Most surplus properties
have a low cost basis. The program, which commenced in 1999, will be ongoing for
a period of several years. During the next four years, the Company estimates
that gross property transactions totaling over six million dollars could be
completed.
Stockholder Rights Plan As explained in Note 5 to the Consolidated Financial
Statements, in January 1998, the Board of Directors adopted a Stockholder Rights
Plan (Plan). In connection with the Plan, a dividend distribution of one right
for each common share to purchase preferred stock under certain circumstances
was also authorized. The Plan is designed to protect stockholders and maximize
stockholder value in the event of an unsolicited takeover proposal by
encouraging a prospective acquirer to negotiate with the Board.
Dominguez Merger Page 21
On November 13, 1998, the boards of the Company and Dominguez Services
Corporation (Dominguez) agreed to the merger of the two companies. The agreement
was subsequently amended on March 22, 1999.
Dominguez is a utility holding company whose subsidiaries provide water
service to about 40,000 customers in 20 California communities. Its primary
subsidiary, Dominguez Water Company, is a regulated water utility with its
largest operation serving over 32,000 accounts in the South Bay area of Los
Angeles County adjacent to Cal Water's Hermosa Redondo and Palos Verdes
districts. Dominguez also has operations in Kern County east of Cal Water's
Bakersfield district serving over 4,100 accounts, in the Antelope Valley area
serving about 1,300 accounts and in an area north of San Francisco serving about
1,900 customers.
Dominguez' 1998 operating revenue was $25.3 million. Its net utility
plant was $44.8 million and it had total assets of $52.6 million.
The amended agreement provides that each outstanding Dominguez common
share will be exchanged for between 1.25 and 1.49 shares of Company common
stock. The precise conversion ratio will depend upon the average closing price
of Company common stock for a twenty-day period preceding the transaction's
closing date. The conversion ratio is designed to yield Dominguez shareholders a
$33.75 value for each Dominguez share. At December 31, 1998, there were
1,561,000 shares of Dominguez common stock outstanding. The Company also expects
to assume approximately $12 million of outstanding Dominguez debt.
Dominguez shareholders approved the merger at a meeting in May 1999.
Necessary approvals from federal agencies, including the Securities and Exchange
Commission and Federal Trade Commission, have been received. Final approval of
the CPUC is now anticipated in March 2000.
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Washington Acquisitions
During the fourth quarter of 1999, the Company completed the acquisitions of
Harbor Water Company near Tacoma and South Sound Utility Company near Olympia.
The two companies, which serve 14,800 customers, were merged into a new
subsidiary, Washington Water Service Company. The transactions were completed
through tax-free exchanges of 316,472 Company common shares, valued at $8.5
million for all of the shares of the two companies. The Company also assumed $3
million in outstanding debt. Both transactions were accounted for on a pooling
of interest basis.
New Accounting Standard
In 1998, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities." The statement establishes new accounting and reporting
standards for derivative financial instruments and hedging activities. The
Company expects to adopt the standard in 2000. Its adoption is not anticipated
to have a material impact on the Company's results of operations or financial
position.
Year 2000 Update
Readiness The Company successfully transitioned from 1999 to 2000 without
technology or customer service disruptions as a result of preparation efforts by
our employees in the districts and at the corporate office. A Year 2000 (Y2K)
Transition Team was assembled to ensure the Company's Y2K preparedness. Computer
applications are currently processed on a mainframe-based system and a local
area network (LAN) computer system. Most billing applications are processed on
the mainframe computer. The information systems department (IS) inventoried
software programs and modified them to be Y2K ready. A Y2K compatible
accounting, purchasing and human resources software package was installed and
operated on the LAN during 1999 as scheduled. The Company identified
non-computer equipment and operating systems that potentially contained embedded
date-sensitive chips. Steps were taken to make the equipment and systems Y2K
ready. The Company continues to monitor its computer-based systems for possible
Y2K disruptions and is ready to respond in the event of a Y2K related problem.
Suppliers and vendors with whom the Company has material business
relationships were contacted throughout 1998 and 1999 to assess their Y2K
preparedness. Those contacted included water wholesalers, power supply
companies, chemical vendors, fuel suppliers, banks and the stock registrar.
Operating units continue in 2000 to work with suppliers and vendors to assure
availability of necessary products and supplies.
The Company's water systems operate independent of each other. Each
system is unique as to its operating requirements. Each operating district
prepared a Y2K readiness and response plan. The plans were continually reviewed
and updated as testing was completed and new information received that could
affect the Y2K transition.
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Costs The estimated remediation cost for Y2K preparedness was about $500,000.
This includes the cost of an outside consultant, vendors and computer
programming time. The costs of a new computer system and software package are
not included since their
43
selection and installation were not Y2K driven. No IS projects were deferred as
a result of the Y2K efforts. The Company did accelerate the acquisition of
several portable boosters for use in moving water in the event of a power
outage, with a capitalized cost of about $400,000.
Risks In a worst case scenario, the Company could have been unable to deliver
water to some or all of its customers if wholesale suppliers had not provided
water or power supplies. Additionally, it could have been impossible to produce
customer bills or maintain accounting functions if power sources were not
available or computer billing programs did not properly function. Insurance
coverage was reviewed and the Company and its broker believed that the policies
afforded Y2K coverage.
Contingency Plans Each district maintains an emergency response plan that is
reviewed and updated on a regular basis. These plans are designed to provide for
alternative operating plans and procedures in the event normal operations are
interrupted. The emergency plans were the basis for developing separate Y2K
service interruption preparedness and response plans.
Fixed site and portable auxiliary power generators are located
throughout the service territories. These generators are designed to produce
electric power for wells and pumps to supply water to customers in the event
power companies experience outages. Emergency water connections are maintained
between the Company's water systems and those of adjacent purveyors to provide
an emergency water supply.
Each district has identified high-profile water users, such as
hospitals, and developed contingency plans for continued service in the event of
a service disruption. Detailed Y2K plans included the following: establishing a
timeline to ascertain vendors' ability to provide crucial products and services;
informing employees of Y2K efforts and responsibilities; scheduling maintenance
so that water delivery facilities were on line at year-end; arranging for
alternate water and power supplies; conducting "what if" exercises to develop
responses to loss of water or power outages from normal sources and preparing
for manual water system operations if necessary; identifying plans to provide
water service to critical vendors, such as hospitals; assuring that measures
were in place to maintain water quality and that water testing alternatives were
available; arranging for equipment needs and supplies should Y2K problems
develop; and scheduling employees to be on duty or available for duty as needed.
Notes To Consolidated Financial Statements Page 27
December 31, 1999, 1998, and 1997
Note 1. Organization And Operations
California Water Service Group (Company) is a holding company and through its
wholly owned subsidiaries provides water utility and other related services in
California and Washington. During 1999, the Company reincorporated as a Delaware
corporation. California Water Service Company and Washington Water Service
Company provide regulated utility services under the rules and regulations of
their respective regulatory commissions (jointly referred to as Commissions).
CWS Utility Services provides non-regulated water utility and related utility
services.
The Company operates primarily in one business segment, providing water
and related utility services.
Note 2. Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. The financial statements give retroactive effect
to acquisitions, which were accounted for as poolings of interests. 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 Commissions. 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 Commissions and billings to certain
non-regulated 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 is charged primarily to
operation expenses. Interest is capitalized on plant expenditures during the
construction period and amounted to $324,000 in 1999, $224,000 in 1998, and
$267,000 in 1997.
Intangible assets acquired as part of water systems purchased are
stated at amounts as prescribed by the Commissions. All other intangibles have
been recorded at
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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 Company 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.
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 2.6% in 1999, 1998, and 1997. 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.
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.
Page 28
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.
Accumulated Other Comprehensive Loss The Company has an unfunded Supplemental
Executive Retirement Plan. The unfunded accumulated benefit obligation of the
plan exceeds the accrued benefit cost. This amount exceeds the unrecognized
prior service cost, therefore accumulated other comprehensive loss has been
recorded as a separate component of Stockholders' Equity.
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 the extensions. 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, 1999, the amounts refundable under the 20-year
contracts were $7,664,000 and under 40-year contracts $92,327,000. Estimated
refunds for 2000 for all water main extension contracts are $4,100,000.
Contributions in Aid of Construction Contributions in Aid of Construction
represent payments received from developers, primarily for fire protection
purposes, which are not
51
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 Company 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 Commissions will
reflect revenue requirements for the tax effects of temporary differences
recognized, which have previously been flowed through to customers.
The Commissions have 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
for book purposes. 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 were subject to California
income tax. In 1996 the federal tax law, and in 1997 the California tax law,
changed and the major portion of future advances and contributions are
nontaxable.
Earnings per Share Basic earnings per share (EPS) is calculated using income
available to common stockholders divided by the weighted average shares
outstanding during the year. The Company has no dilutive securities;
accordingly, diluted EPS is not shown.
Note 3. Acquisitions
The Company acquired all of the outstanding stock of Harbor Water Company and
South Sound Utility Company, which form the operations of Washington Water
Service Company, serving 14,800 regulated and non-regulated customers. The
acquisitions, which were completed in 1999, were accounted for as poolings of
interests in exchange for 316,472 shares of Company stock and assumption of
long-term debt of $2,959,000. The results of operations previously reported by
the separate entities and included in the accompanying financial statements are
not significant.
Note 4. Preferred Stock Page 29
As of December 31, 1999 and 1998, 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
election 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
52
due upon voluntary liquidation of Series C. There is no premium in the event of
an involuntary liquidation.
Note 5. Common Stockholders' Equity
The Company is authorized to issue 25,000,000 shares of $.01 par value common
stock. As of December 31, 1999 and 1998, 12,935,612 shares of common stock were
issued and outstanding. All shares of common stock are eligible to participate
in the Company's dividend reinvestment plan. Approximately 10% of stockholders
participate in the plan.
Stockholder Rights Plan In January 1998, the Board of Directors adopted a
Stockholder Rights Plan (the 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 became effective in February 1998
and expire in February 2008. The Plan is designed to provide stockholders
protection and to maximize stockholder 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 stockholder election. The Rights become exercisable upon occurrence of a
Distribution Date. A Distribution Date event occurs if (a) any person
accumulates 15% of the then outstanding Common Stock, (b) any person presents a
tender offer which causes the person's ownership level to exceed 15% and the
Board determines the tender offer not to be fair to the Company's stockholders,
or (c) the Board determines that a stockholder maintaining a 10% interest in the
Common Stock could have an adverse impact on the Company or could attempt to
pressure the Company 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) the Company would distribute separate Rights Certificates to Common
Stockholders 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 the Company merges
into the acquiring person or enters into any transaction that unfairly favors
the acquiring person or disfavors the Company's other stockholders, 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 that
would cause a distribution date is in the Company stockholders' best interest.
Therefore, the Board may, at its option, redeem the Rights at a redemption price
of $.001 per Right.
Note 6. Short-Term Borrowings
As of December 31, 1999, the Company maintained a bank line of credit providing
unsecured borrowings of up to $20,000,000 at the prime lending rate or lower
rates as quoted by the bank. Cal Water maintained a bank line of credit for an
additional $30,000,000 on the same terms as the Company. The line of credit
agreements, which
53
The first mortgage bonds are held by institutional investors and
secured by substantially all of Cal Water's utility plant. The senior notes are
held by institutional investors and are unsecured and require interest-only
payments until maturity. Other long-term debt is primarily equipment financing
arrangements with other financial institutions. Aggregate maturities and sinking
fund requirements for each of the succeeding five years (2000 through 2004) are
$2,651,000, $2,613,000, $5,072,000, $5,265,000, and $2,373,000.
54
A valuation allowance was not required during 1999 and 1998. Based on
historic taxable income and future taxable income projections over the period in
which the deferred assets are deductible, management believes it is more likely
than not that the Company will realize the benefits of the deductible
differences.
Note 9. Employee Benefit Plans Page 32
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, bonds and short-term investment accounts. The data below includes
the unfunded, non-qualified, supplemental executive retirement plan.
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%. Company contributions were
$1,126,000, $1,078,000, and $1,045,000, for the years 1999, 1998 and 1997.
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. Plan assets are invested in a mutual fund, short-term
money market instruments and commercial paper.
The Company records the costs of postretirement benefits during the
employees' years of active service. The Commissions have issued decisions that
authorize rate recovery of tax deductible funding of postretirement benefits and
permit recording of a regulatory asset for the portion of costs that will be
recoverable in future rates.
56
Postretirement benefit expense recorded in 1999, 1998, and 1997 was
$680,000, $635,000, and $581,000. $3,400,000, 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.
For 1999 measurement purposes, a 5.5% 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. A one-percentage point change in assumed health care cost
trends would have the following effect:
In Thousands
1-percentage 1-percentage
Point Increase Point Decrease
Effect on total service and interest costs $250 $(166)
Effect on accumulated postretirement
benefit obligation $1,378 $(1,121)
Page 34
Note 10. Agreement Of Merger With Dominguez Services Corporation
On November 13, 1998, the Boards of Directors of the Company and Dominguez
Services Corporation (Dominguez) agreed to a merger of the two companies.
Dominguez is a utility holding company whose wholly owned subsidiaries provide
water service to about 40,000 accounts in 20 California communities. Dominguez'
1998 operating revenue was $25.3 million, net income was $0.9 million and basic
earnings per share was $0.61. At December 31, 1998, its net utility plant was
$44.8 million and its total assets were $52.6 million.
The merger agreement provides that each outstanding Dominguez common
share will be exchanged on a tax-free basis for Company common shares yielding
an equivalent value of $33.75 per Dominguez share. At December 31, 1999, there
were
58
1,506,512 shares of Dominguez common stock outstanding. The Company also expects
to assume approximately $12.0 million of Dominguez' long-term debt. The
transaction is expected to be accounted for as a pooling of interests.
The only approval the Company has yet to receive is that of the CPUC.
The CPUC's approval of the merger is expected in March of 2000.
Note 11. 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. For cash equivalents, the
carrying amount approximates fair value because of the short-term maturity of
the instruments. The fair value of the Company's long-term debt is estimated at
$175,700,000 as of December 31, 1999, and $153,900,000 as of December 31, 1998,
using a discounted cash flow analysis, based on the current rates available to
the Company for debt of similar maturities. The fair value of advances for
construction contracts is estimated at $31,000,000 as of December 31, 1999, and
$30,000,000 as of December 31, 1998, based on data provided by brokers.
Note 12. Quarterly Financial And Common Stock Market Data (Unaudited)
The Company's common stock is traded on the New York Stock Exchange under the
symbol "CWT." There were approximately 11,000 holders of common stock at
December 31, 1999. Quarterly dividends have been paid on common stock for 220
consecutive quarters and the quarterly rate has been increased each year since
1968.
1999 - in thousands except per share amounts
first second third fourth
Operating revenue $39,853 $52,112 $64,021 $50,454
Net operating income 4,862 8,062 11,051 6,635
Net income 2,621 5,649 8,020 3,629
Basic earnings per share .20 .43 .62 .28
Common stock market price range:
High 31.25 27.63 31.88 32.00
Low 23.38 22.69 25.88 24.13
Dividends paid .27125 .27125 .27125 .27125
1998 - in thousands except per share amounts
first second third fourth
Operating revenue $35,920 $45,275 $63,380 $45,084
Net operating income 4,598 6,660 12,273 7,008
Net income 1,709 3,638 9,662 3,927
Basic earnings per share .13 .28 .74 .30
Common stock market price range:
High 33.75 30.19 27.69 33.13
Low 24.31 21.50 20.75 21.25
Dividends paid .2675 .2675 .2675 .2675
59
Page 35
Independent Auditors' Report
The Stockholders 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, 1999 and
1998, and the related consolidated statements of income, common stockholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 1999. 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, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999, in conformity with generally accepted
accounting principles.
KPMG (signature)
Mountain View, California
January 21, 2000
60
Corporate Information Page 36
Stock Transfer, Dividend Disbursing and Reinvestment Agent
The First National Bank of Boston
(Boston EquiServe)
P.O. Box 644
Boston, MA 02102-0644
800.736.3001
To Transfer Stock
A change of ownership of shares (such as when stock is sold or gifted or when
owners are deleted from or added to stock certificates) requires a transfer of
stock. To transfer stock, the owner must complete the assignment on the back of
the certificate and sign it exactly as his or her name appears on the front.
This signature must be guaranteed by an eligible guarantor institution (banks,
stock brokers, savings and loan associations and credit unions with membership
in approved signature medallion programs) pursuant to SEC Rule 17AD-15. A
notary's acknowledgement is not acceptable. This certificate should then be sent
to Boston EquiServe, Stockholder Services, by registered or certified mail with
complete transfer instructions.
Bond Registrar
US Bank Trust, N.A.
One California Street
San Francisco, CA 94111-5402
415.273.4580
Executive Office
California Water Service Group
1720 North First Street
San Jose, CA 95112-4598
408.367.8200
Annual Meeting
The Annual Meeting of Stockholders will be held on Wednesday, April 19, 2000 at
10 a.m. at the Company's Executive Office, located at 1720 North First Street in
San Jose, California. Details of the business to be transacted during the
meeting will be contained in the proxy material, which will be mailed to
stockholders on or about March 17, 2000.
Annual Report for1999 on Form 10-K
A copy of the Company's report for 1999 filed with the Securities and Exchange
Commission on Form 10-K will be available in April 2000 and can be obtained by
any stockholder at no charge upon written request to the address below.
Stockholder Information
California Water Service Group
Attn: Stockholder Relations
1720 North First Street
San Jose, CA 95112-4598
61
408.367.8200 or 800.750.8200
http://www.calwater.com
- -----------------------
62
Inside Back Cover
Board Of Directors
California Water Service Group, California Water Service Company, CWS Utility
Services (PHOTOGRAPHS: a picture of each director appears above the caption)
Peter C. Nelson*
President and Chief Executive Officer
Robert W. Foy*
Chairman of the Board
C.H. Stump*++
Former Chairman of the Board and former
CEO of California Water Service Company
Linda R. Meier+++
Member, National Advisory Board, Haas Public
Service Center; Member of the Board of
Directors, Comerica Bank-California
George A. Vera+
Chief Financial Officer,
the David & Lucile Packard Foundation
J.W. Weinhardt+*
Chairman of SJW Corp. and Chairman of its subsidiary, San Jose Water Company
Edward D. Harris, JR., M.D.+*
George DeForest Barnett Professor of Medicine,
Stanford University Medical Center
Richard P. Magnuson++
Private Venture Capital Investor
Robert K. Jaedicke+++
Professor Emeritus of Accounting and former
Dean, Stanford Graduate School of Business
Officers
California Water Service Company
Robert W. Foy (1,2,3)
Chairman of the Board
Peter C. Nelson (1,2,3)
President and Chief Executive Officer
63
Gerald F. Feeney (1,2,3)
Vice President, Chief Financial Officer and Treasurer
Francis S. Ferraro
Vice President, Regulatory Matters
James L. Good (2)
Vice President, Corporate Communications and Marketing
Robert R. Guzzetta (2)
Vice President, Engineering and Water Quality
Christine L. McFarlane
Vice President, Human Resources
Raymond H. Taylor
Vice President, Operations
Raymond L. Worrell
Vice President, Chief Information Officer
Calvin L. Breed (1)
Controller, Assistant Secretary and Assistant Treasurer
Paul G. Ekstrom (1,2,3)
Corporate Secretary
John S. Simpson
Assistant Secretary, Manager of New Business
Washington Water Service Company
Michael P. Ireland
President
+ Member of the Audit Committee
++ Member of the Compensation Committee
o Member of the Executive Committee
o 1 Holds the same position with California Water Service Group
o 2 Holds the same position with CWS Utility Services
o 3 Also an officer of Washington Water Service Company
64
California Water Service Group (back cover)
1720 North First Street
San Jose, California 95112-4598
408.367.8200
www.calwater.com
Four company logos appear on the back cover:
California Water Service Group
California Water Service Company
CWS Utility Services
Washington Water Service Company
65