EXHIBIT 13.1
Ten-Year Financial Review
Dollars in thousands, except per share amounts
2002 2001 2000 1999 1998 1997 1996 1995 1994 1993
Summary of Operations
Operating revenue
Residential $184,894 $173,823 $171,234 $163,681 $150,491 $158,210 $148,313 $132,859 $127,228 $122,585
Business 46,404 44,944 44,211 41,246 38,854 40,520 37,605 35,873 33,712 31,360
Industrial 11,043 9,907 11,014 12,695 10,150 10,376 9,748 9,952 9,080 8,415
Public authorities 12,706 11,860 11,609 10,898 9,654 11,173 10,509 9,585 9,397 8,535
Other 8,104 6,286 6,738 6,417 5,777 4,886 4,083 4,833 3,767 4,985
Total operating revenue 263,151 246,820 244,806 234,937 214,926 225,165 210,258 193,102 183,184 175,880
Operating expenses 232,854 221,669 211,610 201,890 183,245 188,020 177,356 164,958 155,012 145,517
Interest expense, other
income and expenses, net 11,224 10,186 13,233 11,076 11,821 11,388 11,502 11,176 11,537 12,785
Net income $ 19,073 $ 14,965 $ 19,963 $ 21,971 $ 19,860 $ 25,757 $ 21,400 $ 16,968 $ 16,635 $ 17,578
Common Share Data
Earnings per share - diluted $ 1.25 $ 0.97 $ 1.31 $ 1.44 $ 1.31 $ 1.71 $ 1.42 $ 1.13 $ 1.17 $ 1.26
Dividend declared 1.12 1.115 1.100 1.085 1.070 1.055 1.040 1.020 0.990 0.960
Dividend payout ratio 90% 115% 84% 75% 82% 62% 73% 90% 85% 76%
Book value $ 13.12 $ 12.95 $ 13.13 $ 12.89 $ 12.49 $ 12.15 $ 11.47 $ 10.97 $ 10.72 $ 10.03
Market price at year-end 23.65 25.75 27.00 30.31 31.31 29.53 21.00 16.38 16.00 20.00
Common shares outstanding
at year-end
(in thousands) 15,182 15,182 15,146 15,094 15,015 15,015 15,015 14,934 14,890 13,773
Return on average common
stockholders' equity 9.7% 7.6% 10.1% 11.5% 10.8% 14.5% 12.8% 10.6% 11.1% 12.6%
Long-term debt interest
coverage 2.73 2.64 3.31 3.79 3.64 4.37 3.81 3.41 3.49 3.34
Balance Sheet Data
Net utility plant $696,988 $624,342 $582,782 $564,390 $538,741 $515,917 $495,985 $471,994 $455,769 $437,065
Utility plant expenditures 88,800 62,049 37,161 48,599 41,061 37,511 40,310 31,031 32,435 31,097
Total assets 800,582 710,214 666,605 645,507 613,143 594,444 569,745 553,027 516,507 497,717
Long-term debt including
current portion 251,365 207,981 189,979 171,613 152,674 153,271 151,725 154,416 138,628 138,863
Capitalization ratios:
Common stockholders' equity 44.0% 48.8% 51.1% 53.0% 54.6% 53.8% 52.7% 50.9% 52.9% 49.3%
Preferred stock 0.7% 0.9% 0.9% 0.9% 1.0% 1.0% 1.1% 1.1% 1.2% 1.2%
Long-term debt 55.3% 50.3% 48.0% 46.1% 44.4% 45.2% 46.2% 48.0% 45.9% 49.5%
Other Data
Water production (million
gallons)
Wells and surface supply 67,488 65,283 65,408 65,144 57,482 63,736 60,964 54,818 53,274 48,598
Purchased 64,735 61,343 62,237 58,618 54,661 59,646 56,769 57,560 59,850 59,103
Total water production 132,223 126,626 127,645 123,762 112,143 123,382 117,733 112,378 113,124 107,701
Metered customers 380,087 371,281 366,242 361,235 354,832 350,139 345,307 335,238 332,146 326,564
Flat-rate customers 78,901 79,146 78,104 77,892 77,568 77,878 77,991 78,330 79,159 81,416
Customers at year-end,
including Hawthorne 458,988 450,427 444,346 439,127 432,400 428,017 423,298 413,568 411,305 407,980
New customers added 8,561 6,081 5,219 6,727 4,383 4,719 9,730 2,263 3,325 2,906
Revenue per customer $ 579 $ 552 $ 554 $ 539 $ 500 $ 529 $ 502 $ 468 $ 447 $ 433
Utility plant per customer 2,182 2,020 1,916 1,851 1,768 1,694 1,632 1,580 1,520 1,459
Employees at year-end 802 783 797 790 759 752 740 738 729 717
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Management's Discussion and Analysis of Results of Operations and Financial
Condition
California Water Service Group (Company) is a holding company,
incorporated in Delaware, with four operating subsidiaries: California Water
Service Company (Cal Water), CWS Utility Services (Utility Services), New Mexico
Water Service Company (New Mexico Water) and Washington Water Service Company
(Washington Water). Cal Water, New Mexico Water and Washington Water are
regulated public utilities. Their assets and operating revenues currently
comprise the majority of the Company's assets and revenues. The regulated
utilities also provide some non-regulated water-related services. Utility
Services provides non-regulated water operations and related services to private
companies and municipalities. The following discussion and analysis provides
information regarding the Company, its assets, operations and financial
condition.
FORWARD-LOOKING STATEMENTS
This annual report, including the Letter to Stockholders and
Management's Discussion and Analysis, contains forward-looking statements within
the meaning established by the Private Securities Litigation Reform Act of 1995
(Act). The forward-looking statements are intended to qualify under provisions
of the federal securities laws for "safe harbor" treatment established by the
Act. Forward-looking 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, forecasts, predicts, believes, estimates,
anticipates, projects 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. They are subject to uncertainty and
changes in circumstances. Actual results may vary materially from what is
contained in a forward-looking statement. Factors that may cause a result
different than expected or anticipated include: future economic conditions,
governmental and regulatory commissions' decisions, changes in regulatory
commissions' policies or procedures, the timeliness of regulatory commissions'
actions concerning rate relief, new legislation, electric power interruptions,
access to capital, increases in suppliers' prices and the availability of
supplies including water and power, changes in environmental compliance
requirements, acquisitions, the ability to successfully implement business
plans, changes in customer water use patterns and the impact of weather on
operating results, especially as it impacts water sales. When considering
forward-looking statements, the reader should keep in mind the cautionary
statements included in this paragraph. The Company assumes no obligation to
provide public updates of forward-looking statements.
BUSINESS
Cal Water, which began operation in 1926, is a public utility supplying
water service to 440,500 customers in 75 California communities through 25
separate water systems or districts. Cal Water's 24 regulated systems, which are
subject to regulation by the California Public Utilities Commission (CPUC),
serve 434,400 customers. An additional 6,100 customers receive service through a
long-term lease of the City of Hawthorne's water system, which is not subject to
CPUC regulation. Cal Water accounts for 96% of the Company's total customers and
98% of the Company's operating revenue.
Washington Water's utility operations are regulated by the Washington
Utilities and Transportation Commission (WUTC). Washington Water, which started
operations in 1999, provides domestic water service to 14,400 customers in the
Tacoma and Olympia areas, and accounts for 2% of the Company's operating
revenue. An additional 3,900 customers are served under operating agreements
with private owners.
New Mexico Water acquired the assets of Rio Grande Utility Corporation
in July 2002. New Mexico Water provides service to 2,400 water and 1,700
wastewater customers south of Albuquerque. Its regulated operations, which
account for less than 1% of the Company's operating revenue, are subject to the
jurisdiction of the New Mexico Public Regulation Commission. It also provides
non-regulated meter reading service under contract with a county.
Rates and operations for regulated customers are subject to the
jurisdiction of the respective state's regulatory commissions. The commissions
require that water rates for each regulated district be independently
determined. The commissions are expected to authorize water rates sufficient to
recover normal operating expenses and allow the utility to earn a fair and
reasonable return on invested capital. Rates for the City of Hawthorne water
system are established in accordance with an operating agreement and are subject
to ratification by the Hawthorne City Council. Fees for other operating
agreements are based on contracts negotiated between the parties.
Utility Services derives non-regulated income from contracts with other
private companies and municipalities to operate water systems and provide meter
reading and billing services. It also leases communication antenna sites,
operates recycled water systems and conducts real estate sales of surplus
properties.
CRITICAL ACCOUNTING POLICIES
The Company maintains its accounting records in accordance with
accounting principles generally accepted in the United States of America and as
directed by the regulatory commissions to which the Company's operations are
subject. The process of preparing financial statements requires the use of
estimates on the part of management. The estimates used by management are based
on historic experience and an understanding of current facts and circumstances.
Management believes that the following accounting policies are critical because
they involve a higher degree of complexity and judgement and can have a material
impact on the Company's results of operations and financial condition.
Revenue Recognition. Revenue from metered customers includes billings
to customers based on monthly meter readings plus an estimate for unbilled
revenue which represents water used between the last reading of the customer's
meter and the end of the accounting period. The unbilled revenue amount is
recorded as a current asset on the balance sheet under the caption "Unbilled
Revenue." At December 31, 2002, the unbilled revenue amount was $8.0 million and
at December 31, 2001, was $7.3 million. The unbilled revenue amount is generally
higher during the summer months when water sales are higher. The amount recorded
as unbilled revenue varies depending on water usage in the preceding
224
period, the number of days between meter reads for each billing cycle, and the
number of days between each cycle's meter reading and the end of the accounting
cycle.
Flat-rate customers are billed in advance at the beginning of the
service period. The revenue is prorated so that the portion of revenue
applicable to the current accounting period is included in that period's
revenue. The portion related to a subsequent accounting period is recorded as
unearned revenue on the balance sheet and recognized as revenue when earned in
the subsequent accounting period. The unearned revenue liability was $1.7
million at December 31, 2002 and 2001. It is included in "Other accrued
liabilities" on the balance sheet.
Expense-balancing and Memorandum Accounts. Expense-balancing accounts
and memorandum accounts represent costs incurred, but not billed to Cal Water
customers. The amounts included in these accounts relate to rate increases
charged to the Company by suppliers of purchased water and purchased power, and
increases in pump taxes. The Company does not record expense-balancing or
memorandum accounts in its financial statements as revenue, nor record a
receivable until the CPUC has authorized recovery of the higher costs and
customers have been billed. The accounts are only used to track the higher
costs. The cost increases, which are beyond the Company's control, are referred
to as "offsetable expenses" because under certain circumstances they are
recoverable from customers in future offset rate increases.
In October 2001, the CPUC adopted a resolution implementing its staff's
interim recommendation concerning practices and policies that enable water
utilities to recover cost increases in purchased water, purchased power and pump
taxes. The interim recommendation directed that future Company requests to
recover offsetable expenses will be processed only if an operating district has
filed a General Rate Case (GRC) application within a three-year period and the
district is not earning more than its authorized rate of return on a
forward-looking, pro forma basis. Neither of these requirements applied to
offset rate increase recovery prior to adoption of the resolution. The CPUC also
directed its staff to open a proceeding to evaluate offsetable expense recovery
practices and policies and to recommend permanent revisions.
Historically, offset rate increases enabled water utilities to recover
as a pass-through cost increases for offsetable expenses that were not known or
anticipated when customer rates were established and were beyond the utility's
control. Offsetable expenses incurred prior to the CPUC's adoption of the
staff's interim recommendation were frozen as of November 29, 2001 in the
balancing accounts. The Company was authorized to track offsetable expenses
incurred after the CPUC changed its policy with regard to regulatory memorandum
accounts for potential recovery subject to the CPUC's future determination of
appropriate practices and policies. Because of the uncertainty of collection,
the Company's accounting policy is to not record the expense-balancing and
memorandum account amounts in its financial statements until such amounts are
billed to customers.
In September 2002, the assigned administrative law judge recommended
that the CPUC adopt as permanent the interim recommendation regarding recovery
of expense-balancing and memorandum accounts as described above, but modify the
limit on the amount subject to recovery. Under the interim rules, a utility is
not allowed to recover any of the balancing or memorandum account balance if it
is earning more than its authorized return on equity. However, the proposed
modification by the administrative law judge would allow recovery of a portion
of the balancing or memorandum account up to the amount by which the Company's
over earning of its authorized rate of return did not exceed the amount in the
balancing account. While this recommendation was an improvement over the interim
rules currently in place, the Company believes there should be no limit on
allowed recovery of the balancing and memorandum accounts. The Company is
continuing to present its arguments to the CPUC staff.
In December 2002, the CPUC issued a decision that will allow the
Company to recover offsetable expenses tracked in the frozen balancing accounts.
The decision provided that recovery of these expenses will not be subject to the
interim rules adopted in October 2001. The CPUC is now expected to adopt
permanent rules regarding recovery of memorandum accounts during the first half
of 2003. The Company is unable to predict what the final rules will comprise or
their financial impact.
At December 31, 2001, the amount included in the balancing and
memorandum accounts was $6.5 million. At December 31, 2002, the amount had
increased to $12.5 million after reflecting collection of $1.9 million of
balancing account power costs during 2002. The increase in balancing and
memorandum accounts was attributable primarily to higher electric costs incurred
by the Company since 2001 when power rates charged to the Company by electric
suppliers, as authorized by the CPUC, increased an average of 48%. Increases in
the memorandum accounts are expected to be smaller once current power rates are
reflected in customer rates through future GRC decisions and assuming there are
no large increases in purchased water or power costs.
Regulated Utility Accounting. Because the Company operates extensively
in a regulated business, it is subject to the provisions of Statement of
Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of
Certain Types of Regulation." Regulators establish rates that are expected to
permit the recovery of the cost of service and a return on investment. In the
event a portion of the Company's operations were no longer subject to the
provisions of SFAS No. 71, the Company would be required to write off related
regulatory assets and liabilities that are not specifically recoverable and
determine if other assets might be impaired. If a regulatory commission
determined that a portion of the Company's assets were not recoverable in
customer rates, the Company would be required to determine if it had suffered an
asset impairment that would require a write-down in the assets' valuation. There
had been no such asset impairment as of December 31, 2002.
Income Taxes. Significant judgment by management is required in
determining the provision for income taxes. The preparation of consolidated
financial statements requires the estimation of income tax expense. The process
involves the estimating of current tax exposure together with assessing
temporary differences resulting from different treatment of certain items, such
as depreciation, for tax and financial statement reporting. These differences
result in deferred tax assets and liabilities, which are reported in the
consolidated balance sheet. The Company must also assess the likelihood that
deferred tax assets will be recovered in future taxable income. To the extent
recovery is unlikely, a valuation allowance would be recorded. If a valuation
allowance were required, it could significantly increase income tax expense. In
management's view, a valuation allowance was not required at December 31, 2002.
225
Pension Benefits. The Company incurs costs associated with its pension
and postretirement health care benefits plans. To measure the expense of these
benefits, management must estimate compensation increases, mortality rates,
future health cost increases and discount rates used to value related
liabilities and to determine appropriate funding. Different estimates used by
management could result in significant variances in the cost recognized for
pension benefit plans. The estimates used are based on historical experience,
current facts, future expectations and recommendations from independent advisors
and actuaries. The Company uses an investment advisor to provide expert advice
in managing its benefit investments. To diversify investment risk, the plan's
goal is to invest 60% of the assets in equity mutual funds and 40% in bond
funds. At December 31, 2002, 48% of the assets were invested in equity mutual
funds and 52% in bond funds. Based on the market values of the investment funds,
for the year ended December 31, 2002, the total return on the pension plan
assets was a decline of 3.7%, and for the year ended December 31, 2001, pension
plan assets had a positive 2.6% total return. For December 31, 2002, the
discount rate used for pension plan obligations or pension plan expense was
6.7%, which was based on high-quality bond rates in December 2002. The long-term
rate of return used to determine the Company's pension obligation was 8%. By
comparison, a 20-year return of assets invested using the same investment
diversification as for the Company's pension plan would have returned 11.8%. The
Company anticipates any increase in funding for the pension and postretirement
health care benefits plans will be recovered in future customer rates.
RESULTS OF OPERATIONS
Earnings and Dividends. Net income in 2002 was $19,073,000 compared to
$14,965,000 in 2001 and $19,963,000 in 2000. Diluted earnings per common share
were $1.25 in 2002, $0.97 in 2001 and $1.31 in 2000. The weighted average number
of common shares outstanding was 15,185,000 in 2002, 15,186,000 in 2001, and
15,129,000 in 2000. As explained below, the decline in 2001 net income resulted
from three primary factors: low water sales to existing customers due to weather
conditions, significantly higher purchased power costs and delays in receipt of
regulatory rate relief.
At its January 2002 meeting, the Board of Directors increased the
common stock dividend for the 35th consecutive year. 2002 also marked the 58th
consecutive year that a dividend had been paid on the Company's common stock.
The annual dividend paid in 2002 was $1.12, a 0.4% increase over the $1.115 paid
in 2001, which was an increase of 1.4% over the $1.100 paid in 2000. The
dividend increases were based on projections that the higher dividend could be
sustained while still providing the Company with adequate financial resources
and flexibility. Earnings not paid as dividends are reinvested in the business
for the benefit of stockholders. The dividend payout ratio was 90% in 2002, 115%
in 2001, and 84% in 2000, an average of 97% during the three-year period.
Operating Revenue. Operating revenue, including revenue from the City
of Hawthorne lease, was $263.2 million, 6.6% more than the $246.8 million
recorded in 2001. Revenue in 2000 was $244.8 million. The sources of changes in
operating revenue were:
Dollars in millions 2002 2001 2000
Customer water usage $ 6.9 $ (5.7) $ 4.8
Rate increases 6.6 5.4 3.0
Usage by new customers 2.8 2.3 2.1
Net change $ 16.3 $ 2.0 $ 9.9
Average revenue per customer (in dollars) $ 579 $ 552 $ 554
Average metered customer usage (Ccf) 373 363 371
New customers added 8,600 6,100 5,200
Temperatures and rainfall in the Company's service territories were
relatively normal throughout 2002. In 2001, the weather patterns were cooler and
more rainy than normal. From a water sales perspective, 2002's weather resulted
in a 2% increase in customer's water usage compared to 2001 and a $6.9 million
increase in revenue.
Rate increases added $6.6 million to 2002 revenue. Revenue from GRC
decisions received in 2001 accounted for $2.7 million of the increase, $2.0
million came from step rate increases and $1.9 million from offset rate
increases to recover electric costs included in expense-balancing accounts for
four California districts. No new GRC decisions were authorized by the CPUC
during 2002. Washington Water did receive a GRC decision in 2002. The "RATES AND
REGULATION" section of this report provides a detailed discussion of regulatory
activity.
During 2001, revenue from usage by existing customers declined $5.7
million. A cool, wet spring, mild summer and early fall rains throughout the
Company's service territories caused water usage by existing customers to
decline by 2%. Rainfall was near normal in the northern part of California, but
well above normal in the south. The unusually heavy rains in southern California
reduced water sales, a trend that continued all year because of the year's
weather pattern. Washington Water experienced dry conditions during the winter
and spring months; however, summer rains reduced water sales in the normally
high usage summer months.
The December 31, 2002, customer count including the Hawthorne customers
was 459,000, an increase of 2% from the 450,400 customers at the end of 2001,
which was an increase of 1% from the 444,300 customers at the end of 2000. The
increase in customers is due to normal growth within existing service areas and
acquisitions of water systems. The acquisition in July 2002 of the Rio Grande
Utility Corporation's 4,100 customers is included in the customer count
increase.
226
Operating Income and Expenses. Total operating expenses, including
those for the Hawthorne operation, were $232.9 million in 2002, $221.7 million
in 2001 and $211.6 million in 2000.
Water pumped from Company-owned wells provided 50.4% of water delivered to
customers in 2002. Water purchased from wholesale suppliers provided 49.0% and
the remaining 0.6% was obtained from surface supplies. For 2001, the
corresponding percentages were 50.6%, 48.9% and 0.5%.
As a group, water production costs, which consist of purchased water,
purchased power and pump taxes, comprise the largest segment of total operating
costs. Water production costs accounted for 45% of total operating costs in
2002, 2001 and 2000. The rates charged for wholesale water supplies, electricity
and pump taxes are established by various public agencies. As such, these rates
are beyond the Company's control. The table below provides comparative
information regarding water production costs during the past three years:
Dollars in millions 2002 2001 2000
Purchased water $ 76.7 $ 73.2 $73.8
Purchased power 22.9 21.1 15.1
Pump taxes 6.3 5.9 6.3
Total water production costs $105.9 $100.2 $95.2
Change from prior year 6% 5% 5%
Water production (billions of gallons) 132 127 128
Change from prior year 4% (1)% 3%
Water production expenses vary with wholesale suppliers' prices, the
quantity of water produced to supply customer water usage, and the sources of
supply. In 2002, four wholesale water suppliers increased their rates charged to
the Company. The increases ranged from 2% to 5%. One wholesale supplier reduced
its rate by 9%. In 2001, seven wholesale water suppliers increased rates with
increases ranging from 2% to 7%. In December 2001, wholesale suppliers in the
Los Angeles area refunded $1.4 million for over-collection of prior period water
purchases. The refunds were recorded as a reduction of purchased water costs.
There were no comparable refunds in 2002. During 2003, wholesale rate increases
are expected in 17 districts ranging from 1% to 47%. The 47% increase will add
an estimated $1.0 million to purchased water cost. The increased costs will be
tracked in regulatory memorandum accounts that the Company will include in
future rate proceedings for recovery.
Purchased power is required to operate wells and pumps. Prior to 2001,
the Company had not been subjected to significant electric power cost increases.
However, California energy costs rose significantly in 2001. In January 2001,
the CPUC approved an energy surcharge that increased the Company's cost of
purchased electricity by 10%. A second, more significant 38% increase in
electric costs became effective in May 2001, bringing the total increase to 48%.
When the CPUC proposed electric cost increases, the Company believed the higher
costs were recoverable from consumers on a pass-through basis under established
CPUC procedures regarding expense-balancing accounts. However, the CPUC
subsequently revised its rules regarding recovery of the higher costs, resulting
in delays in recovering the higher costs. While no new power rate increases are
proposed or known at this time, the Company continues to purchase electricity
from suppliers at rates greater than it is recovering from its water customers
in 20 California districts.
Purchased power increased $1.8 million in 2002, $6.0 million in 2001
and $0.7 million in 2000. The 2002 cost increase was caused by higher electric
rates paid through May 2002 as compared to 2001's electric rates and a 5%
increase in well production. The purchased power cost increase in 2000 was due
mainly to a 3% increase in water production.
Employee payroll and benefits charged to operations and maintenance was
$50.3 million in 2002, $47.8 million for 2001, and $44.5 million for 2000. 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 2002, there were 802 employees, including 12 employees added in New
Mexico with the acquisition of Rio Grande Utility Corporation. At the end of
2001 and 2000, there were 783 and 797 employees, respectively. Most
non-supervisory employees are represented by the Utility Workers Union of
America, AFL-CIO, with the exception of certain engineering and laboratory
employees who are represented by the International Federation of Professional
and Technical Engineers, AFL-CIO. In December 2002, the Company successfully
negotiated new three-year agreements with both unions covering 2003 through
2005. Wage increases under the new agreements will be 1% in 2003, 1.5% in 2004
and 2% in 2005. Improvements in employee benefit plans were also negotiated.
During 2000, a curtailment of the Dominguez pension plan was recorded
resulting in a non-taxable gain of $1.2 million that was offset against
operating expenses. The curtailment occurred because the Dominguez pension plan
was frozen at the merger date and its participants became participants in the
Company's pension plan. Previous amounts expensed by Dominguez but not funded to
the plan comprise the curtailment amount. This amount is included in the $44.5
million reported for payroll and benefits charged to operations and maintenance
expense.
Income tax expense was $12.6 million in 2002, $9.7 million in 2001 and
$11.6 million in 2000. The changes in taxes are generally due to variations in
taxable income.
227
Long-term debt interest expense increased $1.4 million compared to
2001. Series E, 7.11% $20 million senior notes were issued in May 2002 and
Series F, 5.90% $20 million senior notes were issued in August 2002. Proceeds
from the issues were used to repay short-term bank borrowings and to fund the
Company's construction program.
As part of a program to refinance certain high interest rate first
mortgage bonds, Series G and Series H, 5.29% senior notes were issued in
November and December 2002, each for $20 million. With the proceeds from these
two issues, three series of first mortgage bonds totaling $33 million were
redeemed. The remaining proceeds were used to repay short-term bank borrowings.
The issuance of the new senior notes caused long-term interest expense
to increase because of the higher principal amount outstanding. In 2001,
interest on long-term debt increased $1.3 million over 2000. The issuance of $20
million of Series D senior notes in September 2001 and $20 million of Series C
senior notes in October 2000, net of sinking fund payments on first mortgage
bonds, resulted in a larger principal amount of long-term debt outstanding and
thus increased interest expense. In 2002, 2001 and 2000, interest capitalized on
construction projects was $1.5 million, $0.9 million, and $0.7 million,
respectively. The increase in the amount capitalized in 2002 is attributable to
an increase in the Company's construction expenditures, particularly those
associated with construction of a water treatment plant in the Bakersfield
district. Interest coverage of long-term debt before income taxes was 2.7 times
in 2002, 2.6 times in 2001 and 3.3 times in 2000. The reduction in interest
coverage for 2002 and 2001 compared to 2000 resulted from lower earnings and the
new senior note issues outstanding. The interest coverage is expected to improve
once GRC decisions are authorized by the CPUC and as a result of the lower
interest costs realized by refinancing certain first mortgage bond issues.
Other interest expense, which includes short-term bank borrowings
needed to meet operating and interim construction funding, decreased $0.6
million in 2002. The amount borrowed in 2002 was larger because of an increase
in capital expenditures. In 2001, other interest increased by $0.1 million
because higher borrowings were necessary due to reduced cash flow from
operations and increased capital expenditures. Lower interest rates on
short-term borrowings in both years offset the interest cost that resulted from
higher borrowing levels. There was $36.4 million in short-term borrowings
outstanding at December 31, 2002 and $22.0 million at December 31, 2001.
Other Income and Expenses. Other income is derived from management
contracts under which the Company operates private and municipally-owned water
systems and recycled water systems and provides meter reading, water testing and
billing services to various cities; leases of communication antenna sites; sales
of surplus property; and interest on short-term investments. Other income, net
of expenses, was $5.6 million in 2002, $5.8 million in 2001 and $1.4 million in
2000. During 2002, $3.0 million in pre-tax profits were realized from surplus
properties sold as part of the Real Estate Program that is described in more
detail in the "LIQUIDITY AND CAPITAL RESOURCES" section of this report. There
were $3.9 million of gains from surplus property sales in 2001 and no property
sales in 2000.
RATES AND REGULATION
2002 Regulatory Activity. Washington Water filed a GRC application in
February 2002. The WUTC issued its decision early in April 2002 granting a $1
million increase in annual revenue to cover higher operating costs and capital
expenditures.
In June 2002, the CPUC authorized the Company to increase rates in its
Bakersfield district by $796,000 on an annual basis. This decision was based on
an advice letter filing to cover approximately $6 million of construction cost
incurred to date for a new water treatment plant.
The Company filed a Notice of Intent to file GRC applications for three
California districts in July 2002. The Commission's staff accepted the
applications in November. Four additional district GRC applications, including
the General Office operation, were submitted in January 2003. Combined, these
districts represent 17% of the California customers. The Commission staff has
indicated that a decision on these filings should be expected in late 2003.
2001 Regulatory Activity. After analyzing 17 Cal Water districts that
were eligible for general rate filings in 2001, and based on current earnings
levels, projected expense increases, including higher electric power costs, and
expected capital expenditures, applications were filed in July 2001 for 15
districts covering about 70% of Cal Water's customers. The applications
requested an 11.5% return on equity including 75 basis points to reflect the
increased risk associated with the CPUC's changes in recovery of water
production expense increases and $21 million in new annual revenue. Under the
CPUC's rate case processing schedule, a decision on the district GRC
applications was expected by the third quarter of 2002. However, despite the
filing of briefs by all parties in May 2002, a Proposed Decision has not been
issued. At this time, a final decision is expected in April 2003, about 20
months after filing of the applications. Based on the administrative law judge's
Draft of a Proposed Decision (DPD) released in January 2003, the Company would
be authorized a $12.8 million increase in annual revenue. Additionally, the DPD
recommends a return on equity of 9.7% with an equity percentage of
capitalization at 51.5%. While that is positive news, it does not recognize that
regulatory delays have resulted in the loss of revenues, which the DPD finds
just and reasonable.
The DPD also recommends an allocation method for sharing expenses
between regulated and non-regulated activities that is inconsistent with a prior
Commission decision that was issued following a Commission rulemaking
investigation. Furthermore, the DPD proposes changing the rate-setting practice
regarding the treatment of gain on the sale for surplus property. The existing
rules are based on legislation adopted in 1995 by the California legislature,
which requires that gains realized on the sale of surplus property be reinvested
in new utility plant and that the Company be allowed to earn a reasonable rate
of return on the reinvestment. As proposed in the DPD, the Company would be
required to treat the reinvestment of gains on the sale of surplus property as
contributed plant and it would not be allowed to earn a return on its
reinvestment. The Company, along with other California water utilities, opposes
these rate-setting changes and will aggressively defend the legislation
administratively and, if necessary, pursue legislative remedies. If these
proposals were adopted by the Commission, they would have a
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detrimental impact on the Company's non-regulated activities and surplus real
estate program. The DPD on treatment of gains on sale of properties could result
in a reduction of earnings and the rate base on which the Commission determines
the Company's future earnings. However, because this is only a draft that does
not recommend specific actions, the Company cannot predict the final outcome of
this matter. Since 1997, the Company has recorded $10.4 million in pretax gains
under its surplus property sale program.
In October 2001, the CPUC adopted a resolution implementing its staff's
interim recommendation concerning practices and policies that enable water
utilities to recover increases in purchased water, purchased power and pump
taxes. These expenses are referred to as "offsetable expenses." The CPUC also
directed its staff to open a proceeding to evaluate offsetable expense recovery
practices and policies, and recommend permanent revisions. Historically, offset
rate increases have enabled water utilities to recover increases in offsetable
expenses that were not anticipated when customer rates were established and are
beyond the utility's control. Future Company requests to recover offsetable
expenses will be processed only if a district has filed a GRC application within
its three-year rate case cycle and the district is not earning more than its
authorized rate of return on a forward-looking, pro forma basis. Neither of
these requirements applied to offset rate increases prior to adoption of the
resolution. The Company can continue to track offsetable expenses in regulatory
memorandum accounts for potential recovery subject to the CPUC's future
determination of appropriate practices and policies.
During 2001, the rates charged to the Company by electric power
suppliers were increased 48%. In May 2001, immediately after the CPUC authorized
substantial electric rate increases for the state's two largest power companies,
the Company requested authorization to recover $5.9 million in higher power
costs for 23 of its 24 regulated California districts. The CPUC's authorization
allowing the Company to recover a portion of the higher power costs in four
districts was not effective until September and November 2001, well after the
high usage summer months. The authorization will allow recovery in four
districts totaling $2.7 million in additional annual revenue. The CPUC did not
authorize any additional recovery of the higher electric costs during 2002.
However, in December 2002, the CPUC did authorize the Company to file for
recovery of up to $6.4 million of electric cost increases tracked in
expense-balancing accounts. In January 2003, the Company applied to the CPUC
requesting authorization to recover the $6.4 million of electric increases
included in the expense-balancing accounts. A resolution regarding these advice
letter filings is expected in the first half of 2003.
Legislative Initiative. Regulatory delays in obtaining GRC decisions
have been costly to California regulated water utilities. In recent years, the
Company has experienced significant revenue losses due to regulatory delays. The
Company normally files its GRC applications in July. The CPUC's stated rate
processing plan provides for a decision within ten months of accepting a GRC
application. When decisions are not issued in a timely manner, customer rates
are not increased. As a result, the Company loses revenue and does not recover
costs during the period the decisions are delayed.
California Assembly Bill 2838 became effective January 1, 2003. This
bill is intended to preserve the cash flow and financial ratings of regulated
water utilities by providing interim rate relief based on inflation and a
procedure for applying the final adopted GRC rates on a retroactive basis. In
December 2002, the Company filed for protection of its 2002 GRC applications
under the new law. The Commission staff rejected the application on the basis
that the legislation does not apply to GRC applications submitted prior to
January 1, 2003. An appeal of the Commission staff rejection has been filed with
the Commission.
WATER SUPPLY
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 the supply from wholesale suppliers; and other districts obtain the
supply from a combination of well and purchased sources. A small portion of the
supply is from surface sources processed through three Company-owned water
treatment plants. In 2003, the Company expects to complete construction of a new
water treatment plant in the Bakersfield district that will increase the amount
of surface water delivered to that system and reduce the amount of water pumped
from wells. On average, slightly more than half of the water delivered to
customers is produced from wells and surface supply, with the remainder
purchased from wholesale suppliers.
California's normal weather pattern yields little precipitation between
mid-spring and mid-fall. The Washington service areas receive precipitation in
all seasons with the heaviest amounts during the winter. New Mexico's rainfall
is heaviest in the summer monsoon season. Water usage in all service areas is
highest during the warm and dry summers and declines in the cool winter months.
Rain and snow during the winter months replenish underground water basins and
fill reservoirs providing the water supply for subsequent delivery to customers.
To date, snow and rainfall accumulation during the 2002-2003 water year has been
above average. Precipitation in the prior five years has been near normal
levels. Water storage in California's reservoirs at the end of 2002 was at
historic average. The Company believes that its supply from underground aquifers
and purchased sources should be adequate to meet customer demand during 2003.
The Company also develops long-term water supply plans for each of its districts
to help assure an adequate water source under various operating and supply
conditions.
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 strives for complete compliance with all requirements set
forth by the various agencies.
The Safe Drinking Water Act (SDWA) 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
expected to pose a risk to public health
229
when 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.
The amended SDWA allows the EPA to require monitoring of up to 30 contaminants
in any five-year cycle. 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 in accordance with SDWA requirements. Employees are provided
training in water operations and water treatment procedures. Water pumped from
underground sources is treated as necessary or required by regulations. The
Company owns and operates three surface water treatment plants. The cost of
existing 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. The states can impose more stringent regulations than mandated by EPA.
In addition to the EPA's requirements, various regulatory agencies could require
increased monitoring and possibly require additional treatment of water
supplies.
During 2001, EPA released a new, lower Maximum Contaminant Level (MCL)
standard of 10 parts per billion for arsenic, a naturally-occurring element that
is sometimes present in groundwater. Compliance with the new standard is
required by January 2006. Of the Company's 600 wells, 56 will require treatment
to comply with the new MCL. The Company estimates the compliance cost at $61
million in capital expenditures over the next three years and $10 million in
additional annual operating costs. The State of California could establish a
lower arsenic MCL standard. If the state were to set the standard at five parts
per billion, the estimated capital expenditures necessary for compliance would
be approximately $125 million. At this time, the Company is unable to predict if
the state will adopt the EPA standard or require a lower MCL. The Company is
participating in testing alternate arsenic treatment technologies in order to
meet the standard in the most cost-efficient manner. The required capital
expenditures to meet the new standards and the increased operating costs
associated with new treatment are expected to be recovered in customers' future
water rates.
The Company anticipates that the EPA will issue other regulations that
will require further monitoring and possible treatment for specific
contaminants. Depending on the MCLs contained in the regulations, the cost of
compliance with the new regulations could be significant in certain Company
districts. The Company intends to request recovery for capital investments and
additional treatment costs needed to remain in compliance with established
health standards through the ratemaking process.
The Company is also working with regional water quality control boards
and air quality districts to meet current and upcoming regulations. The focus of
this work is to meet more stringent National Pollutant Discharge Elimination
System requirements for water discharged from wells and for diesel exhaust
emissions from operation of emergency generators.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. The Company's short-term liquidity is provided by bank lines
of credit and internally generated funds. On a long-term basis, the Company
obtains financing through its access to debt and equity markets.
Short-term Financing. Negotiations to renew separate bank credit
agreements for the Company and Cal Water that were scheduled to expire on April
30, 2003, have been completed. The new agreements, which replace a combined $60
million credit line, became effective on February 28, 2003, and expire on April
30, 2005. Under the new agreements the Company will have available a total of
$65 million. Of the total, $55 million is designated for Cal Water and $10
million for the Company, including funding of its subsidiaries' operations. Cal
Water's $55 million portion can be used solely for purposes of the regulated
California utility. As of July 1, 2003, the credit facility available to Cal
Water will be reduced to $45 million. The reduction will lower the commitment
fee paid by Cal Water on the unused portion of the credit line. The prior
agreements required a 30-day out-of-debt period for borrowings under the
agreements in calendar year 2002. However, on September 23, 2002, the agreements
were amended to extend the out-of-debt compliance period to between January 1,
2002 and April 30, 2003. The new agreements will also have a 30-day out-of-debt
requirement that must be met by December 31, 2003.
During 2002 and 2001, the Company had committed $7.6 million of the $10
million credit line to a contractor for construction of a customer and operation
center. The Company has occupied the new facility where four of its southern
California district operations were consolidated. The combined operations will
provide for more efficient service to customers in the South Bay area of Los
Angeles County. The tax-free exchange of seven surplus Company properties to the
contractor for the new customer and operations center was completed on September
30, 2002. Because the transaction was structured as a property exchange,
acquiring the new facility did not require a significant expenditure of cash.
Under terms of the exchange agreement, during the construction period the
Company had guaranteed the contractor's bank loan. The new facility, which is
valued at over $7 million, served as security to the Company for the guarantee.
When the property exchange was completed, the contractor paid off the bank loan,
and the Company was released from its guarantee.
Washington Water has loan commitments from two banks to meet its
operating and capital equipment purchase requirements at interest rates
negotiated with the banks. At December 31, 2002, nothing was outstanding under
the short-term commitments. Generally, short-term borrowings under the
commitments are converted annually to long-term borrowings with repayment terms
tied to system and equipment acquisitions.
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New Mexico Water Company has a credit arrangement with a New Mexico
bank that was renewed in January 2003 for a 16-month period. The interest rate
for the agreement is based on prime rate plus 75 basis points. At December 31,
2002, the amount borrowed was $2,380,000. The renewal increased the amount
available under the line to $2.9 million.
The water business is seasonal. Revenue is lower in the cool, wet
winter months when less water is used compared to the warm, dry summer months
when water use is higher and more revenue is generated. During the winter
period, the need for short-term borrowings under the bank lines of credit
increases. The increase in cash flow during the summer allows short-term
borrowings to be paid down. Short-term borrowings that remain outstanding more
than one year have generally been converted to long-term debt. In years when
more than normal precipitation falls in the Company's service areas or
temperatures are lower than normal, especially in the summer months, customer
water usage can be lower than normal. The reduction in water usage reduces
cashflow from operations and increases the need for short-term bank borrowings.
During 2002 and 2001, the need for short-term borrowings was greater due to an
increase in construction expenditures primarily related to construction of the
Bakersfield water treatment plant. Regulatory lag, which is the delay in
receiving authorization to increase customer rates to cover capital expenditures
and higher operating costs, resulted in the need for increased short-term bank
borrowings in both 2002 and 2001.
Credit Ratings. California Water Service Company's first mortgage bonds
are rated by Moody's Investors Service (Moody's) and Standard & Poor's (S&P).
The Company's bank line of credit agreement contains a provision that if the
Company's Moody's or S&P's senior debt ratings falls below investment grade, the
credit line may be terminated by the bank. At the end of the third quarter 2002,
the Company met separately with the two credit rating agencies at annual rating
reviews. Following the review, Moody's issued a news release stating that it was
placing the Company's Aa3 senior secured debt rating on review for possible
downgrade and subsequently lowered the rating to A1. Moody's indicated that the
primary reason for the action was delayed rate relief from the CPUC and the
Company's capital spending requirements for water infrastructure and
environmental compliance needs. In November 2002, S&P lowered the Company's
corporate credit rating from AA- to A+. In its news release, S&P stated that the
change "has been caused principally by deterioration in regulatory support from
the California Public Utilities Commission," noting that decisions for recovery
of reasonable expenses have been delayed as much as 18 months. In the news
release, S&P classified the Company's outlook as "stable," saying, "Standard &
Poor's does not expect that Cal Water will experience any funding anxiety beyond
that associated with regulatory tardiness." The Company believes the credit
rating agencies will maintain investment grade ratings for the Company's first
mortgage bonds.
Long-term Financing. Long-term financing, which includes common stock,
preferred stock, first mortgage bonds, senior notes and other debt securities,
has been used to replace short-term borrowings and fund construction.
Internally-generated funds come from earnings not paid out as dividends,
depreciation and deferred income taxes. Additional information regarding the
bank borrowings and long-term debt is presented in notes 8 and 9 to the
financial statements. The Company believes that long-term financing is available
to it through debt and equity markets. In March 2002, the CPUC issued a decision
granting Cal Water authority to complete up to $250 million of equity and debt
financing through 2005, subject to certain restrictions. In addition to Company
funds, construction projects are funded by developers' contributions in aid of
construction which are not refundable and advances for construction which are
refundable.
In both 2002 and 2001, long-term financing was provided by issuance of
senior notes. During 2002, Series E, 7.11% senior notes were issued in May and
Series F, 5.90% senior notes were issued in August. During 2001, Series D, 7.13%
senior notes were issued in September. Each series, which is an obligation of
Cal Water, was issued for $20 million. These senior note issues do not require
sinking fund payments.
During 2002, the Company initiated a program to refinance a portion of
Cal Water's outstanding first mortgage bonds. The refinancing is intended to
take advantage of the available lower interest rates. The Company estimates that
the total program, which will be completed in two phases, will save
approximately $1.5 million in annual interest costs. The first phase of the
program was completed in 2002 and included refinancing of Series S, BB and DD
first mortgage bonds, and Series P that matured on November 1, 2002. Including
Series P, the total first mortgage bond principal balance refinanced for the
four series was $33,940,000. The refinancing was accomplished with funds from
the issue of two new series of lower interest cost, unsecured senior notes.
Series G, $20 million senior notes were issued in November 2002 and Series H,
$20 million senior notes were issued in December 2002. The interest rate on both
series is 5.29% and both mature in 2022. Each series requires annual sinking
fund payments of $1.8 million commencing in 2012.
The second phase of the refinancing is expected to be completed in May
2003 when two $10 million senior notes are issued under Series I and J to redeem
Series EE first mortgage bonds. Institutional investors have committed to these
two issues. The interest rate for Series I will be determined at closing, but is
expected be similar to the Series J interest rate which will be 5.54%. Depending
on interest rates at the time, Series FF and GG first mortgage bonds will be
considered for possible refinancing during 2003.
In 2002 and 2000, $1.9 million and $3.6 million, respectively, of net
income was reinvested in the business after payment of dividends. Cash flow
during 2001 was lower than expected because of lower water usage by existing
customers, regulatory lag in receiving rate relief and increased operating
costs, especially for purchased power costs. As a result, funds required to pay
2001 dividends exceeded net income by $2.1 million, resulting in a reduction of
stockholders' equity. The reduced cash flow also required the Company to borrow
additional funds under the bank line of credit agreement.
The Company has a Dividend Reinvestment and Stock Purchase Plan (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. The Plan provides that shares required for the Plan may be purchased on
the open market or be newly issued shares. During 2002 and 2001, shares 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
231
per share could be dilutive. Also, stockholders may experience dilution of their
ownership percentage unless they participate in an offering at the same level of
current ownership.
2003 Financing Plan. The Company's 2003 financing plan includes raising
approximately $60 million of new capital. The plan includes issuance of $20
million in senior notes to institutional investors. The senior note financing
was completed on February 28, 2003, when Series K 4.58% and Series L 5.48% notes
were issued, each for $10 million. Additionally, a global shelf registration
statement is being prepared. From the global shelf registration, the Company
expects to issue approximately $40 million of common stock. As currently
contemplated, the common stock issue will be accomplished with an initial issue
during the second quarter and a second issue late in the third quarter. However,
the Company does not plan to issue common stock until after the CPUC has issued
a decision for the 2001 GRC applications. Therefore, if the CPUC decision is
delayed, the common stock issues are also likely to be delayed. Beyond 2003,
future issues from the shelf registration could include common stock, preferred
stock or debt instruments sold to individual investors.
Contractual Obligations. The Company's contractual obligations are
summarized in the table below. Long-term debt payments include annual sinking
fund payments on first mortgage bonds, maturities of long-term debt and annual
payments on other long-term obligations. Advances for Construction represent
annual contract refunds to developers for the cost of water systems paid for by
the developers. The contracts are non-interest bearing and refunds are generally
on a straight-line basis over a 40-year period. Operating leases are generally
rents for office space. The total amount presented for operating leases is for a
20-year period.
Less Than After
Contractual Obligations (In thousands) Total 1 Year 2-3 Years 4-5 Years 5 Years
Long-Term Debt $251,365 $1,000 $ 1,896 $ 1,776 $246,693
Advances for Construction 115,459 4,605 15,243 11,146 84,465
Operating leases 21,000 833 1,834 1,834 16,499
The Company has water supply contracts with wholesale suppliers in 16
of its operating districts. For each contract, the cost of water is established
by the wholesale supplier and is generally beyond the Company's control. The
amount paid annually to the wholesale suppliers is charged to purchased water
expense on the Company's statement of income. Three contracts noted below
require minimum payments. The other contracts do not require minimum annual
payments. The amount paid under the contracts, except for the contract with
Stockton East Water District (SEWD), varies with the volume of water purchased
from the wholesalers. The contract with SEWD requires payments totaling
$3,779,000 for 2003, a 27% increase over 2002. The amount paid under this
contract is fixed annually and generally does not vary with the quantity of
water delivered by the district during the year. Because of the fixed price
arrangement, the Company operates to receive as much water as possible from SEWD
in order to minimize the cost of operating wells to supplement SEWD deliveries.
Two contracts require the Company to purchase minimum quantities of water at the
contractors' current wholesale rate for purchased water. Under both contracts,
the Company operates so that purchases exceed the contractual minimum amount.
The Company plans to continue to purchase at least the minimum water requirement
under both contracts in the future.
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 first mortgage bonds.
In 2002, utility plant expenditures totaled $88.4 million compared to
$62.0 million in 2001. The 2002 construction program included $71.6 million of
Company-funded projects and $16.8 million of projects funded by funds received
from developers for non-refundable contributions in aid of construction and
refundable advances for construction. The Company's 2002 projects were funded by
internally-generated funds, borrowings under bank credit lines, and issuance of
long-term debt senior notes. The Company's 2001 projects were funded by
internally-generated funds, borrowings under bank credit lines, and issuance of
$20 million in senior notes.
The 2003 Company-funded construction budget was authorized at $51.7
million. It includes $4.5 million for the fifth year of a five-year program to
construct a water treatment plant to accommodate growth and meet water quality
standards in the Bakersfield district. Construction of the plant is proceeding
on-time and on-budget. Over the five-year period, the plant and related pumping
and pipeline facilities are estimated to cost $49.0 million. Also in the 2003
budget is $10.7 million for new and replacement water mains and $12.1 million
for new wells, pumping equipment and storage facilities. The budget will be
funded by funds from operations, bank borrowings and long-term debt and equity
financing. New subdivision construction will be financed by developers'
non-refundable contributions-in-aid-of-construction and refundable advances for
construction.
Company-funded construction budgets over the next five years are
projected to be about $330 million. Included in the estimated amount is $61
million for compliance with arsenic water quality regulations, completion of the
Bakersfield treatment plant and expansion and replacement of water plant
infrastructure including the start of a program to replace certain wells that
are nearing the end of their service life.
Capital Structure. In 2002, common stockholders' equity increased $1.9
million and in 2000 increased $3.6 million by net income not paid out as
dividends. In 2001, common stockholders equity was reduced by the $2.1 million
that dividends paid exceeded net income. 36,180 shares of common stock were
issued in 2001 for the acquisition of the Nish water systems. The long-term debt
portion of the capital structure increased in 2002, 2001 and 2000 primarily due
to the issuance of new senior notes. It was reduced by first mortgage bond
sinking fund payments.
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The Company's total capitalization at December 31, 2002, was $453.1
million and at the end of 2001 was $402.7 million. Because of the decline in
2001 net income and issuance of additional senior notes, the debt component of
capitalization has increased and the equity component has decreased. The Company
expects that its planned issuance of common equity, and receipt of regulatory
relief will add to the common equity portion of capitalization in 2003 and
future years. At December 31 capitalization ratios were:
2002 2001
Common equity 44.0% 48.8%
Preferred stock 0.7% 0.9%
Long-term debt 55.3% 50.3%
The return on average common equity was 9.7% in 2002 compared to 7.6%
in 2001. The low return on average common equity in 2001 was directly related to
the decline in net income.
Acquisitions. Rio Grande Utility Corporation. On July 1, 2002, after
receiving state regulatory commission approval, the Company acquired certain
assets of Rio Grande Utility Corporation (Rio Grande) through New Mexico Water.
The purchase included the water and wastewater assets of Rio Grande, which
serves 2,400 water and 1,700 wastewater customers about 30 miles south of
Albuquerque. The purchase price was $2,300,000 in cash, plus assumption of
$3,100,000 in outstanding debt. Rate base for the system is approximately
$5,400,000.
The Rio Grande purchase price was allocated to the fair value of net
assets acquired, including utility plant, water rights and assumed liabilities.
The results of operations include the operating results of Rio Grande since the
acquisition date. The allocation of fair value is based on management's estimate
of the fair value for purchase accounting purposes at the date of acquisition.
The purchase price allocations are subject to revision if management obtains
additional information.
For 2001, Rio Grande had gross revenue of $1,485,000. Its gross utility
plant in service at December 31, 2001, was $12,458,000 and net utility plant in
service was $9,153,000. The regulatory decision authorizing the purchase
included an authorization to increase annual water rates by $115,000.
National Utilities Corporation. In June 2002, New Mexico Water signed
an agreement to purchase National Utilities Corporation for approximately
$700,000. National Utilities serves 700 water customers located adjacent to the
Rio Grande water system and another 1,000 water customers located 150 miles
south of Albuquerque, New Mexico. The purchase will entitle New Mexico Water to
purchase up to 2,000 acre-feet of water annually as required for its operations.
The purchase is subject to the approval of the New Mexico Public Regulation
Commission. Regulatory approval is expected in the third quarter of 2003.
National Utilities had 2002 revenue of $554,000 and total assets of $1,410,000.
Its net utility plant in service at December 31, 2001, was $1,178,000.
Kaanapali Water Corporation. In August 2002, the Company agreed to
acquire the Kaanapali Water Corporation for $7.7 million in cash. Kaanapali
Water provides water utility services to 500 customers on the island of Maui in
Hawaii, including 10 resorts and eight condominium projects. It posted 2001
revenues of $3.3 million, and has net plant of approximately $7.3 million and
current assets of $0.4 million. The transaction is subject to approval of the
Hawaii Public Utilities Commission, and an application requesting approval was
filed in October 2002. A decision is expected by mid-2003.
Nish Water Systems. On January 25, 2001, the CPUC approved the
Company's acquisition of the Nish water systems in Visalia. The four systems
serve 1,100 customers and had annual revenue of $0.2 million. The Company issued
36,180 shares of its common stock valued at $0.9 million and assumed debt of
$0.3 million to complete the transaction, which was accounted for as a pooling
of interests. The effect of pooling was deemed not to be material; therefore,
prior year financial statements have not been restated and pro forma disclosures
were not considered significant. The net equity of Nish was recorded as an
adjustment to retained earnings as of January 1, 2001.
Washington Water. In 2002, Washington Water purchased the assets of
eight water companies that serve 181 customers and generate $0.1 million in
annual revenue. The combined purchase price was $0.1 million. During 2001,
Washington Water purchased the assets of seven water companies that serve 681
customers and generate about $0.3 million in annual revenue. The combined
purchase price was $0.7 million.
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. Most surplus properties have a low cost basis. A program has been
developed to realize the value of certain surplus properties through sale or
lease of those properties. The program will be ongoing for a period of several
years. During the next four years, the Company estimates that gross property
transactions totaling over $10 million could be completed. During 2002, the
Company completed four sales totaling $3.0 million in pretax proceeds. In 2001,
$4.0 million in pretax sales were completed through two sales.
Stockholder Rights Plan. As explained in Note 7 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.
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FINANCIAL RISK MANAGEMENT
The Company does not participate in hedge arrangements, such as forward
contracts, swap agreements, options or other contractual agreements relative to
the impact of market fluctuations on its assets, liabilities, production or
contractual commitments. The Company operates only in the United States, and
therefore, is not subject to foreign currency exchange rate risks.
Terrorism Risk. Since the September 11, 2001, terrorist attacks, to
safeguard its water supply and facilities, the Company has heightened security
at its facilities and taken added precautions for the safety of our employees
and the water we deliver to our customers. While the Company does not make
public comments on its security programs, it has been in contact with federal,
state and local law enforcement agencies to coordinate and improve water
delivery systems' security. The Company has also assigned a high priority to
completing work necessary to comply with new EPA requirements concerning
security of water facilities. This effort encompasses all of the Company's
operations.
Interest Rate Risk. The Company does have exposure to market risk that
includes changes in interest rates. Interest rate risk exists because the
Company's financing includes the use of long-term debt obligations with maturity
dates up to 30 years from the date of issue. If interest rates increase, the
Company's future long-term financing may be done at higher rates, resulting in a
need to recover higher cost in customers' future rates. Cal Water's long-term
obligations are first mortgage bonds and senior note obligations that are
generally placed with insurance companies at fixed interest rates. Washington
Water's long-term obligations are for periods of up to 10 years and are placed
with two banks. New Mexico Water's long-term debt obligations are with a bank
with maturities of 16 months. During 2002, the Company issued four series of $20
million senior notes with interest rates ranging from 5.29% to 7.11%. The range
of interest rates is an example of changing market conditions. To expand access
to capital debt markets, the Company will investigate the use of private and
public markets for future debt issues. It may also consider financing on a
parent company basis, rather than on a subsidiary-by-subsidiary basis.
The Company's short-term financing is provided by bank lines of credit
that are discussed under the "Liquidity and Capital Resources" section of this
report. Short-term borrowings that are not repaid from operating cash or funded
by retained earnings are generally converted to long-term debt issues. The
Company plans to continue the financing of its construction program with a
combination of debt and equity issues. Financing of acquisitions have been done
using Company common stock or through the debt financing vehicles available to
the subsidiary companies.
Value Risk. Because the Company operates primarily in a regulated
industry, its value risk is somewhat lessened; however, regulated parameters
also can be recognized as limitations to operations and earnings, and the
ability to respond to certain business conditions changes. During 2002 and 2001,
the Company experienced value risk because of the impact on earnings of CPUC
decisions or the lack of decision on earnings. Non-regulated operations are
subject to risk of contract constraints and performance by the Company in
achieving its objectives. Value risk management is accomplished using various
financial models that consider changing business parameters. It is also
supplemented by considering various risk control processes that may be available
as circumstances warrant.
Stock Market Performance Risk. While the Company's stock price has not
been significantly affected by poor performance of the general stock market over
the past two years, the Company's performance could be affected in other areas.
The Company provides its employees a defined benefit pension plan and
postretirement medical benefit plan. The Company is responsible for funding both
of these plans and a portion of the plans' assets are invested in stock market
equities, other than Company stock. Poor performance of the equity investments
could result in a need for additional future funding and cost to make up for a
loss of value in the equity investments. The Company expects to recover its
costs associated with the benefit plans in customer rates.
Equity Risk. The Company does not have equity investments and,
therefore, it does not have equity risks.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 143, "Accounting for Asset Retirement Obligations," which applies to
legal obligations associated with the retirement of long-lived assets and the
associated asset retirement costs. The Statement is effective for the Company in
the first quarter of 2003. The Company does not expect the adoption of SFAS No.
143 to have a significant impact on its financial position or results of
operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." This Statement
requires that a liability for costs associated with an exit or disposal activity
be recognized and measured initially at fair value only when the liability is
incurred. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company does not
expect the impact of adopting SFAS No. 146 to have a significant impact on the
Company's financial position, results of operations, or cash flows.
In November 2002, the FASB issued Interpretation No. 45, "Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." Interpretation No. 45 requires a
liability to be recognized at the time a company issues a guarantee for the fair
value of the obligations assumed under certain guarantee agreements. Additional
disclosures about guarantee agreements are also required in the interim and
annual financial statements. The Company does not believe adoption of
Interpretation No. 45 will have a material impact on the Company's results of
operations or financial position. The recognition and measurement provision of
FIN 45 are effective
234
for the years beginning after December 31, 2002. The disclosure
requirements are effective for December 31, 2002, financial statements; however,
the Company is not a party to any guarantees at this time.
In December 2002, the FASB issued Statement No. 148, "Accounting for
Stock-Based Compensation, Transition and Disclosure." This statement provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. It also requires
that disclosure of the pro forma effect of using the fair-value method of
accounting for stock-based employee compensation be displayed more prominently
and in a table in annual financial statements. Additionally, the statement
requires disclosure of the pro forma effect in interim financial statements. The
transition and annual disclosure requirements of Statement No. 148 are effective
for the Company for 2002. The interim disclosure requirements are effective for
the Company's first quarter of 2003. The Company does not expect Statement No.
148 to have a material effect on its results of operations or financial
condition.
235
Consolidated Balance Sheet
In thousands, except per share data
December 31, 2002 and 2001 2002 2001
Assets
Utility plant:
Land $ 11,513 $ 10,709
Depreciable plant and equipment 927,244 859,846
Construction work in progress 48,624 26,826
Intangible assets 13,929 12,277
Total utility plant 1,001,310 909,658
Less accumulated depreciation and amortization 304,322 285,316
Net utility plant 696,988 624,342
Current assets:
Cash and cash equivalents 1,063 953
Receivables:
Customers 14,831 14,572
Other 9,130 8,228
Unbilled revenue 7,969 7,291
Materials and supplies at average cost 2,760 2,147
Taxes and other prepaid expenses 7,234 7,224
Total current assets 42,987 40,415
Other assets:
Regulatory assets 46,089 38,893
Unamortized debt premium and expense 6,798 3,800
Other 7,720 2,764
Total other assets 60,607 45,457
$ 800,582 $ 710,214
236
2002 2001
Capitalization and Liabilities
Capitalization:
Common stock, $0.01 par value; 25,000 shares
authorized, 15,182 $ 152 $ 152
outstanding in 2002 and 2001
Additional paid-in capital 49,984 49,984
Retained earnings 149,215 147,299
Accumulated other comprehensive loss (134) (816)
Total common stockholders' equity 199,217 196,619
Preferred stock without mandatory redemption
provision, $25 par value,
380 shares authorized, 139 shares outstanding 3,475 3,475
Long-term debt, less current maturities 250,365 202,600
Total capitalization 453,057 402,694
Current liabilities:
Current maturities of long-term debt 1,000 5,381
Short-term borrowings 36,379 22,000
Accounts payable 23,706 24,032
Accrued taxes 3,742 3,813
Accrued interest 2,873 2,535
Other accrued liabilities 23,841 21,228
Total current liabilities 91,541 78,989
Unamortized investment tax credits 2,774 2,882
Deferred income taxes 31,371 28,816
Regulatory and other liabilities 28,804 20,680
Advances for construction 115,459 106,657
Contributions in aid of construction 77,576 69,496
Commitments and contingencies
$ 800,582 $ 710,214
See accompanying Notes to Consolidated Financial Statements.
237
Consolidated Statement of Income
In thousands, except per share data
For the years ended December 31, 2002, 2001 and 2000 2002 2001 2000
Operating revenue $263,151 $246,820 $244,806
Operating expenses:
Operations:
Purchased water 76,672 73,174 73,768
Purchased power 22,897 21,130 15,136
Pump taxes 6,344 5,910 6,275
Administrative and general 37,646 36,521 32,974
Other 34,073 34,109 32,308
Maintenance 11,587 12,131 11,592
Depreciation and amortization 21,238 19,226 18,368
Income taxes 12,568 9,728 11,571
Property and other taxes 9,829 9,740 9,618
Total operating expenses 232,854 221,669 211,610
Net operating income 30,297 25,151 33,196
Other income and expenses:
Non-regulated income, net 2,637 1,979 1,413
Gain on the sale of non-utility property 2,980 3,864 --
Total other income and expenses 5,617 5,843 1,413
Income before interest expense 35,914 30,994 34,609
Interest expense:
Long-term debt interest 15,554 14,187 12,901
Other interest 1,287 1,842 1,745
Total interest expense 16,841 16,029 14,646
Net income $ 19,073 $ 14,965 $ 19,963
Earnings per share:
Basic $ 1.25 $ 0.98 $ 1.31
Diluted $ 1.25 $ 0.97 $ 1.31
Weighted average number of common shares outstanding:
Basic 15,182 15,182 15,126
Diluted 15,185 15,186 15,129
See accompanying Notes to Consolidated Financial Statements.
238
Consolidated Statement of Common Stockholders' Equity and Comprehensive Income
In thousands
For the years ended Accumulated
December 31, 2002, 2001 and 2000 Additional Other Total
Common Paid-in Retained Comprehensive Stockholders'
Stock Capital Earnings Loss Equity
Balance at December 31, 1999 $ 151 $ 49,340 $ 145,610 $ (517) $ 194,584
Net income -- -- 19,963 -- 19,963
Other comprehensive income -- -- -- 31 31
Comprehensive income -- -- -- -- 19,994
Issuance of common stock -- 644 -- -- 644
Dividends paid:
Preferred stock -- -- 153 -- 153
Common stock -- -- 16,235 -- 16,235
Total dividends paid -- -- 16,388 -- 16,388
Balance at December 31, 2000 151 49,984 149,185 (486) 198,834
Net income -- -- 14,965 -- 14,965
Other comprehensive loss -- -- -- (330) (330)
Comprehensive income -- -- -- -- 14,635
Acquisition 1 -- 220 -- 221
Dividends paid:
Preferred stock -- -- 153 -- 153
Common stock -- -- 16,918 -- 16,918
Total dividends paid -- -- 17,071 -- 17,071
Balance at December 31, 2001 152 49,984 147,299 (816) 196,619
Net income -- -- 19,073 -- 19,073
Other comprehensive income -- -- -- 682 682
Comprehensive income -- -- -- -- 19,755
Dividends paid:
Preferred stock -- -- 153 -- 153
Common stock -- -- 17,004 -- 17,004
Total dividends paid -- -- 17,157 -- 17,157
Balance at December 31, 2002 $ 152 $ 49,984 $ 149,215 $ (134) $ 199,217
See accompanying Notes to Consolidated Financial Statements.
239
Consolidated Statement of Cash Flows
In thousands
For the years ended December 31, 2002, 2001 and 2000 2002 2001 2000
Operating activities:
Net income $ 19,073 $ 14,965 $ 19,963
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation and amortization 21,238 19,226 18,368
Deferred income taxes, investment tax credits, and
regulatory assets and liabilities, net 786 2,919 (3,203)
Gain on sale of non-utility property (2,980) (3,864) --
Changes in operating assets and liabilities
Receivables (1,088) (2,186) (1,503)
Unbilled revenue (561) 673 235
Accounts payable (431) (2,461) (255)
Other current assets and liabilities 1,287 6,642 1,093
Other changes, net (3,909) (625) 638
Net adjustments 14,342 20,324 15,373
Net cash provided by operating activities 33,415 35,289 35,336
Investing activities:
Utility plant expenditures
Company funded (71,553) (53,379) (33,540)
Developer advances and contributions in aid of construction (16,808) (8,670) (3,621)
Proceeds from sale of non-utility assets 3,006 3,999 --
Acquisitions (2,300) (701) (709)
Net cash used in investing activities (87,655) (58,751) (37,870)
Financing activities:
Net short-term borrowings 12,435 7,402 599
Issuance of common stock -- -- 644
Issuance of long-term debt 80,324 20,524 20,326
Advances for construction 12,545 6,498 3,846
Refunds of advances for construction (4,597) (4,166) (3,870)
Contributions in aid of construction 7,740 10,868 1,883
Retirement of long-term debt (36,940) (2,881) (2,920)
Dividends paid (17,157) (17,071) (16,388)
Net cash provided by financing activities 54,350 21,174 4,120
Change in cash and cash equivalents 110 (2,288) 1,586
Cash and cash equivalents at beginning of year 953 3,241 1,655
Cash and cash equivalents at end of year $ 1,063 $ 953 $ 3,241
Supplemental disclosures of cash flow information: Cash paid during the
year for:
Interest (net of amounts capitalized) $ 16,527 $ 14,785 $ 14,785
Income taxes 10,205 11,775 11,775
Non-cash financing activity - common stock issued in acquisitions -- 899 --
See accompanying Notes to Consolidated Financial Statements.
240
Notes to Consolidated Financial Statements
December 31, 2002, 2001, and 2000
1
ORGANIZATION AND OPERATIONS
California Water Service Group (Company) is a holding company that
through its wholly-owned subsidiaries provides water utility and other related
services in California, Washington and New Mexico. California Water Service
Company (Cal Water), Washington Water Service Company (Washington Water) and New
Mexico Water Service Company (New Mexico Water) provide regulated utility
services under the rules and regulations of their respective state's regulatory
commissions (jointly referred to as Commissions). CWS Utility Services provides
non-regulated water utility and utility-related services.
The Company operates primarily in one business segment, providing water
and related utility services.
2
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries.
Intercompany transactions and balances have been eliminated.
Reclassifications 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.
Use of Estimates The preparation of consolidated financial statements
in conformity with accounting principles generally accepted in the United States
of America 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 and waste 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.
Expense balancing and memorandum accounts are used to track suppliers'
rate increases for purchased water, purchased power and pump taxes that are not
included in customer water rates. The cost increases are referred to as
"Offsetable Expenses" because under certain circumstances they are recoverable
from customers in future rate increases designed to offset the higher costs. The
Company does not record the balancing and memorandum accounts until the
Commission has authorized a change in customer rates and the customer has been
billed.
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 $1,473,000 in 2002, $858,000 in 2001, and
$703,000 in 2000.
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 cost and are amortized over their useful life. Included in
intangible assets is $6,515,000 paid to the City of Hawthorne in 1996 to lease
the city's water system and associated water rights. The asset is being
amortized on a straight-line basis over the 15-year life of the lease.
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 2.4% in 2002, 2001 and 2000. 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 in accordance
with tax regulations.
Cash Equivalents Cash equivalents include highly liquid investments,
primarily U.S. Treasury and U.S. Government agency interest bearing securities,
with original maturities of three months or less.
Restricted Cash Restricted cash primarily represents proceeds collected
through a surcharge on certain customers' bills plus interest earned on the
proceeds and is used to service California Safe Drinking Water Bond obligations.
In addition, there are compensating balances at a bank in support of borrowings.
All restricted cash is classified in other prepaid expenses. At December 31,
2002 and 2001, the amounts restricted were $1,131,000 and $887,000,
respectively.
Regulatory Assets The Company records regulatory assets for future
revenues expected to be realized as the tax effects of certain temporary
differences previously passed through to customers reverse. The temporary
differences relate primarily to the difference between book and
241
income tax depreciation on utility plant that was placed in service before the
regulatory Commissions adopted normalization for ratemaking purposes. The
regulatory assets are net of revenue related to deferred income taxes that were
provided at prior tax rates and the amount that would be provided at current tax
rates. The differences will reverse over the remaining book lives of the related
assets.
In addition, regulatory assets include items that are recognized as
liabilities for financial statement purposes, which will be recovered in future
customer rates. The liabilities relate to postretirement benefits, vacation and
self-insured workers' compensation accruals.
Long-lived Assets The Company regularly reviews its long-lived assets
for impairment, annually or when events or changes in business circumstances
have occurred, which indicate the carrying amount of such assets may not be
fully realizable. Potential impairment of assets held for use is determined by
comparing the carrying amount of an asset to the future undiscounted cash flows
expected to be generated by that asset. If assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the carrying
value of the assets exceeds the fair value of the assets. There have been no
such impairments as of December 31, 2002.
Long-term Debt Premium, Discount and Expense The discount and issuance
expense on long-term debt is 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, less the accrued benefit, exceeds the unrecognized prior
service cost. 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 for
rate setting purposes. Annual refunds are made to developers 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, 2002 and 2001, the amounts
refundable under the 20-year contracts were $3,248,000 and $4,320,000,
respectively, and under 40-year contracts were $111,136,000 and $102,337,000,
respectively. In addition, other Advances for Construction totaling $1,075,000
at December 31, 2002, are refundable based upon customer connections. Estimated
refunds for 2003 for all water main extension contracts are $4,600,000.
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 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 only
deposits for new services were taxable. In late 2000, federal regulations were
further modified to exclude fire services from tax.
Earnings Per Share Basic earnings per share (EPS) is calculated by
dividing income available to common stockholders (net income less preferred
stock dividend of $153,000) by the weighted average shares outstanding during
the year. Diluted EPS is calculated by dividing income available to common
stockholders by the weighted average shares outstanding including potentially
dilutive shares as determined by application of the treasury stock method. The
difference between basic and diluted weighted average number of common stock
outstanding is the effect of dilutive common stock options outstanding.
Stock-based Compensation The Company has a stockholder-approved
Long-Term Incentive Plan that allows granting of nonqualified stock options. The
Company has adopted the disclosure requirements of Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
and as permitted by the statement, applies Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," for its plan. All of the
Company's outstanding options have an exercise price equal to the market price
on the date they were granted. No compensation expense was recorded for the
years ended December 31, 2002, 2001 or 2000.
The table below illustrates the effect on net income and earnings per
share as if the Company had applied the fair value recognition provisions of
FASB Statement No. 123, "Accounting for Stock-Based Compensation," to
stock-based employee compensation.
242
In thousands, except per share amounts 2002 2001 2000
Net income, as reported $19,073 $14,965 $19,963
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects 86 57 24
Pro forma net income $18,987 $14,908 $19,939
Earnings per share:
Basic - as reported $ 1.25 $ 0.98 $ 1.31
Basic - pro forma $ 1.25 $ 0.98 $ 1.31
Diluted - as reported $ 1.25 $ 0.97 $ 1.31
Diluted - pro forma $ 1.24 $ 0.97 $ 1.30
Recent Accounting Pronouncements In June 2001, the Financial Accounting
Standards Board (FASB) issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which applies to legal obligations associated with the retirement
of long-lived assets and the associated asset retirement costs. The Statement is
effective for the Company in the first quarter of 2003. The Company does not
expect the adoption of SFAS No. 143 to have a significant impact on its
financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." This Statement
requires that a liability for costs associated with an exit or disposal activity
be recognized and measured initially at fair value only when the liability is
incurred. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company does not
expect the impact of adopting SFAS No. 146 to be significant to the Company's
financial position, results of operations, or cash flows.
In December 2002, the FASB issued Statement No. 148, "Accounting for
Stock-Based Compensation, Transition and Disclosure." This statement provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. It also requires
that disclosures of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed more prominently
and in a table. Additionally, the statement requires disclosure of the pro forma
effect in interim financial statements. The transition and annual disclosure
requirements of Statement No. 148 are effective for the Company in 2002. The
interim disclosure requirements are effective for the Company's first quarter of
2003. The Company does not expect Statement No. 148 to have a material effect on
its results of operations or financial condition.
3
MERGER WITH DOMINGUEZ SERVICES CORPORATION
The Merger between the Company and Dominguez was completed on May 25,
2000. On the merger date, each outstanding Dominguez common share was exchanged
for 1.38 shares of Company common stock. The Company issued 2,210,254 new common
shares in exchange for the 1,601,679 outstanding Dominguez shares. Dominguez
provided water service in 21 California communities. The former Dominguez
operations became districts within Cal Water. The Merger was accounted for as a
pooling of interests. There were no intercompany transactions as a result of the
Merger. Certain reclassifications were made to the historical financial
statements of the companies to conform presentation. No adjustments were made to
the Dominguez net assets in applying the accounting practices of the Company.
Dominguez previously reported common stock of $1,542,000 that was reclassified
by the Company to "Paid-in-Capital" in accordance with the Company's financial
statement presentation. The Company and Dominguez each had December 31
year-ends; therefore no adjustment was required to retained earnings due to a
change in fiscal year-ends.
4
OTHER ACQUISITIONS
During 2002, after receiving regulatory approval, the Company acquired
the assets of Rio Grande Utility Corporation (Rio Grande) through its
wholly-owned subsidiary, New Mexico Water. The purchase includes the water and
wastewater assets of Rio Grande, which serves water and wastewater customers in
unincorporated areas of Valencia County, New Mexico. The purchase price was
$2,300,000 in cash, plus assumption of $3,100,000 in outstanding debt. Rate base
for the system is $5,400,000, including intangible water rights valued at
$732,000.
In 2001, the Company acquired four companies operating in Cal Water's
Visalia district. The acquisitions were completed in February 2001, in exchange
for 36,180 shares of Company common stock worth $899,000 and assumed debt of
$218,000. The acquisitions were accounted for under the pooling of interests
method of accounting; however, due to the results from operations not being
material to the Company's consolidated results from operations, prior periods
were not restated. The net equity acquired was recorded as an increase to
retained earnings at the beginning of the year. In addition, Washington Water
purchased the assets of eight water companies for cash of $701,000.
243
During 2000, Washington Water purchased the assets of Mirrormount Water
Services and Lacamas Farmsteads Water Company for $639,000 in cash and assumed
debt. To provide in-house engineering, Washington Water also purchased the
assets of Robischon Engineers, Inc. in April 2000 for $70,000 in cash.
Condensed balance sheets and pro forma results of operations for these
acquisitions have not been presented since the effect of these purchases are not
material. Acquisitions that involved purchase of assets were accounted for under
the purchase method of accounting.
5
INTANGIBLE ASSETS
As of December 31, 2002 and 2001, intangible assets that will continue
to be amortized and those not amortized were:
2002 2001
Amounts in thousands Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Value Amortization Value Value Amortization Value
Amortized intangible assets:
Hawthorne lease $ 6,515 $ 2,968 $ 3,547 $ 6,515 $ 2,534 $ 3,981
Water pumping rights 1,046 2 1,044 1,046 -- 1,046
Water planning studies 1,783 238 1,545 1,054 109 945
Leasehold improvements and other 2,160 1,027 1,133 1,969 920 1,049
Total $11,504 $ 4,235 $ 7,269 $10,584 $ 3,563 $ 7,021
Unamortized intangible assets:
Perpetual water rights $ 2,425 -- $ 2,425 $ 1,693 -- $ 1,693
For the years ending December 31, 2002, 2001 and 2000, amortization of
intangible assets was $670,000, $630,000 and $507,000. Estimated future
amortization expense related to intangible assets for the succeeding five years
is $671,000 per year for 2003 to 2007 and $3,243,000 beyond 2007.
6
PREFERRED STOCK
As of December 31, 2002 and 2001, 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.
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. Each Series C preferred share is entitled
to sixteen votes, with the right to cumulative votes at any election of
directors.
7
COMMON STOCKHOLDERS' EQUITY
The Company is authorized to issue 25,000,000 shares of $0.01 par value
common stock. As of December 31, 2002 and 2001, 15,182,046 shares of common
stock were issued and outstanding.
Dividend Reinvestment and Stock Repurchase Plan The Company has a
Dividend Reinvestment and Stock Purchase Plan (Plan), which allows stockholders
to reinvest dividends to purchase additional Company common stock. The Plan also
allows stockholders and other investors to purchase Company common stock through
the transfer agent. The Plan provides that shares required for the Plan may be
purchased on the open market or be newly issued shares. During 2002 and 2001,
shares were purchased on the open market.
Stockholder Rights Plan The Company's Stockholder Rights Plan (Plan) is
designed to provide stockholders protection and to maximize stockholder value by
encouraging a prospective acquirer to negotiate with the Board. The Plan was
adopted in 1998 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 in certain circumstances. The Rights are for a ten-year period that
expires in February 2008.
Each Right represents a right to purchase 1/100th share of Series D
Preferred Stock at the price of $120, subject to adjustment (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 would cause 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 would
244
thereafter be void), would 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 $0.001 per Right.
8
SHORT-TERM BORROWINGS
At December 31, 2002, the Company maintained a bank line of credit
providing unsecured borrowings of up to $10,000,000 at the prime lending rate or
lower rates as quoted by the bank. Cal Water maintained a separate bank line of
credit for an additional $50,000,000 on the same terms as the Company's line of
credit. The agreements require a 30-day out-of-debt period for borrowings under
the agreements in calendar year 2002. However, on September 23, 2002, the
agreements were amended to extend the out-of-debt compliance period to between
January 1, 2002, and April 30, 2003. As explained in Note 16 Subsequent Events,
the lines of credit, which were scheduled to expire on April 30, 2003, were
renegotiated on February 28, 2003. At December 31, 2002, $34,000,000 was
outstanding.
Washington Water has a loan commitment for $100,000 from a bank to meet
its operating and capital equipment purchase requirements at interest rates
negotiated with the bank. At December 31, 2002, nothing was outstanding under
the short-term commitment.
New Mexico Water has a $2.9 million credit agreement with a New Mexico
bank that was renewed in January 2003 for a 16-month period. The interest rate
for the agreement is based on prime rate plus 75 basis points. At December 31,
2002, the amount borrowed was $2,379,000.
The following table represents borrowings under the bank lines of
credit:
Dollars in thousands 2002 2001 2000
Maximum short-term borrowings $52,285 $36,800 $26,750
Average amount outstanding $25,495 $24,453 $16,810
Weighted average interest rate 3.44% 5.29% 7.77%
Interest rate at December 31 3.61% 3.16% 7.88%
244
9
LONG-TERM DEBT
As of December 31, 2002 and 2001, long-term debt outstanding was:
Interest Maturity
In thousands Series Rate Date 2002 2001
First Mortgage Bonds: J 8.86% 2023 $ 4,000 $ 4,000
K 6.94% 2012 5,000 5,000
P 7.875% 2002 -- 2,565
S 8.50% 2003 -- 2,580
BB 9.48% 2008 -- 11,520
CC 9.86% 2020 18,400 18,500
DD 8.63% 2022 -- 19,100
EE 7.90% 2023 19,100 19,200
FF 6.95% 2023 19,100 19,200
GG 6.98% 2023 19,100 19,200
84,700 120,865
Senior Notes: A 7.28% 2025 20,000 20,000
B 6.77% 2028 20,000 20,000
C 8.15% 2030 20,000 20,000
D 7.13% 2031 20,000 20,000
E 7.11% 2032 20,000 --
F 5.90% 2017 20,000 --
G 5.29% 2022 20,000 --
H 5.29% 2022 20,000 --
160,000 80,000
California Department of 3.0% to
Water Resources loans 7.4% 2003-33 2,797 2,886
Other long-term debt 3,868 4,230
Total long-term debt 251,365 207,981
Less current maturities 1,000 5,381
Long-term debt excluding current maturities $250,365 $202,600
The first mortgage bonds and unsecured senior notes are obligations of
Cal Water. All 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 require interest-only payments until maturity,
except series G and H which have an annual sinking fund requirement of $1.8
million starting in 2012. The Department of Water Resources (DWR) loans were
financed under the California Safe Drinking Water Bond Act. Repayment of
principal and interest on the DWR loans is through a surcharge on customer
bills. Other long-term debt is primarily equipment and system acquisition
financing arrangements with financial institutions. Compensating balances of
$227,000 as of December 31, 2002, are required by these institutions. Aggregate
maturities and sinking fund requirements for each of the succeeding five years
(2003 through 2007) are $1,000,000, $932,000, $909,000, $928,000 and $918,000.
10
OTHER ACCRUED LIABILITIES
As of December 31, 2001 and 2002, other accrued liabilities were:
In thousands 2002 2001
Accrued pension and postretirement benefits $ 9,635 $ 9,777
Accrued and deferred compensation 6,041 4,926
Accrued insurance 2,914 1,317
Other 5,251 5,208
$23,841 $21,228
246
11
INCOME TAXES
Income tax expense consists of the following:
In thousands Federal State Total
2002 Current $8,797 $2,406 $11,203
Deferred 1,039 326 1,365
Total $9,836 $2,732 $12,568
2001 Current $6,472 $2,136 $ 8,608
Deferred 1,456 (336) 1,120
Total $7,928 $1,800 $ 9,728
2000 Current $7,961 $2,519 $10,480
Deferred 1,554 (463) 1,091
Total $9,515 $2,056 $11,571
Income tax expense computed by applying the current federal 35% tax rate 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 2002 2001 2000
Computed "expected" tax expense $ 11,074 $ 8,643 $ 11,037
Increase (reduction) in taxes due to:
State income taxes net of federal tax benefit 1,818 1,170 1,336
Investment tax credits (191) (156) (155)
Other (133) 71 (647)
Total income tax $ 12,568 $ 9,728 $ 11,571
The components of deferred income tax expense were:
In thousands 2002 2001 2000
Depreciation $ 2,405 $ 2,337 $ 2,031
Developer advances and contributions (789) (783) (814)
Bond redemption premiums 806 (42) (61)
Investment tax credits (95) (94) (61)
Other (962) (298) (4)
Total deferred income tax expense $ 1,365 $ 1,120 $ 1,091
The tax effects of differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 31, 2002 and
2001 are presented in the following table:
In thousands 2002 2001
Deferred tax assets:
Developer deposits for extension agreements and contributions
in aid of construction $37,923 $41,531
Federal benefit of state tax deductions 6,325 5,744
Book plant cost reduction for future deferred ITC amortization 1,639 1,703
Insurance loss provisions 876 537
Pension plan 1,136 938
Other 4,703 868
Total deferred tax assets 52,602 51,321
Deferred tax liabilities:
Utility plant, principally due to depreciation differences 82,130 79,348
Premium on early retirement of bonds 1,843 789
Total deferred tax liabilities 83,973 80,137
Net deferred tax liabilities $31,371 $28,816
A valuation allowance was not required at December 31, 2002 and 2001.
Based on historical 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.
247
12
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, bonds and short-term investment
accounts. The data in the tables below includes the unfunded, non-qualified,
supplemental executive retirement plan. In addition, the tables reflect a plan
amendment effective January 1, 2003, that increased the annual minimum benefit,
which is recognized over the working life of the employees.
Benefits earned by Dominguez employees under the Dominguez pension plan
were frozen as of the merger date and future pension benefits to those employees
will be provided under the Company pension plan. The Dominguez plan was
curtailed. The Dominguez plan was fully funded and additional contributions to
the plan could not be funded, although plan annual expense was recorded. As a
result of the curtailment, accrued pension liability of $1,218,000 that had been
expensed by Dominguez in prior years was reversed by the Company in 2000. The
amount was offset against other operations expense.
Savings Plan The Company sponsors a 401(k) qualified, defined
contribution savings plan that allowed participants to contribute up to 18% of
pre-tax compensation. The Company matches fifty cents for each dollar
contributed by the employee up to a maximum Company match of 4.0%. Company
contributions were $1,422,000, $1,425,000, and $1,298,000, for the years 2002,
2001 and 2000, respectively.
Other Postretirement Plans The Company provides substantially all
active, permanent 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. Plan assets are invested in
mutual funds, short-term money market instruments and commercial paper. 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 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.
The following table reconciles the funded status of the plans with the
accrued pension liability and the net postretirement benefit liability as of
December 31, 2002 and 2001:
Pension Benefits Other Benefits
In thousands 2002 2001 2002 2001
Change in benefit obligation:
Beginning of year $ 60,359 $ 59,098 $ 14,708 $ 12,052
Service cost 2,968 2,786 815 625
Interest cost 4,404 4,333 1,037 858
Assumption change 30 1,326 699 1,943
Plan amendment 15,424 11 40 --
Experience loss 660 2,289 845 15
Benefits paid (4,276) (9,484) (641) (785)
End of year $ 79,569 $ 60,359 $ 17,503 $ 14,708
Change in plan assets:
Fair value of plan assets at beginning of year $ 57,340 $ 63,648 $ 2,300 $ 2,067
Actual return on plan assets (2,377) 1,356 (79) 237
Employer contributions 5,616 1,820 885 781
Retiree contributions -- -- 470 415
Benefits paid (4,276) (9,484) (1,111) (1,200)
Fair value of plan assets at end of year $ 56,303 $ 57,340 $ 2,465 $ 2,300
Funded status $(23,266) $ (3,019) $(15,038) $(12,408)
Unrecognized actuarial (gain) or loss 1,281 (6,191) 5,025 3,339
Unrecognized prior service cost 18,875 4,525 786 817
Unrecognized transition obligation -- -- 3,045 3,321
Unrecognized net initial asset -- -- (276) (276)
Net amount recognized $ (3,110) $ (4,685) $ (6,458) $ (5,207)
248
Amounts recognized on the balance sheet consist of:
Pension Benefits Other Benefits
In thousands 2002 2001 2002 2001
Accrued benefit costs $(3,110) $(4,685) $(6,458) $(5,207)
Additional minimum liability (4,784) (1,396) -- --
Intangible asset 4,650 580 -- --
Accumulated other comprehensive loss 134 816 -- --
Net amount recognized $(3,110) $(4,685) $(6,458) $(5,207)
Pension Benefits Other Benefits
2002 2001 2002 2001
Weighted average assumptions as of December 31:
Discount rate 6.70% 7.00% 6.70% 7.00%
Long-term rate of return on plan assets 8.00% 8.00% 8.00% 8.00%
Rate of compensation increases 1.00 to 4.25% 4.25% -- --
Net periodic benefit costs for the pension and other postretirement
plans for the years ending December 31, 2002, 2001 and 2000 included the
following components:
Pension Plan Other Benefits
In thousands 2002 2001 2000 2002 2001 2000
Service cost $ 2,968 $ 2,786 $ 2,846 $ 815 $ 625 $ 544
Interest cost 4,404 4,333 4,079 1,037 858 790
Expected return on plan assets (4,497) (4,946) (4,498) (216) (212) (152)
Net amortization and deferral 1,166 855 486 500 363 357
Net periodic benefit cost $ 4,041 $ 3,028 $ 2,913 $2,136 $1,634 $1,539
Postretirement benefit expense recorded in 2002, 2001, and 2000 was
$1,157,000, $885,000, and $781,000, respectively. $5,165,000, 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 2002 measurement purposes, the Company assumed a 7% annual rate of
increase in the per capita cost of covered benefits with the rate decreasing 1%
per year to a long-term annual rate of 5% per year after two years. 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 is
estimated to have the following effect:
1-percentage 1-percentage
In thousands Point Increase Point Decrease
Effect on total service and interest costs $ 354 $ (279)
Effect on accumulated postretirement benefit obligation $ 2,742 $ (2,216)
249
13
STOCK-BASED COMPENSATION PLANS
The Company has a stockholder-approved Long-Term Incentive Plan that
allows granting of nonqualified stock options, performance shares and dividend
units. Under the plan, a total of 1,500,000 common shares are authorized for
option grants. Options are granted at an exercise price that is not less than
the per share common stock market price on the date of grant. The options vest
at a 25% rate on their anniversary date over their first four years and are
exercisable over a ten-year period. At December 31, 2002, 36,750 options were
exercisable at a weighted average price of $24.08.
Certain key Dominguez executives participated in the Dominguez 1997
Stock Incentive Plan that was terminated at the time Dominguez merged with the
Company. The plan provided that in the event of a merger of Dominguez into
another entity, granted but unexercised stock options issued became exercisable.
Prior to the Merger, all outstanding Dominguez options were exercised and
converted into Dominguez shares, and subsequently converted to 52,357 shares of
Company common stock.
The fair value of stock options used to compute pro forma net income
and earnings per share disclosures is the estimated fair value at grant date
using the Black-Scholes option-pricing model with the following assumptions:
2002 2001 2000
Expected dividend 4.5% 4.3% 4.3%
Expected volatility 27.7% 30.4% 22.0%
Risk-free interest rate 3.25% 4.6% 4.9%
Expected holding period in years 5.0 5.0 5.0
The following table summarizes the activity for the stock option plans:
Weighted Weighted Weighted
Average Average Average
Exercise Remaining Options Fair
Shares Price Contractual Life Exercisable Value
Outstanding at December 31, 1999 52,357 $23.45 - 19,092 -
Granted 53,500 23.06 $3.74
Exercised (52,357) 23.45
Outstanding at December 31, 2000 53,500 23.06 9.5 - -
Granted 58,000 25.94 5.65
Cancelled (12,000) 24.50
Outstanding at December 31, 2001 99,500 24.57 8.8 11,875 -
Granted 55,000 25.15 4.41
Outstanding at December 31, 2002 154,500 24.77 8.2 36,750 -
14
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 $306,140,000 as of December 31, 2002, and
$214,046,000 as of December 31, 2001, 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 $34,000,000 as of December 31, 2002 and $32,000,000 as of December 31, 2001,
based on data provided by brokers.
15
COMMITMENTS AND CONTINGENCIES
Commitments The Company leases office facilities in many of its
operating districts. The total paid and charged to operations for such leases
was $800,000 in 2002, $720,000 in 2001 and $760,000 in 2000. Payments under the
lease commitments over the succeeding five years 2003 through 2007 are estimated
to be $833,000, $893,000, $941,000, $943,000 and $891,000. Over the 20-year
period through 2023, payments under lease commitments, assuming renewal of
existing or replacement leases, is estimated to be $21,000,000.
The Company has long-term contracts with two wholesale water suppliers
that require the Company to purchase minimum annual water quantities. Purchases
are priced at the suppliers' then current wholesale water rate. The Company
operates to purchase sufficient water to equal or exceed the minimum quantities
under both contracts. The total paid under the contracts was $6,816,000 in 2002,
$6,208,000 in 2001 and $5,400,000 in 2000. The estimated payments under the
contracts for the five years 2003 through 2007 are $8,000,000, $8,300,000,
$8,600,000, $9,000,000 and $9,300,000.
250
The water supply contract with Stockton East Water District (SEWD)
requires a fixed, annual payment and does not vary during the year with the
quantity of water delivered by the district. Because of the fixed price
arrangement, the Company operates to receive as much water as possible from SEWD
in order to minimize the cost of operating Company-owned wells used to
supplement SEWD deliveries. The total paid under the contract was $2,967,000 in
2002, $3,496,000 in 2001 and $3,269,000 in 2000. Pricing under the contract
varies annually. For 2003, the estimated payment is $3,779,000.
During 2001 and 2002, the Company committed up to $7.6 million of the
its bank line of credit to a contractor for construction of a customer and
operation center. The tax-free exchange of seven surplus Company properties to
the contractor for the new customer and operations center was completed on
September 30, 2002. Because the transaction was structured as a property
exchange, acquiring the new facility did not require a significant expenditure
of cash. Under terms of the exchange agreement, during the construction period
the Company had guaranteed the contractor's bank loan. The new facility, which
is valued at over $7 million, served as security to the Company for the
guarantee. When the property exchange was completed, the contractor paid off the
bank loan, and the Company was released from its guarantee.
In 2002, the Company agreed to acquire the Kaanapali Water Corporation
for $7,700,000 in cash. The acquisition is subject to approval of the Hawaii
Public Utilities Commission, which is expected in mid-2003. Also in 2002, the
New Mexico Water signed an agreement to purchase National Utilities Corporation
for approximately $700,000 in cash. The purchase of National Utilities is
subject to the approval of the New Mexico Public Regulation Commission, which is
expected in the third quarter of 2003.
Contingencies In 1995, the State of California's Department of Toxic
Substances Control (DTSC) named the Company as a potential responsible party for
cleanup of a toxic contamination plume in the Chico groundwater. The toxic spill
occurred when cleaning solvents, which were discharged into the city's sewer
system by local dry cleaners, leaked into the underground water supply due to
breaks in the city's sewer pipes. The DTSC contends that the Company's
responsibility stems from its operation of wells in the surrounding vicinity
that caused the contamination plume to spread. While the Company intends to
cooperate with the cleanup effort, it denies any responsibility for the
contamination or the resulting cleanup and intends to vigorously resist any
action that may be brought against it. The Company has negotiated with DTSC
regarding dismissal of the Company from the claim in exchange for the Company's
cooperation in the cleanup effort. However, no agreement was reached with DTSC
regarding dismissal of the Company from the DTSC action. In December 2002, the
Company was named along with eight other defendants in a lawsuit filed by DTSC
for the cleanup of the plume. The suit asserts that the defendants are jointly
and severally liable for the estimated cleanup of $8.7 million. The Company
believes that it has insurance coverage for this claim and that if it were
ultimately held responsible for a portion of the cleanup costs, there would not
be a material adverse effect on the Company's financial position or results of
operations.
In July 2002, the Company was served with a lawsuit in state court
naming it as one of several defendants for damages alleged to have resulted from
waste oil contamination in the Company's drinking water. The suit did not
specify a dollar amount. The Company does not believe that the complaint alleges
any facts under which it may be held liable. The Company has filed a motion to
dismiss the suit on various grounds. The Court has not ruled on the Company's
motion. If necessary, the Company intends to vigorously defend the suit. In
2000, the plaintiff in this action brought a suit against the Company in federal
court with similar allegations concerning drinking water contamination. That
suit was dismissed; however, the Court did not bar the plaintiff from filing an
amended complaint. The Company's insurance carrier is paying for legal defense
costs and the Company believes that its insurance policy will cover all costs
related to this matter.
In December 2001, the Company and several other defendants were served
with a lawsuit by the estate and immediate family members of a deceased employee
of a pipeline construction contractor. The contractor's employee had worked on
various Company projects over a number of years. The plaintiffs allege that the
Company and other defendants are responsible for an asbestos-related disease
that is claimed to have caused the death of the contractor's employee. The
complaint seeks damages in excess of $50,000, in addition to unspecified
punitive damages. The Company denies responsibility in the case and intends to
vigorously defend itself. Pursuant to an indemnity provision in the contracts
between the contractor and the Company, the contractor has accepted liability
for the claim against the Company and is reimbursing the Company for its defense
costs.
The Company and City of Stockton (City) purchase water from Stockton
East Water District (SEWD). The City has discussed with SEWD its belief that
SEWD's meter, which recorded water deliveries to the City's system,
malfunctioned for some period of time, and as a result the City overpaid for
water deliveries from SEWD. The City has told SEWD that it believes it was
overcharged between $800,000 and $2,300,000. If the City's assertion is correct,
it could mean that the Company was undercharged. The Company cannot determine
whether SEWD agrees with the City's assertion or whether and in what amount SEWD
will make a refund to the City. If SEWD were to make a refund to the City, it
could have a future operating fund shortfall, which might result in higher
future purchased water costs for the Company's Stockton district. However, the
Company believes that if purchased water costs increased, the increase would be
recovered in customers' future billings.
The Company is involved in other proceedings or litigation arising in
the ordinary course of operations. The Company believes the ultimate resolution
of such matters will not materially affect its financial position, results of
operations or cash flows.
16
SUBSEQUENT EVENTS
Negotiations to renew separate bank credit agreements for the Company
and Cal Water that were scheduled to expire on April 30, 2003, have been
completed. The new agreements, which replace a combined $60 million credit line,
became effective on February 28, 2003, and expire on April 30, 2005. Under the
new agreements the Company will have available a total of $65 million. Of the
total, $55 million is designated for Cal Water and $10 million for the Company
including funding of its subsidiaries' operations. Cal Water's $55 million
portion can be used solely
251
for purposes of the regulated California utility. On July 1, 2003, the
credit facility available to Cal Water will be reduced to $45 million. The
reduction will lower the commitment fee paid by Cal Water on the unused portion
of the credit line. Like the prior agreements, the new agreements also have a
30-day out-of-debt requirement that must be met by December 31, 2003.
On February 28, 2003, the Company issued two series of senior notes to
institutional investors, each for $10 million. The 5.48% Series L notes mature
in February 2018. The 4.58% Series K notes mature in December 2010. Proceeds
from the notes were used to repay outstanding short-term bank borrowings.
In February 2003, the Commission staff recommended that the Company be
fined up to $9,600,000 and refund $470,000 in revenue for failing to report two
acquisitions as required by the Commission. One acquisition was completed prior
to adoption of the reporting requirement by the Commission; the other was
inadvertently not reported. The Company acquired the two water systems, which
serve 283 customers, for approximately $140,000. The Company is preparing its
response to the staff report. The Company does not believe that the staff's
recommendation will be upheld when this matter is considered by the Commission;
accordingly, no liability has been accrued.
17
QUARTERLY FINANCIAL DATA (UNAUDITED)
The Company's common stock is traded on the New York Stock Exchange
under the symbol "CWT." Through 2002, quarterly dividends have been paid on
common stock for 232 consecutive quarters and the quarterly rate has been
increased each year since 1968.
2002 - in thousands except per share amounts First Second Third Fourth
Operating revenue $51,611 $69,183 $81,440 $60,917
Net operating income 5,281 8,300 11,515 5,201
Net income 1,928 6,619 7,675 2,852
Diluted earnings per share 0.12 0.43 0.50 0.19
Common stock market price range:
High 26.25 26.69 26.45 25.95
Low 23.20 23.40 21.60 23.65
Dividends paid .2800 .2800 .2800 .2800
2001 - in thousands except per share amounts
Operating revenue $47,008 $66,958 $76,310 $56,544
Net operating income 3,792 8,050 9,517 3,792
Net income 221 5,764 5,920 3,060
Diluted earnings per share 0.01 0.37 0.39 0.20
Common stock market price range:
High 28.60 27.70 27.00 27.50
Low 23.38 24.10 23.77 24.00
Dividends paid .27875 .27875 .27875 .27875
Independent Auditors' Report
THE 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, 2002 and
2001, and the related consolidated statements of income, common stockholders'
equity and comprehensive income, and cash flows for each of the years in the
three-year period ended December 31, 2002. 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 auditing standards generally
accepted in the United States of America. 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, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2002 in conformity with accounting
principles generally accepted in the United States of America.
Mountain View, California
January 29, 2003, except as to Note 16, which is as of February 28,2003
252
Corporate Information
STOCK TRANSFER, DIVIDEND DISBURSING AND REINVESTMENT AGENT
Fleet National
Bank c/o EquiServe L.P.
P.O. Box 43010 Providence, RI 02940-3010 (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 EquiServe, L. P. 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 23,
2003, 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 26, 2003.
DIVIDEND DATES FOR 2003
Quarter Declaration Record Date Payment Date
First January 29 February 7 February 21
Second April 23 May 2 May 16
Third July 23 August 1 August 15
Fourth October 22 October 31 November 14
ANNUAL REPORT FOR 2002 ON FORM 10-K
A copy of the Company's report for 2002 filed with the Securities and
Exchange Commission (SEC) on Form 10-K will be available in April 2003 and can
be obtained by any stockholder at no charge upon written request to the address
below. The Company's filings with the SEC can viewed via the link to the SEC's
EDGAR system on the Company's web site.
STOCKHOLDER INFORMATION
California Water Service Group
Attn: Stockholder Relations
1720 North First Street
San Jose, CA 95112-4598
(408) 367-8200 or (800) 750-8200
http://www.calwater.com
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
253
Paul G. Ekstrom (4) Vice President, Customer Service, and Corporate
Secretary
Richard D. Nye (1,2,3) Vice President, Chief Financial Officer and
Treasurer
Francis S. Ferraro (2,5) Vice President, Regulatory Matters and
Corporate Development
Robert R. Guzzetta (2) Vice President, Engineering and Water Quality
Christine L. McFarlane Vice President, Human Resources
Raymond H. Taylor Vice President, Operations
Dan L. Stockton Vice President, Chief Information Officer
Calvin L. Breed (1) Controller, Assistant Secretary and Assistant
Treasurer
Washington Water Service Company
Michael P. Ireland President
New Mexico Water Service Company
Robert J. Davey President
(1) Holds the same position with California Water Service Group
(2) Also an officer of CWS Utility Services
(3) Also an officer of Washington Water Service Company and New Mexico
Water Service Company
(4) Also Corporate Secretary of California Water Service Group, CWS
Utility Services, Washington Water Service Company and New Mexico Water
Service Company
(5) Holds the same position with New Mexico Water Service Company
BOARD OF DIRECTORS
Peter C. Nelson*
President and Chief Executive Officer
Robert W. Foy*
Chairman of the Board
C. H. Stump
Director Emeritus
Former Chairman of the Board and former CEO of California Water Service
Company
George A. Vera+
Vice President and Chief Financial Officer, the David & Lucile Packard
Foundation
Langdon W. Owen+
President, Don Owen & Associates; Member of the Board of Directors,
Metropolitan Water District of Southern California
Richard P. Magnuson+++ss.
Private Venture Capital Investor
Edward D. Harris, Jr., M.D.++*ss.
Professor of Medicine, Emeritus, Stanford University Medical Center
Douglas M. Brown+++ss.
President and Chief Executive Officer of Tuition Plan Consortium
Linda R. Meier+++ss.
Member, National Advisory Board, Haas Public Service Center; Member of
the Board of Directors, Greater Bay Bancorp; Chair of the Western
Regional Advisory Board of International Education; Member of the
National Board of the Institute of International Education; and Member
of the Board of Directors, Stanford Alumni Association
+Member of the Audit Committee
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++Member of the Compensation Committee
*Member of the Executive Committee
ss.Member of the Nominating/Corporate Governance Committee
255