Form: 10-K

Annual report pursuant to Section 13 and 15(d)

March 1, 2011

Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 10-K
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2010
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission file No. 1-13883
 
CALIFORNIA WATER SERVICE GROUP
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
  77-0448994
(I.R.S. Employer
Identification No.)
     
1720 North First Street,
San Jose, California
(Address of Principal Executive Offices)
  95112
(Zip Code)
 
(408) 367-8200
(Registrant’s Telephone Number, including Area Code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class:   Name of Each Exchange on Which Registered:
 
Common Stock, $0.01 par value per share
  New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232,405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No þ
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ
 
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant was $743 million on June 30, 2010, the last business day of the registrant’s most recently completed second fiscal quarter. The valuation is based on the closing price of the registrant’s common stock as traded on the New York Stock Exchange.
 
Common stock outstanding at February 24, 2011, 20,833,303 shares.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the definitive proxy statement for the California Water Service Group 2011 Annual Meeting are incorporated by reference into Part III hereof.
 


 

 
TABLE OF CONTENTS
 
             
        Page
 
  Business     3  
    Forward-Looking Statement     3  
    Overview     4  
    Regulated Business     5  
    Non-Regulated Business     6  
    Operating Segment     7  
    Growth     7  
    Geographical Service Areas and Number of Customers at Year-end     7  
    Rates and Regulations     8  
    Water Supply     12  
    Seasonal Fluctuations     15  
    Utility Plant Construction     15  
    Sale of Surplus Properties     15  
    California Energy Situation     15  
    Impact of Climate Change Legislation     15  
    Security at Company Facilities     16  
    Quality of Water Supplies     16  
    Competition and Condemnation     16  
    Environmental Matters     17  
    Employees     17  
    Executive Officers of the Registrant     18  
  Risk Factors     18  
  Unresolved Staff Comments     32  
  Properties     32  
  Legal Proceedings     32  
  Submission of Matters to a Vote of Security Holders     32  
 
PART II
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     33  
  Selected Financial Data     35  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     36  
    Overview     36  
    Critical Accounting Policies and Estimates     36  
    Results of Operations     38  
    Rates and Regulation     43  
    Water Supply     47  
    Liquidity and Capital Resources     47  
  Quantitative and Qualitative Disclosures About Market Risk     52  
  Financial Statements and Supplementary Data     53  
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     89  
  Controls and Procedures     89  
  Other Information     89  
 
PART III
  Directors and Executive Officers and Corporate Governance     89  
  Executive Compensation     90  
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     90  
  Certain Relationships and Related Transactions and Director Independence     90  
  Principal Accountant Fees and Services     90  
 
PART IV
  Exhibits, Financial Statement Schedules     91  
    Signatures     92  
    Exhibit Index     93  
 EX-12.1
 EX-21
 EX-23.1
 EX-31.1
 EX-31.2
 EX-32


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PART I
 
Item 1.   Business.
 
Forward-Looking Statements
 
This annual report, including all documents incorporated by reference, contains forward-looking statements within the meaning established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements in this annual report are based on currently available information, expectations, estimates, assumptions and projections, and our management’s beliefs, assumptions, judgments and expectations about us, the water utility industry and general economic conditions. These statements are not statements of historical fact. When used in our documents, statements that are not historical in nature, including words like “expects,” “intends,” “plans,” “believes,” “may,” “estimates,” “assumes,” “anticipates,” “projects,” “predicts,” “forecasts,” “should,” “seeks,” or variations of these words or similar expressions are intended to identify forward-looking statements. The forward-looking statements are not guarantees of future performance. They are based on numerous assumptions that we believe are reasonable, but they are open to a wide range of uncertainties and business risks. Consequently, actual results may vary materially from what is contained in a forward-looking statement.
 
Factors which may cause actual results to be different than those expected or anticipated include, but are not limited to:
 
  •  governmental and regulatory commissions’ decisions, including decisions on proper disposition of property;
 
  •  changes in regulatory commissions’ policies and procedures;
 
  •  the timeliness of regulatory commissions’ actions concerning rate relief;
 
  •  changes in the capital markets and access to sufficient capital on satisfactory terms;
 
  •  new legislation;
 
  •  changes in accounting valuations and estimates;
 
  •  changes in accounting treatment for regulated companies, including adoption of International Financial Reporting Standards, if required;
 
  •  electric power interruptions;
 
  •  increases in suppliers’ prices and the availability of supplies including water and power;
 
  •  fluctuations in interest rates;
 
  •  changes in environmental compliance and water quality requirements;
 
  •  acquisitions and the ability to successfully integrate acquired companies;
 
  •  the ability to successfully implement business plans;
 
  •  civil disturbances or terrorist threats or acts, or apprehension about the possible future occurrences of acts of this type;
 
  •  the involvement of the United States in war or other hostilities;
 
  •  our ability to attract and retain qualified employees;
 
  •  labor relations matters as we negotiate with the unions;
 
  •  federal health care law changes could result in increases to Company health care costs and additional income tax expenses in future years;
 
  •  implementation of new information technology systems;
 
  •  changes in operations that result in an impairment to acquisition goodwill;


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  •  restrictive covenants in or changes to the credit ratings on current or future debt that could increase financing costs or affect the ability to borrow, make payments on debt, or pay dividends;
 
  •  general economic conditions, including changes in customer growth patterns and our ability to collect billed revenue from customers;
 
  •  changes in customer water use patterns and the effects of conservation;
 
  •  the impact of weather on water sales and operating results;
 
  •  the ability to satisfy requirements related to the Sarbanes-Oxley Act and other regulations on internal controls; and
 
  •  the risks set forth in “Risk Factors” included elsewhere in this quarterly report.
 
In light of these risks, uncertainties and assumptions, investors are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this annual report or as of the date of any document incorporated by reference in this annual report, as applicable. When considering forward-looking statements, investors should keep in mind the cautionary statements in this annual report and the documents incorporated by reference. We are not under any obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.
 
Overview
 
California Water Service Group is a holding company incorporated in Delaware with six operating subsidiaries: California Water Service Company (Cal Water), New Mexico Water Service Company (New Mexico Water), Washington Water Service Company (Washington Water), Hawaii Water Service Company, Inc. (Hawaii Water), and CWS Utility Services and HWS Utility Services LLC (CWS Utility Services and HWS Utility Services LLC being referred to collectively in this annual report as Utility Services). Cal Water, New Mexico Water, Washington Water, and Hawaii Water are regulated public utilities. The regulated utility entities also provide some non-regulated services. Utility Services provides non-regulated services to private companies and municipalities. Cal Water was the original operating company and began operations in 1926.
 
Our business is conducted through our operating subsidiaries. The bulk of the business consists of the production, purchase, storage, treatment, testing, distribution and sale of water for domestic, industrial, public and irrigation uses, and for fire protection. We also provide non-regulated water-related services under agreements with municipalities and other private companies. The non-regulated services include full water system operation, billing and meter reading services. Non-regulated operations also include the lease of communication antenna sites, lab services, and promotion of other non-regulated services. Earnings may be significantly affected by the sale of surplus real properties if and when they occur.
 
During the year ended December 31, 2010, there were no significant changes in the kind of products produced or services rendered or those provided by our operating subsidiaries, or in the markets or methods of distribution.
 
Our mailing address and contact information is:
 
California Water Service Group
1720 North First Street
San Jose, California 95112-4598
telephone number: 408-367-8200
www.calwatergroup.com
 
Annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports are available free of charge through our website. The reports are available on our website as soon as reasonably practicable after such reports are filed with the SEC.


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Regulated Business
 
California water operations are conducted by the Cal Water and CWS Utility Services entities, which provide service to approximately 470,200 customers in 83 California communities through 26 separate districts. Of these 26 districts, 24 districts are regulated water systems, which are subject to regulation by the California Public Utilities Commission (CPUC). The other 2 districts, the City of Hawthorne and the City of Commerce, are governed through their respective city councils and are outside of the CPUC’s jurisdiction. California water operations account for approximately 94% of our total customers and approximately 94% of our total consolidated operating revenue.
 
Hawaii Water provides service to approximately 4,200 water and wastewater customers on the islands of Maui and Hawaii, including several large resorts and condominium complexes. Hawaii’s regulated operations are subject to the jurisdiction of the Hawaii Public Utilities Commission. Hawaii Water accounts for less than 1% of our total customers and approximately 4% of our total operating revenue. HWS Utility Services LLC was organized in 2007 and began non-regulated operations in January 2008.
 
Washington Water provides domestic water service to approximately 15,700 customers in the Tacoma and Olympia areas. Washington Water’s utility operations are regulated by the Washington Utilities and Transportation Commission. Washington Water accounts for approximately 3% of our total customers and approximately 2% of our total consolidated operating revenue.
 
New Mexico Water provides service to approximately 7,800 water and wastewater customers in the Belen, Los Lunas and Elephant Butte areas in New Mexico. New Mexico’s regulated operations are subject to the jurisdiction of the New Mexico Public Regulation Commission. New Mexico Water accounts for approximately 2% of our total customers and approximately 1% of our total consolidated operating revenue.
 
The state regulatory bodies governing our regulated operations are referred to as the Commissions in this annual report. Rates and operations for regulated customers are subject to the jurisdiction of the respective state’s regulatory commission. The Commissions require that water and wastewater rates for each regulated district be independently determined. The Commissions are expected to authorize rates sufficient to recover normal operating expenses and allow the utility to earn a fair and reasonable return on invested capital.
 
We distribute water in accordance with accepted water utility methods. Where applicable, we hold franchises and permits in the cities and communities where we operate. The franchises and permits allow us to operate and maintain facilities in public streets and right- of-ways as necessary.
 
We operate the City of Hawthorne and the City of Commerce water systems under lease agreements. In accordance with the lease agreements, we receive all revenues from operating the systems and are responsible for paying the operating costs. Rates for the City of Hawthorne and City of Commerce water systems are established in accordance with operating agreements and are subject to ratification by the respective city councils. The terms of other operating agreements range from one-year to three-year periods with provisions for renewals.
 
In February 1996, we entered into an agreement to operate the City of Hawthorne water system. The system, which is located near the Hermosa-Redondo district, serves about half of Hawthorne’s population. The agreement required us to make an up-front $6.5 million lease payment to the city that is being amortized over the lease term. Additionally, annual lease payments of $0.2 million are made to the city and indexed to changes in water rates. Under the lease we are responsible for all aspects of system operation and capital improvements, although title to the system and system improvements reside with the city. In exchange, we receive all revenue from the water system, which was $7.5 million, $6.1 million and $5.2 million in 2010, 2009, and 2008, respectively. At the end of the lease, the city is required to reimburse us for the unamortized value of capital improvements made during the term of the lease. The 15-year lease expired in February 2011 and was extended on a month-to-month basis. The City of Hawthorne is in the process of determining how they will handle their water system and we plan to submit a proposal to the City during 2011 to provide these services for an additional fifteen year period
 
In July 2003, an agreement was negotiated with the City of Commerce to lease and operate its water system. The lease requires us to pay $0.8 million per year in monthly installments and pay $200 per acre-foot for water usage exceeding 2,000 acre-feet per year plus a percentage of certain operational savings that may be realized.


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Under the lease agreement, we are responsible for all aspects of the system’s operations. The city is responsible for capital expenditures, and title to the system and system improvements resides with the city. We bear the risks of operation and collection of amounts billed to customers. The agreement includes a procedure to request rate changes for costs changes outside of our control and other cost changes. In exchange, we receive all revenue from the system, which totaled $1.8 million in 2010, $1.7 million in 2009 and $2.0 million in 2008. The City of Commerce lease is a 15-year lease and expires in 2018.
 
The City of Hawthorne and the City of Commerce leases revenues are governed through their respective city councils and are considered non-regulated because they are outside of the CPUC’s jurisdiction. We report revenue and expenses for the City of Hawthorne and City of Commerce leases in operating revenue and operating expenses because we are entitled to retain all customer billings and are generally responsible for all operating expenses.
 
Non-Regulated Businesses
 
Fees for non-regulated activities are based on contracts negotiated between the parties. Under other contract arrangements, we operate municipally owned water systems, privately owned water systems, and recycled water distribution systems, but are not responsible for all operating costs. Non-regulated revenue received from water system operations is generally determined on a fee-per-customer basis.
 
Non-regulated activities consist primarily of:
 
  •  operating water and waste water systems, which are owned by other entities;
 
  •  providing meter reading and billing services;
 
  •  leasing communication antenna sites on our properties;
 
  •  operating recycled water systems;
 
  •  providing lab services for water quality testing;
 
  •  marketing and billing of optional third party insurance program to our residential customers;
 
  •  selling surplus property; and
 
  •  other services as requested by the client.
 
The revenue from these activities is not included in operating revenue, and therefore is reported below net operating income on the income statement. Due to the variety of services provided and activities being outside of our core business, the number of customers is not tracked for these non-regulated activities, except customers for the City of Hawthorne and the City of Commerce.
 
We provide operating and maintenance, meter reading and customer billing services for several municipalities in California. We also provide sewer and refuse billing services to several municipalities.
 
We lease antenna sites to telecommunication companies, which place equipment at various Company-owned sites. Lease revenues totaled $2.2 million, $2.0 million, and $2.0 million in 2010, 2009 and 2008, respectively. The antennas are used in cellular phone and personal communication applications. We continue to negotiate new leases for similar uses.
 
In 2006, we started an Extended Service Protection program (ESP) in California covering certain repairs to residential customer’s water line between the meter and the home. The non-regulated program was operated by CWS Utility Services. Typically the utility is responsible for servicing and maintaining the water line up to and including the meter. The home owner is responsible for the water line from the meter to the house. In late 2007, we contracted with Home Service USA to replace the ESP program with an insurance product. Home Service USA now provides water line protection insurance, sewer line protection insurance, and internal plumbing protection insurance to Cal Water’s customers. Cal Water includes charges for these optional non-tariffed services on its bills and CWS Utility Services facilitates marketing these products to its customers. Revenues for these services were $2.0 million, $1.7 million, and $1.5 million in 2010, 2009, and 2008, respectively.


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In the first quarter of 2008, the Company’s wholly-owned subsidiary HWS Utility Services, LLC, acquired contracts to operate and maintain water and wastewater systems in Hawaii. The purchase price of $1.3 million was amortized over calendar years 2008, 2009, and 2010.
 
Operating Segment
 
We operate in one reportable segment, the supply and distribution of water and providing water-related utility services.
 
Growth
 
We intend to continue exploring opportunities to expand our regulated and non-regulated water and wastewater businesses in the western United States. The opportunities could include system acquisitions, lease arrangements similar to the City of Hawthorne and City of Commerce contracts, full service system operation and maintenance agreements, meter reading, billing contracts and other utility-related services. Management believes that a holding company structure facilitates providing non-regulated utility services, which are not subject to any Commission’s jurisdiction.
 
Geographical Service Areas and Number of Customers at Year-end
 
Our principal markets are users of water within our service areas. Most of the geographical service areas are regulated; however, the City of Hawthorne and City of Commerce are included due to similarities in structure and risk of operations. The approximate number of customers served in each district is as follows:
 
Regulated Customers, City of Hawthorne and City of Commerce Customers at December 31, (rounded to the nearest hundred)
 
                 
    2010     2009  
 
SAN FRANCISCO BAY AREA
               
Mid-Peninsula (serving San Mateo and San Carlos)
    36,400       36,200  
South San Francisco (including Colma and Broadmoor)
    16,900       16,800  
Bear Gulch (serving portions of Menlo Park, Atherton, Woodside and Portola Valley)
    18,800       18,600  
Los Altos (including portions of Cupertino, Los Altos Hills, Mountain View and Sunnyvale)
    18,700       18,700  
Livermore
    18,300       18,200  
                 
      109,100       108,500  
                 
SACRAMENTO VALLEY
               
Chico (including Hamilton City)
    27,900       27,700  
Oroville
    3,600       3,600  
Marysville
    3,700       3,700  
Dixon
    2,900       2,800  
Willows
    2,400       2,400  
Redwood Valley (Lucerne, Duncans Mills, Guerneville, Dillon Beach, Noel Heights & portions of Santa Rosa)
    2,000       2,000  
                 
      42,500       42,200  
                 
SALINAS VALLEY
               
Salinas
    28,000       27,900  
King City
    2,500       2,500  
                 
      30,500       30,400  
                 


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    2010     2009  
 
SAN JOAQUIN VALLEY
               
Bakersfield
    67,600       66,900  
Stockton
    42,800       42,400  
Visalia
    40,300       39,800  
Selma
    6,100       6,000  
Kern River Valley
    4,300       4,300  
Antelope Valley (Fremont Valley, Lake Hughes, Lancaster & Leona Valley)
    1,400       1,400  
                 
      162,500       160,800  
                 
LOS ANGELES AREA
               
East Los Angeles (including portions of the City of Commerce service area)
    26,700       26,600  
Hermosa-Redondo (serving Hermosa Beach, Redondo Beach and a portion of Torrance)
    26,600       26,500  
Dominguez (Carson and portions of Compton, Harbor City, Long Beach, Los Angeles and Torrance)
    33,800       33,700  
Palos Verdes (including Palos Verdes Estates, Rancho Palos Verdes, Rolling Hills Estates and Rolling Hills)
    24,100       24,000  
Westlake (a portion of Thousand Oaks)
    7,000       7,000  
Hawthorne and Commerce (leased municipal systems)
    7,400       7,400  
                 
      125,600       125,200  
                 
CALIFORNIA TOTAL
    470,200       467,100  
HAWAII
    4,200       4,200  
NEW MEXICO
    7,800       7,800  
WASHINGTON
    15,700       15,600  
                 
COMPANY TOTAL
    497,900       494,700  
                 
 
Rates and Regulation
 
The state regulatory commissions have plenary powers setting rates and operating standards. As such, state commission decisions significantly impact the Company’s revenues, earnings, and cash flows. The amounts discussed herein are generally annual amounts, unless specifically stated, and the financial impact to recorded revenue is expected to occur over a 12-month period from the effective date of the decision. In California, water utilities are required to make several different types of filings. Most filings result in rate changes that remain in place until the next General Rate Case (GRC). As explained below, surcharges and surcredits to recover balancing and memorandum accounts as well as general rate case interim rate catch-up surcharges are temporary rate changes, which have specific time frames for recovery.
 
GRCs, escalation rate increase filings, and offset filings change rates to amounts that will remain in effect until the next GRC. The CPUC follows a rate case plan, which requires Cal Water to file a GRC for each of its 24 regulated operating districts every three years. In a GRC proceeding, the CPUC not only considers the utility’s rate setting requests, but may also consider other issues that affect the utility’s rates and operations. Effective with the 2009 GRC, the GRC schedule is based upon a calendar year. The CPUC is generally required to issue its GRC decision prior to the first day of the test year or authorize interim rates. As such, Cal Water’s GRC decisions from 2005 through 2009 were generally issued in the third quarter. In accordance with the rate case plan, the Commission issued a decision on Cal Water’s 2009 general rate case filing in the fourth quarter of 2010 with rates effective on January 1, 2011.

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Between GRC filings utilities may file escalation rate increases, which allow the utility to recover cost increases, primarily from inflation and incremental investment, during the second and third years of the rate case cycle. However, escalation rate increases are subject to a weather-normalized earnings test on a district-by-district basis. Under the earnings test, the CPUC may reduce the escalation rate increase if, in the most recent 12-month period, this earnings test reflects earnings in excess of authorized for that district.
 
In addition, utilities are entitled to file offset filings. Offset filings may be filed to adjust revenues for construction projects authorized in GRCs when the plant is placed in service or for rate changes charged to the Company for purchased water, purchased power, and pump taxes (referred to as “offsettable expenses”). Such rate changes approved in offset filings remain in effect until a GRC is approved.
 
Surcharges and surcredits to amortize balances in the Water Rate Adjustment Mechanism (WRAM) and Modified Cost Balancing Account (MCBA) accounts, which are interest bearing, are filed in April of each year based on the district balances for the last calendar year. Under current procedures, surcharges are expected to be amortized over 12 months for balances less than 5% of district gross revenue, 24 months for balances greater than 5% and less than 10% of district gross revenue, and 36 months for balances greater than 10% of district gross revenue. In the event the combined WRAM and MCBA balance for a district is less than 2.5% of district gross revenue, the amount will not be amortized at that time. The WRAM and MCBA amounts are cumulative, so if they are not amortized in a given calendar year, the balance will be rolled forward and reviewed with the following year balance. Cal Water has applied along with other utilities to recover surcharges over a shorter period. It is anticipated a favorable decision will be made in 2011 to recover WRAM and MCBA accounts within 24 months or less.
 
Remaining Unrecorded Balances from Previously Authorized Balancing Accounts Recoveries/Refunds
 
The total net under-collected incremental cost balancing accounts (ICBA) memorandum and balancing accounts was approximately $1.4 million as of December 31, 2010. Effective July 1, 2008, the ICBA memorandum and balancing accounts were replaced with the MCBA. In CPUC decision 10-12-017, Cal Water was authorized to file to recover its remaining balances in these accounts. This filing will occur in the first quarter of 2011 and is anticipated to collect a substantial portion of the remaining balance over a 12-month period.
 
Application to Resolve Commission’s Procedures for WRAM amortization
 
In 2010, Cal Water became aware of an inconsistency between the Commission’s authorized recovery periods for balancing accounts and the previously authorized 12-month and 18-month amortization periods. In order to maintain revenue neutrality as customers respond to aggressive conservation rates and programs, a “full WRAM” (offset by an MCBA) was crafted for most of Cal Water’s ratemaking units to ensure that Cal Water would continue to recover the revenue amounts authorized for that unit by the CPUC. In 2010, the CPUC applied periods of up to 24 and 36 months to amortize some WRAM/MCBA balances. Cal Water, along with four other investor-owned water utilities filed a joint application in September 2010 to modify the enabling language of the WRAM/MCBA accounts to change the amortization periods to 24 months or less. It is anticipated a favorable decision will be made in 2011 to recover WRAM and MCBA accounts within 24 months or less.
 
2010 Regulatory Activity
 
2007 California GRC Escalation Rate Increase
 
On July 3, 2007, Cal Water filed its 2007 GRC application covering eight districts and general office costs. On July 10, 2008, the CPUC approved a settlement between Cal Water and the Division of Ratepayer Advocates, and authorized annual rate increases for eight districts of $33.4 million. In its order, the CPUC allowed Cal Water to file immediately to recover its increased general costs in all other districts. The CPUC order also allows for additional rate increases, including escalation increases, which Cal Water requested in 2010, and offset increases after construction of certain large capital projects. In July 2010, Cal Water filed escalation rate increases in seven districts to increase rates by $4.2 million. These filings were approved effective in July 2010 as requested.


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2008 California Cost of Capital Application
 
Cal Water received a decision in July 2009 in its 2008 Cost of Capital review which established a weighted cost of capital adjustment mechanism (WCCM). Under this mechanism, Cal Water is required to annually compare the October to September annual average Moody AA utility bond index with a 2008-2009 benchmark. If the average increased or decreased by 100 basis points from the benchmark, Cal Water would be required to file a rate change to reflect an increased or decreased return on equity. In 2009 and 2010 this mechanism was not triggered as the index did not change by 100 basis points.
 
Cal Water will file an application with the CPUC in May of 2011 to review its cost of capital for 2012 through 2014. We cannot predict if this or another adjustment mechanism will be adopted by the CPUC in that proceeding.
 
2009 California GRC Decision
 
On July 2, 2009, Cal Water filed its 2009 GRC application covering all 24 districts and general office costs. The GRC application requested an increase of $70.6 million or 16.75% in rates for 2011, $24.8 million or 5.04% in rates for 2012 and $24.8 million or 4.79% in rates for 2013. On December 2, 2010, the CPUC issued decision 10-12-017, which approved a settlement between Cal Water, the Division of Ratepayer Advocates, and several intervenors representing the interests of individual district customers. This decision allows for revenue increases of $25.4 million or 5.6% in 2011. Cal Water is also allowed to file for increases of $9.6 million or 2.0% for 2012, and $9.0 million or 2.0% for 2013 subject to adjustment for indexed inflation and contingent upon passing a weather normalized earnings test. This decision also allows for offset increases after construction of 77 large capital projects in various operating districts.
 
In addition, the Company was authorized to make a deviation from its escalation expense and exclude employee health care, retiree health insurance, and conservation expenses from it escalation filings in 2012 and 2013. Instead for these three significant expense items, the CPUC has enumerated fixed three-year budgets for these expenses. It is anticipated that the budgets for these areas will more closely align with the actual expenses now that this change has been initiated.
 
The CPUC also authorized a Pension Balancing Account to track the difference between authorized pension contributions included in rates and the costs actually incurred. It is anticipated that this account will allow Cal Water to reduce some of the volatility it experiences in regard to these costs.
 
The Company was also authorized to combine the rates and tariffs of the South San Francisco and the Mid Peninsula Districts, located on the San Francisco peninsula, into a single ratemaking area in 2011. This new ratemaking area is known as the Bayshore District. Previously, the two separate districts had been operated out of a combined location.
 
Due to the transition between a phased rate case and a total company filing, the CPUC delayed the rate cases of 16 Cal Water districts. However, to compensate for this delay, the CPUC authorized interim rates from the authorized effective date under the old rate case plan. The difference between revenue requirements that were effective in the interim period and those calculated based on a final determination in the 2009 general rate case filing are being recovered as customer surcharges over a three-year period. Cal Water anticipates these surcharges will recover $3.3 million in 2011, $2.2 million in 2012, and $1.2 million in 2013.
 
Low Income Ratepayer Assistance Program
 
Cal Water currently administers a Low Income Ratepayer Assistance Program (LIRA) in accordance with decision 06-11-053. This program provides qualifying low income customers with a 50% discount on their service charge (up to a maximum of $10 per month). It imposes a surcharge on non-qualifying customers of $0.01 per hundred cubic feet of monthly water consumption for metered customers and between $0.24 and $0.41 per flat rate service per month. Due to a successful enrollment of over 41,000 customers, this account had accumulated an under collection of approximately $3.7 million as of December 31, 2010, and is recorded in non-current regulatory assets. In July 2010, Cal Water filed an advice letter to adjust the surcharge in order to ameliorate this undercollection situation. The CPUC rejected this filing and determined that this surcharge could only be adjusted during a GRC. Cal Water must either wait until the next GRC in 2012 to file this change in surcharge or file an application to


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modify the enabling language of the LIRA program. At this point, Cal Water believes this amount will be fully recoverable as the program is in line with CPUC policy and objectives. Cal Water will file an application to modify the enabling language to ameliorate the under-collection situation.
 
2010 Ka’anapali (Hawaii) GRC Filing
 
On December 30, 2010, Hawaii Water filed its 2010 GRC application for the Ka’anapali Service Area. The Hawaii Public Utilities Commission (HPUC) requires a separate rate application for all service areas and uses a historic based test year. The Ka’anapali GRC requested additional revenue of $1.5 million or an increase of 38.2% over the prior year. The HPUC has accepted this filing as complete and Hawaii Water anticipates a resolution in the second quarter of 2011.
 
Request for MTBE regulatory treatment
 
On July 8, 2009, Cal Water filed an application requesting that the CPUC adopt ratemaking treatment of proceeds from its partial settlement of MTBE contamination litigation. Cal Water requested that all of the proceeds be reinvested in infrastructure to treat or replace MTBE-contaminated facilities. In addition, Cal Water requested that 50% of the reinvestment be included in rate base upon which Cal Water could earn its authorized fair and reasonable rate of return. The remaining 50% of the settlement proceeds would be included in rate base as contributions in aid of construction which does not earn a return. Cal Water also requested specific regulatory treatment of future settlement or litigation proceeds that may occur in the consolidated MTBE cases. As an interim step, Cal Water and the CPUC’s Division of Ratepayer Advocates agreed to track all proceeds and remediation costs in a memorandum account for future disposition. This treatment removes from rate base certain future capital projects that will be constructed to replace or treat for MTBE.
 
On October 14, 2010, in a separate industry-wide proceeding, the CPUC issued an interim decision in its review of general policies for accounting treatment of contamination proceeds. The interim decision would require all proceeds to be used first to pay transactional expenses, then to make ratepayers whole for costs to ensure the water system complies with the Commission’s water quality standards. The interim decision allows for a risk-based consideration of proceeds which exceed the costs of the remediation described above and may result in some sharing of excess, or “net” proceeds. The interim decision also allows the utility to track litigation and settlement proceeds, along with transactional costs and remediation costs, in a memorandum account. It directs the utility to include a request for disposition of its memorandum account in a general rate case.
 
Because treatment or replacement of Cal Water’s MTBE contaminated wells will occur over a number of years, and because litigation continues with remaining defendants, a final disposition of Cal Water’s memorandum account will occur at an unknown future date. Cal Water has filed a joint motion with the CPUC’s Division of Ratepayer Advocates to dismiss the July 2009 application and address the contamination proceeds after the conclusion of litigation and remediation. Cal Water cannot predict the timing or outcome of a ruling on that motion or on the outcome of the proceeding.
 
2010 Expense Offset filings
 
In 2010, Cal Water filed advice letters to offset increased purchased water and pump tax rates in nine of its regulated districts totaling $24.2 million in annual revenue. Expense offsets are dollar-for-dollar increases in revenue to match increased expenses and interact with the WRAM and MCBA mechanisms so that net operating income is not affected by an offset increase.
 
In the future, Cal Water plans to file advice letters to offset expected increases in purchased water and pump tax charges in some districts. Cal Water cannot predict the exact timing or dollar amount of the changes.
 
2010 Ratebase Offset filings
 
In 2010, Cal Water filed advice letters to offset infrastructure improvements in seven of its regulated districts totaling $0.8 million in annual revenue. Companies are allowed to file ratebase offsets to increase revenues for


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construction projects authorized in GRCs when the plant is placed in service. The projects for these filings were authorized in the 2006 and 2007 GRCs.
 
Water Supply
 
Our source of supply varies among our operating districts. Certain districts obtain all of their supply from wells; some districts purchase all of their supply from wholesale suppliers; and other districts obtain supply from a combination of wells and wholesale suppliers. A small portion of supply comes from surface sources and is processed through Company-owned water treatment plants. During 2010, an estimated 122 billion gallons of water was produced to meet customer demand, down 7.3% from the estimated 132 billion gallons produced in 2009. The 2010 average daily water production was approximately 334 million gallons. Historically, approximately half of the Company’s water supply is purchased from wholesale suppliers with the balance pumped from wells. In 2010, approximately 48 percent of the Company’s supply was obtained from wells, 47 percent was purchased from wholesale suppliers and 5 percent was obtained from surface supplies. By comparison, in 2009, the average daily water production was approximately 360 million gallons. Well water is generally less expensive and the Company strives to maximize the use of its well sources in districts where there is an option between well or purchased supply sources.
 
In California, we obtain our water supply from wells, surface runoff or diversion, and by purchase from public agencies and other wholesale suppliers. Our water supply has been adequate to meet customer demand; however, during periods of drought, some districts have experienced mandatory water rationing. California’s rainy season usually begins in November and continues through March with the most rain typically falling in December, January and February. During winter months, reservoirs and underground aquifers are replenished by rainfall. Snow accumulated in the mountains provides an additional water source when spring and summer temperatures melt the snowpack, producing runoff into streams and reservoirs, and also replenishing underground aquifers. There are six California water treatment plants located in the Bakersfield, Bear Gulch, Kernville, Oroville and Redwood Valley districts. Water for operation of the Bakersfield plants, with a combined capacity of 28 million gallons per day, is drawn from the Kern River under a long-term contract with the City of Bakersfield. The other four plants have a combined capacity of 15.5 million gallons per day.
 
Washington and Hawaii receive rain in all seasons with the majority falling during winter months. Washington Water and Hawaii Water draw all their water supply by pumping from wells. New Mexico Water’s rainfall normally occurs in all seasons, but is heaviest in the summer monsoon season. New Mexico Water pumps all of its water supply from wells based on its water rights.


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The following table shows the estimated quantity of water purchased and the percentage of purchased water to total water production in each California operating district that purchased water in 2010. Other than noted below, all other districts receive 100% of their water supply from wells.
 
                     
    Water
           
    Purchased
    Percentage
     
District
  (MG)     Purchased    
Source of Purchased Supply
 
SAN FRANCISCO BAY AREA
                   
Mid-Peninsula
    5,199       100 %   San Francisco Water Public Utilities Commission
South San Francisco
    2,611       95 %   San Francisco Water Public Utilities Commission
Bear Gulch
    3,853       90 %   San Francisco Water Public Utilities Commission
Los Altos
    2,689       71 %   Santa Clara Valley Water District
Livermore
    2,334       70 %   Alameda County Flood Control and Water Conservation District
SACRAMENTO VALLEY
                   
Oroville
    747       76 %   Pacific Gas and Electric Co. and County of Butte
Redwood Valley
    104       100 %   County of Lake
SAN JOAQUIN VALLEY
                   
Antelope/Kern
    65       20 %   Antelope Valley-East Kern Water Agency and City of Bakersfield
Bakersfield
    4,596       18 %   Kern County Water Agency and City of Bakersfield
Stockton
    7,248       82 %   Stockton East Water District
LOS ANGELES AREA
                   
East Los Angeles
    3,488       65 %   Central Basin Municipal Water District
Dominguez
    9,416       76 %   West Basin Municipal Water District and City of Torrance
City of Commerce
    5       1 %   Central Basin Municipal Water District
Hawthorne
    1,378       100 %   West Basin Municipal Water District
Hermosa-Redondo
    3,615       89 %   West Basin Municipal Water District
Palos Verdes
    6,219       100 %   West Basin Municipal Water District
Westlake
    2,530       100 %   Calleguas Municipal Water District
 
 
MG = million gallons
 
The Bear Gulch district obtains a portion of its water supply from surface runoff from the local watershed. The Oroville and Redwood Valley districts in the Sacramento Valley and the Bakersfield and Kern River Valley districts in the San Joaquin Valley purchase water from a surface supply. Surface sources are processed through our water treatment plants before being delivered to the distribution system. The Bakersfield district also purchases treated water as a component of its water supply.
 
The Chico, Marysville, Dixon, and Willows districts in the Sacramento Valley, the Salinas and King City districts in the Salinas Valley, and the Selma and Visalia districts in the San Joaquin Valley obtain their entire supply from wells. In the Salinas district, which solely depends upon ground water, several wells were taken out of service in the last four years, primarily due to poor water quality. Treatment systems have been installed on some of these wells to meet customer demand. Management believes water supply issues in the Salinas district will be adequately resolved in the future by seeking additional sources or additional treatment.


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Purchases for the Los Altos, Livermore, Oroville, Redwood Valley, Stockton, and Bakersfield districts are pursuant to long-term contracts expiring on various dates after 2011. The water supplies purchased for the Dominguez, East Los Angeles, Hermosa-Redondo, Palos Verdes, and Westlake districts as well as the Hawthorne and Commerce systems are provided by public agencies pursuant to a statutory obligation of continued non- preferential service to purveyors within the agencies’ boundaries. Purchases for the South San Francisco, Mid-Peninsula, and Bear Gulch districts are in accordance with long-term contracts with the San Francisco Public Utilities Commission (SFPUC) until June 30, 2034.
 
Management anticipates water supply contracts will be renewed as they expire though the price of wholesale water purchases is subject to pricing changes imposed by the various wholesalers.
 
Shown below are wholesaler price rates and increases that became effective in 2010 and estimated wholesaler price rates and percent changes for 2011. In 2010, several districts experienced significant purchased water cost increases resulting in a significant impact in the 2010 MCBA balance and the filing of several purchased water offsets.
 
                                                 
    Effective
  2010   Percent
  Effective
  2011   Percent
District
  Month   Unit Cost   Change   Month   Unit Cost   Change
 
Antelope
    January     $ 296.00/af       2.07 %     January     $ 304.00/af       2.70 %
Bakersfield*
    July     $ 154.00/af       0.00 %     July     $ 154.00/af       0.00 %
Bear Gulch
    July     $ 1.90/ccf       15.15 %     July     $ 2.68/ccf       41.05 %
Commerce
    July     $ 805.00/af       23.28 %     January     $ 855.00/af       6.21 %
Dominguez
    July     $ 861.00/af       24.96 %     January     $ 935.00/af       8.59 %
East Los Angeles
    July     $ 805.00/af       23.28 %     January     $ 855.00/af       6.21 %
Hawthorne
    January     $ 861.00/af       24.96 %     January     $ 935.00/af       8.59 %
Hermosa-Redondo
    January     $ 861.00/af       24.96 %     January     $ 935.00/af       8.59 %
Livermore
    January     $ 2.02/ccf       9.19 %     January     $ 2.07/ccf       2.48 %
Los Altos
    July     $ 620.00/af       0.00 %     July     $ 620.00/af       0.00 %
Oroville
    January     $ 152,400.00/yr       0.00 %     January     $ 152,400.00/yr       0.00 %
Palos Verdes
    January     $ 861.00/af       24.96 %     January     $ 935.00/af       8.59 %
Mid-Peninsula
    July     $ 1.90/ccf       15.15 %     July     $ 2.68/ccf       41.05 %
Redwood Valley
    May     $ 55.00/af       10.00 %     May     $ 52.00/af       0.00 %
So. San Francisco
    July     $ 1.90/ccf       15.15 %     July     $ 2.68/ccf       41.05 %
Stockton
    April     $ 533,904.20/mo       20.87 %     April     $ 561,667/mo       5.20 %
Westlake
    January     $ 938.00/af       21.98 %     January     $ 981.00/af       4.58 %
 
 
af = acre foot;
 
ccf = hundred cubic feet;
 
yr = fixed annual cost;
 
mo = fixed monthly cost
 
* untreated water
 
We work with all local suppliers and agencies responsible for water supply to insure adequate, long-term supply for each system.
 
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Water Supply” concerning more information on adequacy of supplies.


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Seasonal Fluctuations
 
Our WRAM/MCBA offset seasonal fluctuations to our operating revenues and net operating income in our California operations, which are 94 percent of total Company operating revenues. However, cash flows from operations and short-term borrowings on our credit facilities are significantly impacted by seasonal fluctuations.
 
Our water business is seasonal in nature and weather conditions can have a material effect on customer usage. Customer demand for water generally is lower during the cooler and rainy, winter months. Demand increases in the spring when warmer weather returns and the rains end, and customer use more water for outdoor purposes, such as landscape irrigation. Warm temperatures during the generally dry summer months result in increased demand. Water usage declines during the fall as temperatures decrease and the rainy season begins. During years in which precipitation is especially heavy or extends beyond the spring into the early summer, customer demand can decrease from historic normal levels, generally due to reduced outdoor water usage. Likewise, an early start to the rainy season during the fall can cause a decline in customer usage. Seasonality of water usage has a significant impact on our cash flows from operations and borrowings on our short-term facilities.
 
Utility Plant Construction
 
We have continually extended, enlarged, and replaced our facilities as required to meet increasing demands and to maintain the water systems. We obtain construction financing using funds from operations, short-term bank borrowings, long-term financing, advances for construction and contributions in aid of construction that are funded by developers. Advances for construction are cash deposits from developers for construction of water facilities or water facilities deeded from developers. These advances are generally refundable without interest over a period of 40 years by equal annual payments. Contributions in aid of construction consist of nonrefundable cash deposits or facilities transferred from developers, primarily for fire protection and relocation projects. We cannot control the amount received from developers. This amount fluctuates from year-to-year as the level of construction activity carried on by developers varies. This activity is impacted by the demand for housing, commercial development, and general business conditions, including interest rates.
 
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” for additional information.
 
Sale of Surplus Real Properties
 
When properties are no longer used and useful for public utility purposes, we are no longer allowed to earn a return on our investment in the property in the regulated business. The surplus property is transferred out of the regulated operations. From time to time, some properties have been sold or offered for sale. As these sales are subject to local real estate market conditions and can take several months or years to close, income from the sale of surplus properties may or may not be consistent from year-to-year.
 
California Energy Situation
 
We continue to use power efficiently to minimize the power expenses passed on to our customers, and maintain backup power systems to continue water service to our customers if the power companies’ supplies are interrupted. Many of our well sites are equipped with emergency electric generators designed to produce electricity to keep the wells operating during power outages. Storage tanks also provide customers with water during blackout periods.
 
Impact of Climate Change Legislation
 
Our operations depend on power provided by other public utilities and, in emergencies, power generated by our portable and fixed generators. If future legislation limits emissions from the power generation process, our cost of power may increase. Any increase in the cost of power will be passed along to our California rate payers through the MCBA or included in our cost of service paid by our rate payers as requested in our general rate case filings
 
Approved in April 2009, the Low Carbon Fuel Standard Program, which went into effect January 1, 2011, requires diesel engines to use low carbon fuel such as biodiesel or other alternatives. This may increase the operating cost of our generators and vehicles.


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We maintain a fleet of vehicles to provide service to our customers, including a number of heavy duty diesel vehicles that we retrofitted by the end of 2010 to meet California emission standards. If future legislation further impacts the cost to operate the fleet or the fleet acquisition cost in order to meet certain emission standards, it will increase our cost of service and our rate base. Any increase in fleet operating costs associated with meeting emission standards will be included in our cost of service paid by our rate payers as requested in our general rate case filings. While recovery of these costs are not guaranteed, we would expect recovery in the regulatory process.
 
Starting January 1, 2010, under the California Environmental Quality Act (CEQA), all capital projects of a certain type (primarily wells, tanks, major pipelines and treatment facilities) will require mitigation of green house gas emissions. The cost to prepare the CEQA documentation and permit will add an estimated ten thousand dollars to such capital projects. This cost will be included in our capital cost and added to our rate base, which will be requested to be paid for by our rate payers. Any increase in the operating cost of the facilities will also be included in our cost of service paid by our rate payers as requested in our general rate case filings. While recovery of these costs are not guaranteed, we would expect recovery in the regulatory process.
 
Proposed cap and trade regulations are scheduled to be implemented in 2012 with the goal of reducing emissions to 1990 levels by the year 2020. Under such regulations, if approved, we will be required to determine our carbon footprint and evaluate our electricity and fuel usage (both diesel and gasoline). We will also be required to evaluate methane emissions from our primary processes in our wastewater plants. At this time we are unable to determine the cost impact of such regulations but any increase in operating costs associated with the cap and trade regulations will be included in our cost of service requested to be paid by our rate payers as requested in our general rate case filings. While recovery of these costs are not guaranteed, we would expect recovery in the regulatory process.
 
Security at Company Facilities
 
Due to terrorist and other risks, we have heightened security at our facilities and have taken added precautions to protect our employees and the water delivered to customers. In 2002, federal legislation was enacted that resulted in new regulations concerning security of water facilities, including submitting vulnerability assessment studies to the federal government. We have complied with regulations issued by the Environmental Protection Agency (EPA) pursuant to our federal legislation concerning vulnerability assessments and have made filings to the EPA as required. In addition, communication plans have been developed as a component of our procedures. While we do not make public comments on our security programs, we have been in contact with federal, state, and local law enforcement agencies to coordinate and improve our water delivery systems’ security.
 
Quality of Water Supplies
 
Our operating practices are designed to produce potable water in accordance with accepted water utility practices. Water entering the distribution systems from surface sources is treated in compliance with federal and state Safe Drinking Water Acts (SDWA) standards. Most well supplies are chlorinated or chloraminated for disinfection. Water samples from each water system are analyzed on a regular, scheduled basis in compliance with regulatory requirements. We operate a state-certified water quality laboratory at the San Jose General Office that provides testing for most of our California operations. Certain tests in California are contracted with independent certified labs qualified under the Environmental Laboratory Accreditation Program. Local independent state certified labs provide water sample testing for the Washington, New Mexico and Hawaii operations.
 
In recent years, federal and state water quality regulations have continued to increase water testing requirements. The SDWA continues to be amended to reflect new public health concerns. We monitor water quality standard changes and upgrade our treatment capabilities to maintain compliance with the various regulations.
 
Competition and Condemnation
 
Our principal operations are regulated by the Commission of each state. Under state laws, no privately owned public utility may compete within any service territory that we already serve without first obtaining a certificate of public convenience and necessity from the applicable Commission. Issuance of such a certificate would only be


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made upon finding that our service is deficient. To management’s knowledge, no application to provide service to an area served by us has been made.
 
State law provides that whenever a public agency constructs facilities to extend a utility system into the service area of a privately owned public utility, such an act constitutes the taking of property and requires reimbursement to the utility for its loss. State statutes allow municipalities, water districts and other public agencies to own and operate water systems. These agencies are empowered to condemn properties already operated by privately owned public utilities. The agencies are also authorized to issue bonds, including revenue bonds, for the purpose of acquiring or constructing water systems. However, if a public agency were to acquire utility property by eminent domain action, the utility would be entitled to just compensation for its loss. In Washington, annexation was approved in February 2008 for property served by us on Orcas Island; however, we continue to serve the customers in the annexed area and do not expect the annexation to impact our operations. To management’s knowledge, other than the Orcas Island property, no municipality, water district, or other public agency is contemplating or has any action pending to acquire or condemn any of our systems.
 
In recent years, consolidation within the water industry has accelerated. A number of publicly traded water companies have been acquired or merged into larger domestic companies. Several acquisitions of publicly traded companies have also been completed by much larger foreign companies. We intend to continue the pursuit of opportunities to expand our business in the western United States, which may include expansion through acquisitions or mergers with other companies.
 
Environmental Matters
 
Our operations are subject to environmental regulation by various governmental authorities. Environmental affairs programs have been designed to provide compliance with water discharge regulations, underground and aboveground fuel storage tank regulations, hazardous materials management plans, hazardous waste regulations, air quality permitting requirements, wastewater discharge limitations and employee safety issues related to hazardous materials. Also, we actively investigate alternative technologies for meeting environmental regulations and continue the traditional practices of meeting environment regulations.
 
For a description of the material effects that compliance with environmental regulations may have on us, see Item 1A. “Risk Factors — Risks Related to Our Regulatory Environment.” We expect environmental regulation to increase, resulting in higher operating costs in the future, which may have a material adverse effect on earnings.
 
Employees
 
At year-end 2010, we had 1,127 employees, including 56 at Washington Water, 51 at Hawaii Water, and 16 at New Mexico Water. In California, most non-supervisory employees are represented by the Utility Workers Union of America, AFL-CIO, except certain engineering and laboratory employees who are represented by the International Federation of Professional and Technical Engineers, AFL-CIO.
 
At December 31, 2010, there were 702 union employees. In November 2009, we negotiated 2010 wage increases with both of our unions of 1.0% and other employee benefit increases, and wage increases of 3% in 2011. The current agreement with the unions is effective through 2011. Management believes that it maintains good relationships with the unions.
 
Employees at Washington Water, New Mexico Water, and Hawaii Water are not represented by unions.


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Executive Officers of the Registrant
 
             
Name
 
Positions and Offices with California Water Service Group
 
Age
 
Peter C. Nelson(1)
  President and Chief Executive Officer since February 1, 1996. Formerly Vice President, Division Operations (1994-1995) and Region Vice President (1989-1994), Pacific Gas & Electric Company, a gas and electric public utility     63  
Martin A. Kropelnicki(2)
  Chief Financial Officer and Treasurer since March 13, 2006. Previously Chief Financial Officer of Power Light Corporation (2005-2006), Chief Financial Officer and Executive Vice President of Corporate Services of Hall Kinion and Associates (1997-2004), Deloitte & Touche Consulting (1996-1997), various positions with Pacific Gas & Electric (1989-1996)     44  
Lynne P. McGhee(2)
  Corporate Secretary since July 25, 2007; Associate Corporate Counsel since May 2003; previously served as a Commissioner legal advisor and staff counsel at the California Public Utilities Commission     46  
Calvin L. Breed(3)
  Controller, Assistant Secretary and Assistant Treasurer since November 1, 1994; previously Treasurer of TCI International, Inc. (1984-1994); a certified public accountant with Arthur Andersen & Co. (1980-1983)     55  
 
 
(1) Holds the same position with California Water Service Company, CWS Utility Services, and Hawaii Water Service Co.; Chief Executive Officer of New Mexico Water Service Company and Washington Water Service Company;
 
(2) Holds the same position with California Water Service Company New Mexico Water Service Company, Washington Water Service Company, Hawaii Water Service Company, Inc., and CWS Utility Services;
 
(3) Holds the same position with California Water Service Company, Washington Water Service Company, and Hawaii Water Service Company; Assistant Secretary and Assistant Treasurer of New Mexico Water Service Company
 
Item 1A.   Risk Factors.
 
The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected.
 
Risks Related to Our Regulatory Environment
 
Our business is heavily regulated by state and federal regulatory agencies and our financial viability depends upon our ability to recover costs from our customers through rates that must be approved by state public utility commissions.
 
California Water Service Company, New Mexico Water Service Company, Washington Water Service Company and Hawaii Water Service Company, Inc., are regulated public utilities which provide water service to our customers. The rates that we charge our water customers are subject to the jurisdiction of the regulatory commissions in the states in which we operate. These commissions set water rates for each operating district independently because the systems are not interconnected. The commissions authorize us to charge rates which they consider to be sufficient to recover normal operating expenses, to provide funds for adding new or replacing water infrastructure, and to allow us to earn what the commissions consider to be a fair and reasonable return on invested capital.
 
Our revenues and consequently our ability to meet our financial objectives are dependent upon the rates we are authorized to charge our customers by the commissions and our ability to recover our costs in these rates. Our management uses forecasts, models and estimates in order to set rates that will provide a fair and reasonable return on our invested capital. While our rates must be approved by the commissions, no assurance can be given that our forecasts, models and estimates will be correct or that the commissions will agree with our forecasts, models and


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estimates. If our rates are set too low, our revenues may be insufficient to cover our operating expenses, capital expenditure requirements and desired dividend levels.
 
We periodically file rate increase applications with the commissions. The ensuing administrative and hearing process may be lengthy and costly. The decisions of the commissions are beyond our control and we can provide no assurances that our rate increase requests will be granted by the commissions. Even if approved, there is no guarantee that approval will be given in a timely manner or at a sufficient level to cover our expenses and provide a reasonable return on our investment. If the rate increase decisions are delayed, our earnings may be adversely affected.
 
Our evaluation of the probability of recovery of regulatory assets is subject to adjustment by regulatory agencies and any such adjustment could adversely affect our results of operations.
 
Regulatory decisions may also impact prospective revenues and earnings, affect the timing of the recognition of revenues and expenses and may overturn past decisions used in determining our revenues and expenses. Our management continually evaluates the anticipated recovery of regulatory assets, liabilities, and revenues subject to refund and provides for allowances and/or reserves as deemed necessary. Current accounting procedures allow us to defer certain costs if we believe it is probable that we will be allowed to recover those costs by future rate increases. If a commission determined that a portion of our assets were not recoverable in customer rates, we may suffer an asset impairment which would require a write down in such asset’s valuation which would be recorded through operations.
 
If our assessment as to the probability of recovery through the ratemaking process is incorrect, the associated regulatory asset or liability would be adjusted to reflect the change in our assessment or any regulatory disallowances. A change in our evaluation of the probability of recovery of regulatory assets or a regulatory disallowance of all or a portion of our cost could have a material adverse effect on our financial results.
 
Regulatory agencies may disagree with our valuation and characterization of certain of our assets.
 
If we determine that assets are no longer used or useful for utility operations, we may remove them from our rate base and subsequently sell those assets. If the commission disagrees with our characterization, we could be subjected to penalties. Furthermore, there is a risk that the commission could determine that appreciation in property value should be awarded to the ratepayers rather than our stockholders.
 
Changes in laws, rules and policies of regulatory agencies can significantly affect our business.
 
Regulatory agencies may change their rules and policies for various reasons, including changes in the local political environment. In some states, regulators are elected by popular vote or are appointed by elected officials, and the results of elections may change the long-established rules and policies of an agency dramatically. For example, in 2001 regulation regarding recovery of increases in electrical rates changed in California. For over 20 years prior to 2001, the California Public Utilities Commission allowed recovery of electric rate increases under its operating rules. However, in 2003, the commission reinstated its policy to allow utilities to adjust their rates for rate changes by the power companies. The original decision by the commission to change its policy, as well as its subsequent decision to reinstate that policy, affected our business.
 
We rely on policies and regulations promulgated by the various state commissions in order to recover capital expenditures, maintain favorable treatment on gains from the sale of real property, offset certain production and operating costs, recover the cost of debt, maintain an optimal equity structure without over-leveraging, and have financial and operational flexibility to engage in non-regulated operations. If any of the commissions with jurisdiction over us implements policies and regulations that do not allow us to accomplish some or all of the items listed above, our future operating results may be adversely affected.
 
In addition, legislatures may repeal, relax or tighten existing laws, or enact new laws that impact the regulatory agencies with jurisdiction over our business or affect our business directly. If changes in existing laws or the implementation of new laws limit our ability to accomplish some or all of our business objectives, our future operating results may be adversely affected.


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We expect environmental regulation to increase, resulting in higher operating costs in the future.
 
Our water and wastewater services are governed by various federal and state environmental protection, health and safety laws, and regulations. These provisions establish criteria for drinking water and for discharges of water, wastewater and airborne substances. The Environmental Protection Agency promulgates numerous nationally applicable standards, including maximum contaminant levels (MCLs) for drinking water. We believe we are currently in compliance with all of the MCLs promulgated to date but we can give no assurance that we will continue to comply with all water quality requirements. If we violate any federal or state regulations or laws governing health and safety, we could be subject to substantial fines or otherwise sanctioned.
 
Environmental laws are complex and change frequently. They tend to become more stringent over time. As new or stricter standards are introduced, they could increase our operating costs. Although we would likely seek permission to recover these costs through rate increases, we can give no assurance that the commissions would approve rate increases to enable us to recover these additional compliance costs.
 
We are required to test our water quality for certain chemicals and potential contaminants on a regular basis. If the test results indicate that we exceed allowable limits, we may be required either to commence treatment to remove the contaminant or to develop an alternate water source. Either of these results may be costly, and there can be no assurance that the commissions would approve rate increases to enable us to recover these additional compliance costs.
 
Legislation regarding climate change may impact our operations
 
Future legislation regarding climate change may restrict our operations or impose new costs on our business. Our operations depend on power provided by other public utilities and, in emergencies, power generated by our portable and fixed generators. If future legislation limits emissions from the power generation process, our cost of power may increase. Any increase in the cost of power will be passed along to our California rate payers through the MCBA or included in our cost of service paid by our rate payers as requested in our general rate case filings. While recovery of these costs are not guaranteed, we would expect recovery in the regulatory process.
 
The Low Carbon Fuel Standard Program, which went into effect January 1, 2011, requires diesel engines to use low carbon fuel such as biodiesel or other alternatives. This may increase the operating cost of our generators and vehicles.
 
We maintain a fleet of vehicles to provide service to our customers, including a number of heavy duty diesel vehicles that we retrofitted by the end of 2010 to meet California emission standards. If future legislation further impacts the cost to operate the fleet or the fleet acquisition cost in order to meet certain emission standards, it will increase our cost of service and our rate base. Any increase in fleet operating costs associated with meeting emission standards will be included in our cost of service paid by our rate payers as requested in our general rate case filings. While recovery of these costs are not guaranteed, we would expect recovery in the regulatory process.
 
Starting January 1, 2010, under the California Environmental Quality Act (CEQA), all capital projects of a certain type (primarily wells, tanks, major pipelines and treatment facilities) will require mitigation of green house gas emissions. The cost to prepare the CEQA documentation and permit will add an estimated ten thousand dollars to such capital projects. This cost will be included in our capital cost and added to our rate base, which will be requested to be paid for by our rate payers. Any increase in the operating cost of the facilities will also be included in our cost of service paid by our rate payers as requested in our general rate case filings. While recovery of these costs are not guaranteed, we would expect recovery in the regulatory process.
 
Proposed cap and trade regulations are scheduled to be implemented in 2012 with the goal of reducing emissions to 1990 levels by the year 2020. Under such regulations, if approved, we will be required to determine our carbon footprint and evaluate our electricity and fuel usage (both diesel and gasoline). We will also be required to evaluate methane emissions from our primary processes in our wastewater plants. At this time we are unable to determine the cost impact of such regulations but any increase in operating costs associated with the cap and trade regulations will be included in our cost of service requested to be paid by our rate payers as requested in our general rate case filings. While recovery of these costs are not guaranteed, we would expect recovery in the regulatory process.


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We are party to a toxic contamination lawsuit which could result in our paying damages not covered by insurance.
 
In 1995, the State of California’s Department of Toxic Substances Control (DTSC) named us as a potential responsible party for cleanup of a toxic contamination plume in the Chico groundwater. In December 2002, we were named along with other defendants in two lawsuits filed by DTSC for the cleanup of the plumes. 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. The DTSC contends that our responsibility stems from our operation of wells in the surrounding vicinity that caused the contamination plumes to spread. While we are cooperating with the clean up, we deny any responsibility for the contamination or the resulting cleanup.
 
In 2007, the Company entered into Court approved consent decrees (Consent Decrees). The Consent Decrees conditioned the Company’s performance upon many factors, including, but not limited to, water pumped and treated by the Company must meet regulatory standards so the Company may distribute to its customers. Pursuant to the terms of the Consent Decrees, the Company will incur capital costs of $1.5 million and future operating costs with a present value of approximately $2.6 million. In its 2007 general rate case (GRC) settlement negotiations, Division of Ratepayer Advocates agreed to track all costs associated with the Consent Decrees including legal costs to pursue insurance coverage for potential future recovery in rates.
 
In connection with these suits, our insurance carrier, Employers Insurance of Wausau (Wausau) filed a separate lawsuit against us for reimbursement of past defense costs, which approximate $1.5 million, and a declaratory determination of coverage. On January 23, 2008, the Court heard various parties’ motions and on September 25, 2008 issued its rulings that Wausau had a duty to defend; therefore, the Company will not have to reimburse Wausau for previously incurred defense costs. The Court did not find Wausau’s actions were intended to harm the Company so the Company will not be able to recover punitive damages. However, the Court also found that the issue of policy coverage would be determined at trial. Trial commenced on June 1, 2009. During trial, the parties entered into a confidential settlement agreement which did not have a significant impact on the Company’s results of operations. The confidential settlement was fully executed on June 23, 2009 and the lawsuit was dismissed with prejudice by the court in October 2009.
 
The number of environmental and product-related lawsuits against other water utilities have increased in frequency in recent years. If we are subject to additional environmental or product-related lawsuits, we might incur significant legal costs and it is uncertain whether we would be able to recover the legal costs from ratepayers or other third parties. In addition, if current California law regarding California Public Utilities Commission’s preemptive jurisdiction over regulated public utilities for claims about compliance with California Department of Health Services and United States Environmental Protection Agency water quality standards changes, our legal exposure may be significantly increased.
 
Risks Related to Our Business Operations
 
Wastewater operations entail significant risks.
 
While wastewater collection and treatment is not presently a major component of our revenues, wastewater collection and treatment involve many risks associated with damage to the surrounding environment. If collection or treatment systems fail or do not operate properly, untreated or partially treated wastewater could discharge onto property or into nearby streams and rivers, causing property damage or injury to aquatic life, or even human life. Liabilities resulting from such damage could materially and adversely affect our results of operations and financial condition.
 
Demand for our water is subject to various factors and is affected by seasonal fluctuations.
 
Demand for our water during the warmer, dry months is generally greater than during cooler or rainy months due primarily to additional requirements for water in connection with irrigation systems, swimming pools, cooling systems and other outside water use. Throughout the year, and particularly during typically warmer months, demand will vary with temperature and rainfall levels. If temperatures during the typically warmer months are cooler than normal, or if there is more rainfall than normal, the demand for our water may decrease.


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In addition, governmental restrictions on water usage during drought conditions may result in a decreased demand for our water, even if our water reserves are sufficient to serve our customers during these drought conditions. However, during the drought of the late 1980’s and early 1990’s the California Public Utilities Commission beginning in 1992 allowed us to surcharge our customers to collect lost revenues caused by customers’ conservation during the drought. Regardless of whether we may surcharge our customers during a conservation period, they may use less water even after a drought has passed because of conservation patterns developed during the drought. Furthermore, our customers may wish to use recycled water as a substitute for potable water. If rights are granted to others to serve our customers recycled water, there will likely be a decrease in demand for our water.
 
The adequacy of our water supplies depends upon a variety of factors beyond our control. Interruption in the water supply may adversely affect our earnings.
 
We depend on an adequate water supply to meet the present and future needs of our customers. Whether we have an adequate supply varies depending upon a variety of factors, many of which are partially or completely beyond our control, including:
 
  •  the amount of rainfall;
 
  •  the amount of water stored in reservoirs;
 
  •  underground water supply from which well water is pumped;
 
  •  changes in the amount of water used by our customers;
 
  •  water quality;
 
  •  legal limitations on water use such as rationing restrictions during a drought; and
 
  •  population growth.
 
We purchase our water supply from various governmental agencies and others. Water supply availability may be affected by weather conditions, funding and other political and environmental considerations. In addition, our ability to use surface water is subject to regulations regarding water quality and volume limitations. If new regulations are imposed or existing regulations are changed or given new interpretations, the availability of surface water may be materially reduced. A reduction in surface water could result in the need to procure more costly water from other sources, thereby increasing our water production costs and adversely affecting our operating results.
 
We have entered into long-term water supply agreements, which commit us to making certain minimum payments whether or not we purchase any water. Therefore, if demand is insufficient to use our required purchases we would have to pay for water we did not receive.
 
From time to time, we enter into water supply agreements with third parties and our business is dependent upon such agreements in order to meet regional demand. For example, we have entered into a water supply contract with the San Francisco Public Utilities Commission that expires on June 30, 2034. We can give no assurance that the San Francisco Public Utilities Commission, or any of the other parties from whom we purchase water, will renew our contracts upon expiration, or that we will not be subject to significant price increases under any such renewed contracts.
 
The parties from whom we purchase water maintain significant infrastructure and systems to deliver water to us. Maintenance of these facilities is beyond our control. If these facilities are not adequately maintained or if these parties otherwise default on their obligations to supply water to us, we may not have adequate water supplies to meet our customers’ needs.
 
If we are unable to access adequate water supplies we may be unable to satisfy all customer demand which could result in rationing. Rationing may have an adverse effect on cash flow from operations. We can make no guarantee that we will always have access to an adequate supply of water that will meet all required quality standards. Water shortages may affect us in a variety of ways. For example, shortages could:
 
  •  adversely affect our supply mix by causing us to rely on more expensive purchased water;


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  •  adversely affect operating costs;
 
  •  increase the risk of contamination to our systems due to our inability to maintain sufficient pressure; and
 
  •  increase capital expenditures for building pipelines to connect to alternative sources of supply, new wells to replace those that are no longer in service or are otherwise inadequate to meet the needs of our customers and reservoirs and other facilities to conserve or reclaim water.
 
We may or may not be able to recover increased operating and construction costs on a timely basis, or at all, for our regulated systems through the ratemaking process. Although we can give no assurance, we may also be able to recover certain of these costs from third parties that may be responsible, or potentially responsible, for groundwater contamination.
 
Changes in water supply costs impact our operations.
 
The cost to obtain water for delivery to our customers varies depending on the sources of supply, wholesale suppliers’ prices, the quality of water required to be treated and the quantity of water produced to fulfill customer water demand. Our source of supply varies among our 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 wells and wholesale suppliers. A small portion of supply comes from surface sources and is processed through Company-owned water treatment plants. On average, slightly more than half of the water we deliver to our customers is pumped from wells or received from a surface supply with the remainder purchased from wholesale suppliers. Water purchased from suppliers usually costs us more than surface supplied or well pumped water. The cost of purchased water for delivery to customers represented 31.6% and 31.2% of our total operating costs in 2010 and 2009, respectively.
 
Wholesale water suppliers may increase their prices for water delivered to us based on factors that affect their operating costs. Purchased water rate increases are beyond our control. In California, effective July 1, 2008, our ability to recover increases in the cost of purchased water changed with the adoption of the MCBA. With this change, actual purchased water costs are compared to authorized purchased water costs with variances, netted against variance in purchased power, pump tax, and metered revenue, recorded to revenue. The balance in the MCBA will be collected in the future by billing the net WRAM and MCBA accounts receivable balances over 12 and 24 month periods, which may have a short-term negative impact on cash flow.
 
Dependency upon adequate supply of electricity and certain chemicals could adversely affect our results of operations.
 
Purchased electrical power is required to operate the wells and pumps needed to supply water to our customers. Although there are back-up power generators to operate a number of wells and pumps in emergencies, an extended interruption in power could impact the ability to supply water. In the past, California has been subject to rolling power blackouts due to insufficient power supplies. There is no assurance we will not be subject to power blackouts in the future. Additionally, we require sufficient amounts of certain chemicals in order to treat the water we supply. There are multiple sources for these chemicals but an extended interruption of supply could adversely affect our ability to adequately treat our water.
 
Purchased power is a significant operating expense. During 2010 and 2009, purchased power expense represented 7.4% and 7.2% of our total operating costs. These costs are beyond our control and can change unpredictably and substantially as occurred in California during 2001 when rates paid for electricity increased 48%. As with purchased water, purchased power costs are included in the MCBA. Cash flows between rate filings may be adversely affected until the commission authorizes a rate change but earnings will be minimally impacted. Cost of chemicals used in the delivery of water is not an element of the MCBA and therefore variances in quantity or cost could impact the results of operations.


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Our ability to generate new operating contracts or renewal of existing operating contracts is affected by local politics.
 
Our revenue and non-regulated revenue growth depends upon our ability to generate new as well as renew operating contracts with cities, other agencies and municipal utility districts. As our services are sold in a political environment, there is exposure to changing trends and municipal preferences. Recent terrorist acts have affected some political viewpoints relative to outsourcing of water or wastewater utility services. Municipalities own and municipal employees operate the majority of water and wastewater systems. Significant marketing and sales efforts are spent demonstrating the benefits of contract operations to elected officials and municipal authorities. The existing political environment means decisions affecting our business are based on many factors, not just economic factors.
 
Our business requires significant capital expenditures that are dependent on our ability to secure appropriate funding. If we are unable to obtain sufficient capital or if the rates at which we borrow increase, there would be a negative impact on our results of operations.
 
The water utility business is capital-intensive. We invest significant funds to add or replace property, plant and equipment. In addition, water shortages may adversely affect us by causing us to rely on more purchased water. This could cause increases in capital expenditures needed to build pipelines to secure alternative water sources. In addition, we require capital to grow our business through acquisitions. We fund our short-term capital requirements from cash received from operations and funds received from developers. We also borrow funds from banks under short-term bank lending arrangements. We seek to meet our long-term capital needs by raising equity through common or preferred stock issues or issuing debt obligations. We cannot give any assurance that these sources will continue to be adequate or that the cost of funds will remain at levels permitting us to earn a reasonable rate of return. In the event we are unable to obtain sufficient capital, our expansion efforts could be curtailed, which may affect our growth and may affect our future results of operations.
 
Our ability to access the capital markets is affected by the ratings of certain of our debt securities. Standard & Poor’s Rating Agency issues a rating on California Water Service Company’s ability to repay certain debt obligations. The credit rating agency could downgrade our credit rating based on reviews of our financial performance and projections or upon the occurrence of other events that could impact our business outlook. Lower ratings by the agency could restrict our ability to access equity and debt capital. We can give no assurance that the rating agency will maintain ratings which allow us to borrow under advantageous conditions and at reasonable interest rates. A future downgrade by the agency could also increase our cost of capital by causing potential investors to require a higher interest rate due to a perceived risk related to our ability to repay outstanding debt obligations.
 
While the majority of our debt is long term at fixed rates, we do have interest rate exposure in our short-term borrowings which have variable interest rates. We are also subject to interest rate risks on new financings. However, if interest rates were to increase on a long-term basis, our management believes that customer rates would increase accordingly, subject to approval by the appropriate commission. We can give no assurance that the commission would approve such an increase in customer rates.
 
We are obligated to comply with specified debt covenants under certain of our loan and debt agreements. Failure to maintain compliance with these covenants could limit future borrowing, and we could face increased borrowing costs, litigation, acceleration of maturity schedules, and cross default issues. Such actions by our creditors could have a material adverse effect on our financial condition and results of operations.
 
Adverse changes to the national and world-wide financial system could result in disruptions in the financial and real estate markets availability and cost of short-term funds for our liquidity requirements, our ability to meet long-term commitments, and our customers’ ability to pay for water services. Any of these could adversely affect our results of operations, cash flows and financial condition.
 
We rely on our current credit facilities to fund short-term liquidity needs if internal funds are not available from operations. Specifically, given the seasonal fluctuations in demand for our water we commonly draw on our credit facilities to meet our cash requirements at times in the year when demand is relatively low. We also may


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occasionally use letters of credit issued under our revolving credit facilities. Disruptions in the capital and credit markets or further deterioration in the strength of financial institutions could adversely affect our ability to draw on our credit facilities. Our access to funds under our credit facilities is dependent on the ability of our banks to meet its funding commitments.
 
Longer-term disruptions in the financial markets as a result of uncertainty, changing or increased regulation, reduced capital-raising alternatives, or failures of significant financial institutions or other factors could adversely affect our access to liquidity. Any disruption could require us to take measures to conserve cash until the markets stabilize or until alternative credit arrangements or other funding for business needs can be arranged. Such measures could include deferring capital expenditures, dividend payments or other discretionary uses of cash.
 
Many of our customers and suppliers also have exposure to risks that their ability to meet their payment and supply commitments are adversely affected by the worldwide financial crisis and recession in the United States and resulting potential disruptions in the financial and real estate markets. We operate in geographic areas that may be particularly susceptible to declines in the price of real property and other consequences of the financial crisis, which could result in significant declines in demand for our products and services in certain of our districts. In the event that any of our significant customers or suppliers, or a significant number of smaller customers and suppliers, are adversely affected by these risks, we may face disruptions in supply, significant reductions in demand for our products and services, inability of customers to pay invoices when due, and other adverse effects that could negatively affect our financial condition, results of operations and/or cash flows.
 
Our operations and certain contracts for water distribution and treatment depend on the financial capability of state and local governments, and other municipal entities such as water districts. Major disruptions in the financial strength or operations of such entities, such as liquidity limitations, bankruptcy or insolvency, could have an adverse effect on our ability to conduct our business and/or enforce our rights under contracts to which such entities are a party.
 
We are a holding company that depends on cash flow from our subsidiaries to meet our obligations and to pay dividends on our common stock.
 
As a holding company, we conduct substantially all of our operations through our subsidiaries and our only significant assets are investments in those subsidiaries. 94% of our revenues are derived from the operations of California Water Service Company. As a result, we are dependent on cash flow from our subsidiaries, and California Water Service Company in particular, to meet our obligations and to pay dividends on our common stock.
 
We can make dividend payments only from our surplus (the excess, if any, of our net assets over total paid-in capital) or if there is no surplus, the net profits for the current fiscal year or the fiscal year before which the dividend is declared. In addition, we can pay cash dividends only if after paying those dividends we would be able to pay our liabilities as they become due. Owners of our capital stock cannot force us to pay dividends and dividends will only be paid if and when declared by our board of directors. Our board of directors can elect at any time, and for an indefinite duration, not to declare dividends on our capital stock.
 
Our subsidiaries are separate and distinct legal entities and generally have no obligation to pay any amounts due on California Water Service Group’s debt or to provide California Water Service Group with funds for dividends. Although there are no contractual or regulatory restrictions on the ability of our subsidiaries to transfer funds to us, the reasonableness of our capital structure is one of the factors considered by state and local regulatory agencies in their ratemaking determinations. Therefore, transfer of funds from our subsidiaries to us for the payment of our obligations or dividends may have an adverse effect on ratemaking determinations. Furthermore, our right to receive cash or other assets upon the liquidation or reorganization of a subsidiary is generally subject to the prior claims of creditors of that subsidiary. If we are unable to obtain funds from our subsidiaries in a timely manner, we may be unable to meet our obligations or pay dividends.


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An important element of our growth strategy is the acquisition of water and wastewater system, including operating agreements. Risks associated with potential acquisitions, divestitures or restructurings may adversely affect us.
 
We may seek to acquire or invest in other companies, technologies, services or products that complement our business. The execution of our growth strategy may expose us to different risks than those associated with our utility operations. We can give no assurance that we will succeed in finding attractive acquisition candidates or investments, or that we would be able to reach mutually agreeable terms with such parties. In addition, as consolidation becomes more prevalent in the water and wastewater industries, the prices for suitable acquisition candidates may increase to unacceptable levels and limit our ability to grow through acquisitions. If we are unable to find acquisition candidates or investments, our ability to grow may be limited.
 
Acquisition and investment transactions may result in the issuance of our equity securities that could be dilutive if the acquisition or business opportunity does not develop in accordance with our business plan. They may also result in significant write-offs and an increase in our debt. The occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.
 
Any of these transactions could involve numerous additional risks, including one or more of the following:
 
  •  problems integrating the acquired operations, personnel, technologies or products with our existing businesses and products;
 
  •  liabilities inherited from the acquired companies’ prior business operations;
 
  •  diversion of management time and attention from our core business to the acquired business;
 
  •  failure to retain key technical, management, sales and other personnel of the acquired business;
 
  •  difficulty in retaining relationships with suppliers and customers of the acquired business; and
 
  •  difficulty in getting required regulatory approvals.
 
In addition, the businesses and other assets we acquire may not achieve the sales and profitability expected. The occurrence of one or more of these events may have a material adverse effect on our business. There can be no assurance that we will be successful in overcoming these or any other significant risks encountered.
 
We may not be able to increase or sustain our recent growth rate, and we may not be able to manage our future growth effectively.
 
We may be unable to continue to expand our business or manage future growth. To successfully manage our growth and handle the responsibilities of being a public company, we believe we must effectively:
 
  •  hire, train, integrate and manage additional qualified engineers for engineering design and construction activities, new business personnel, and financial and information technology personnel;
 
  •  retain key management, augment our management team, and retain qualified and certified water and wastewater system operators;
 
  •  implement and improve additional and existing administrative, financial and operations systems, procedures and controls;
 
  •  expand and upgrade our technological capabilities; and
 
  •  manage multiple relationships with our customers, regulators, suppliers and other third parties.
 
If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities, satisfy customer requirements, execute our business plan or respond to competitive pressures.


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We have a number of large-volume commercial and industrial customers and a significant decrease in consumption by one or more of these customers could have an adverse effect on our operating results and cash flows.
 
Our billed revenues will decrease, and such decrease may be material, if a significant business or industrial customer terminates or materially reduces its use of our water. Approximately $111.7 million, or 24% of our 2010 water utility revenues was derived from business and industrial customers. If any of our large business or industrial customers in California reduce or cease its consumption of our water, the impact to net operating income would be minimal to our operations due to the WRAM and MCBA, but could impact our cash flows. In Hawaii, we serve a number of large resorts which if their water usage was reduced or ceased could have a material impact to our Hawaii operation. The delay between such date and the effective date of the rate relief may be significant and could adversely affect our operating results and cash flows.
 
Our operating cost and costs of providing services may rise faster than our revenues.
 
Our ability to increase rates over time is dependent upon approval of such rate increases by state commissions, or in the case of the City of Hawthorne and the City of Commerce, the City Council, which may be inclined, for political or other reasons, to limit rate increases. However, our costs are subject to market conditions and other factors, which may increase significantly. The second largest component of our operating costs after water production is made up of salaries and wages. These costs are affected by the local supply and demand for qualified labor. Other large components of our costs are general insurance, workers compensation insurance, employee benefits and health insurance costs. These costs may increase disproportionately to rate increases authorized by state commissions and may have a material adverse effect on our future results of operations.
 
Our non-regulated business operates in a competitive market.
 
While a majority of our business is regulated, our non-regulated business participates in a competitive market. We compete with several larger companies whose size, financial resources, customer base and technical expertise may restrict our ability to compete successfully for certain operations and maintenance contracts. Due to the nature of our contract operations business, and to the very competitive nature of the market, we must accurately estimate the cost and profitability of each project while, at the same time, maintaining prices at a level low enough to compete with other companies. Our inability to achieve this balance could adversely impact our results of operations.
 
Demand for our stock may fluctuate due to circumstances beyond our control.
 
We believe that stockholders invest in public utility stocks, in part, because they seek reliable dividend payments. If there is an over-supply of stock of public utilities in the market relative to demand by such investors, the trading price of our securities could decrease. Additionally, if interest rates rise above the dividend yield offered by our equity securities, demand for our stock, and consequently its market price, may also decrease. A decline in demand for our stock may have a negative impact on our ability to finance capital projects.
 
The price of our common stock may be volatile and may be affected by market conditions beyond our control.
 
The trading price of our common stock may fluctuate in the future because of the volatility of the stock market and a variety of other factors, many of which are beyond our control. Factors that could cause fluctuations in the trading price of our common stock include: regulatory developments; general economic conditions and trends; price and volume fluctuations in the overall stock market from time to time; actual or anticipated changes or fluctuations in our results of operations; actual or anticipated changes in the expectations of investors or securities analysts; actual or anticipated developments in our competitors’ businesses or the competitive landscape generally; litigation involving us or our industry; and major catastrophic events or sales of large blocks of our stock.
 
Equity markets in general have recently experienced extreme price and volume fluctuations. Such price and volume fluctuations may continue to adversely affect the market price of our common stock for reasons unrelated to our business or operating results.


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Adverse investment returns and other factors may increase our pension liability and pension funding requirements.
 
A substantial number of our employees are covered by a defined benefit pension plan. At present, the pension plan is underfunded because our projected pension benefit obligation exceeds the aggregate fair value of plan assets. Under applicable law, we are required to make cash contributions to the extent necessary to comply with minimum funding levels imposed by regulatory requirements. The amount of such required cash contribution is based on an actuarial valuation of the plan. The funded status of the plan can be affected by investment returns on plan assets, discount rates, mortality rates of plan participants, pension reform legislation and a number of other factors. There can be no assurance that the value of our pension plan assets will be sufficient to cover future liabilities. Although we have made contributions to our pension plan in recent years, it is possible that we could incur a pension liability adjustment, or could be required to make additional cash contributions to our pension plan, which would reduce the cash available for business and other needs.
 
Work stoppages and other labor relations matters could adversely affect our operating results.
 
At December 31, 2010, 702 of our 1,127 total employees were union employees. Most of our unionized employees are represented by the Utility Workers Union of America, AFL-CIO, except certain engineering and laboratory employees who are represented by the International Federation of Professional and Technical Engineers, AFL-CIO.
 
We believe our labor relations are good, but in light of rising costs for healthcare and pensions, contract negotiations in the future may be difficult. Furthermore, changes in applicable law or regulations could have an adverse effect on management’s negotiating position with respect to our currently unionized employees and/or employees that decide to unionize in the future. We are subject to a risk of work stoppages and other labor relations matters as we negotiate with the unions to address these issues, which could affect our results of operations and financial condition. We can give no assurance that issues with our labor forces will be resolved favorably to us in the future or that we will not experience work stoppages.
 
We depend significantly on the services of the members of our management team, and the departure of any of those persons could cause our operating results to suffer.
 
Our success depends significantly on the continued individual and collective contributions of our management team. The loss of the services of any member of our management team could have a material adverse effect on our business as our management team has knowledge of our industry and customers and would be difficult to replace.
 
Our operations are geographically concentrated in California and this lack of diversification may negatively impact our operations.
 
Although we own facilities in a number of states, over 94% of our operations are located in California. As a result, we are largely subject to weather, political, water supply, labor, utility cost, regulatory and economic risks affecting California.
 
We are also affected by the real property market in California. In order to grow our business, we may need to acquire additional real estate or rights to use real property owned by third parties, the cost of which tends to be higher and more volatile in California relative to other states. The value of our assets in California may decline if there is a decline in the California real estate market which results in a significant decrease in real property values.
 
In 2008 and 2009, we experienced higher than normal uncollectible accounts activity which, we believe, were attributable in part to the significant declines in real estate values and rising unemployment experienced by our customers in a number of our districts in California due to the economic recession. In 2011, we may experience higher than normal uncollectible accounts activity if real estate values continue to decline and unemployment rates continue to increase.


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The effects of natural disasters, terrorist activity, pandemics, or poor water quality or contamination to our water supply may result in disruption in our services and litigation which could adversely affect our business, operating results and financial condition.
 
We operate in areas that are prone to earthquakes, fires, mudslides and other natural disasters. A significant seismic event or other natural disaster in California where our operations are concentrated, could adversely impact our ability to deliver water and adversely affect our costs of operations. A major disaster could damage or destroy substantial capital assets. The California Public Utilities Commission has historically allowed utilities to establish a catastrophic event memorandum account as another possible mechanism to recover costs. However, we can give no assurance that the CPUC or any other commission would allow any such cost recovery mechanism in the future.
 
Our water supplies are subject to contamination, including contamination from the development of naturally-occurring compounds, chemicals in groundwater systems, pollution resulting from man-made sources, such as MTBE, sea water incursion and possible terrorist attacks. If our water supply is contaminated, we may have to interrupt the use of that water supply until we are able to substitute the flow of water from an uncontaminated water source. In addition, we may incur significant costs in order to treat the contaminated source through expansion of our current treatment facilities, or development of new treatment methods. If we are unable to substitute water supply from an uncontaminated water source, or to adequately treat the contaminated water source in a cost-effective manner, there may be an adverse effect on our revenues, operating results and financial condition. The costs we incur to decontaminate a water source or an underground water system could be significant and could adversely affect our business, operating results and financial condition and may not be recoverable in rates. We could also be held liable for consequences arising out of human exposure to hazardous substances in our water supplies or other environmental damage. For example, private plaintiffs have the right to bring personal injury or other toxic tort claims arising from the presence of hazardous substances in our drinking water supplies. Our insurance policies may not be sufficient to cover the costs of these claims.
 
We operate a dam. If the dam were to fail for any reason, we would lose a water supply and flooding likely would occur. Whether or not we were responsible for the dam’s failure, we could be sued. We can give no assurance that we would be able to successfully defend such a suit.
 
In light of the threats to the nation’s health and security ensuing in the wake of the September 11, 2001 terrorist attacks, we have taken steps to increase security measures at our facilities and heighten employee awareness of threats to our water supply. We have also tightened our security measures regarding the delivery and handling of certain chemicals used in our business. We have and will continue to bear increased costs for security precautions to protect our facilities, operations and supplies. These costs may be significant. Despite these tightened security measures, we may not be in a position to control the outcome of terrorist events should they occur.
 
We depend upon our skilled and trained workforce to ensure water delivery. Were a pandemic to occur, we can give no assurance that we would be able to maintain sufficient manpower to ensure uninterrupted service in all of the districts that we serve.
 
We retain certain risks not covered by our insurance policies.
 
We evaluate our risks and insurance coverage annually. Our evaluation considers the costs, risks and benefits of retaining versus insuring various risks as well as the availability of certain types of insurance coverage. In addition, portions of our business are difficult or impracticable to insure. Furthermore, we are also affected by increases in prices for insurance coverage; in particular, we have been, and will continue to be, affected by rising health insurance costs. Retained risks are associated with deductible limits, partial self-insurance programs and insurance policy coverage ceilings. If we suffer an uninsured loss, we may be unable to pass all, or any portion, of the loss on to customers because our rates are regulated by regulatory commissions. Consequently, uninsured losses may negatively affect our financial condition, liquidity and results of operations. There can be no assurance that we will not face uninsured losses pertaining to the risks we have retained.


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We rely on our information technology and a number of complex business systems that could malfunction and result in negative impacts on our profitability and cash flow.
 
Our business is dependent on several complex business systems, certain of which are owned by third parties. The business systems must function reliably in order for us to operate effectively. Among other things, system malfunctions and security breaches could prevent us from operating or monitoring our facilities, billing accurately and timely analysis of financial results. Our profitability and cash flow could be affected negatively in the event these systems do not operate effectively or are circumvented.
 
The accuracy of our judgments and estimates about financial and accounting matters will impact our operating results and financial condition.
 
We make certain estimates and judgments in preparing our financial statements regarding, among others:
 
  •  the useful life of intangible rights;
 
  •  the number of years to depreciate certain assets;
 
  •  amounts to set aside for uncollectible accounts receivable, inventory obsolesces and uninsured losses;
 
  •  our legal exposure and the appropriate accrual for claims, including medical claims and workers’ compensation claims;
 
  •  future costs and assumptions for pensions and other post-retirement benefits; and
 
  •  possible tax uncertainties.
 
The quality and accuracy of those estimates and judgments will have an impact on our operating results and financial condition.
 
In addition, we must estimate unbilled revenues and costs as of the end of each accounting period. If our estimates are not accurate, we will be required to make an adjustment in a future period. Accounting rules permit us to use expense balancing accounts and memorandum accounts that include input cost changes to us that are different from amounts incorporated into the rates approved by the commissions. These accounts result in expenses and revenues being recognized in periods other than in which they occurred.
 
Our controls and procedures may fail or be circumvented.
 
Management regularly reviews and updates our internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could result in lack of compliance with contractual agreements, misstatements in our financial statements in amounts that could be material or could cause investors to lose confidence in our reported financial information, either of which could have a negative effect on the trading price of our stock and may negatively affect our ability to raise future capital.
 
Further, if we or our independent registered public accounting firm discover a material weakness in our internal control over financial reporting, the disclosure of that fact, even if quickly remedied, could reduce the market’s confidence in our financial statements and harm our stock price. In addition, non-compliance with Section 404 of the Sarbanes-Oxley Act of 2002 could subject us to a variety of administrative sanctions, including the suspension or delisting of our common stock from the New York Stock Exchange and the inability of registered broker-dealers to make a market in our common stock, which would further reduce our stock price.


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We may be required to adopt International Financial Reporting Standards (IFRS), or other accounting or financial reporting standards, the ultimate adoption of which could negatively impact our business, financial condition or results of operations.
 
We could be required to adopt IFRS or other accounting or financial reporting standards different from Generally Accepted Accounting Principles (GAAP) in the United States of America, which is currently applicable to our accounting and financial reporting. In 2008 the SEC released a proposed roadmap for the adoption of IFRS according to which we could be required to adopt IFRS in the future. Under GAAP we are subject to the accounting procedures for accounting for the effects of certain types of regulation, which, among other things, allows us to defer certain costs if we believe it is probable that we will be allowed to recover those costs by future rate increases. Currently, IFRS does not contain provisions equivalent to the current GAAP accounting procedures. The implementation and adoption of new accounting or financial reporting standards could affect our reported performance, which in turn could favorably or unfavorably impact our business, financial condition or results of operations. Furthermore, the transition to and application of new accounting or financial reporting standards could result in increased administrative costs. The SEC is expected to make a final determination regarding the adoption of IFRS in 2011.
 
Municipalities, water districts and other public agencies may condemn our property by eminent domain action.
 
State statutes allow municipalities, water districts and other public agencies to own and operate water systems. These agencies are empowered to condemn properties already operated by privately owned public utilities. However, whenever a public agency constructs facilities to extend a utility system into the service area of a privately owned public utility, such an act constitutes the taking of property and requires reimbursement to the utility for its loss. If a public agency were to acquire our utility property by eminent domain action, we would be entitled to just compensation for our loss, but we would no longer have access to the condemned property nor would we be entitled to any portion of revenue generated from the use of such asset going forward.
 
Some anti-takeover provisions contained in our certificate of incorporation and bylaws, as well as provisions of Delaware law, could impair a takeover attempt.
 
We have provisions in our certificate of incorporation and bylaws, each of which could have the effect of rendering more difficult or discouraging an acquisition of the Company deemed undesirable by our Board of Directors. These include provisions:
 
  •  authorizing blank check preferred stock, which the Company could issue with voting, liquidation, dividend, and other rights superior to our common stock.
 
  •  limiting the liability of, and providing indemnification to, the Company’s directors and officers;
 
  •  specifying that the Company’s stockholders may take action only at a duly called annual or special meeting of stockholders and otherwise in accordance with our bylaws and limiting the ability of our stockholders to call special meetings;
 
  •  requiring advance notice of proposals by the Company’s stockholders for business to be conducted at stockholder meetings and for nominations of candidates for election to our Board of Directors; and
 
  •  controlling the procedures for conduct of Board and stockholder meetings and election, appointment and removal of directors.
 
These provisions, alone or together, could deter or delay hostile takeovers, proxy contests and changes in control or management of the Company. As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation Law, which prevents some stockholders from engaging in certain business combinations without approval of the holders of substantially all of our outstanding common stock.
 
Any provision of our certificate of incorporation or bylaws or Delaware law that has the effect of delaying or deterring a change in control of the Company could limit the opportunity for our stockholders to receive a premium


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for their shares of our common stock and also could affect the price that some investors are willing to pay for our common stock.
 
Item 1B.   Unresolved Staff Comments.
 
None
 
Item 2.   Properties.
 
Our physical properties consist of offices and water facilities to accomplish the production, storage, treatment, and distribution of water. These properties are located in or near the geographic service areas listed above in Item 1, “Business — Geographical Service Areas and Number of Customers at Year-end.” Our headquarters, which houses accounting, engineering, information systems, human resources, purchasing, regulatory, water quality, and executive staff, is located in San Jose, California.
 
The real properties owned are held in fee simple title. Properties owned by Cal Water are subject to the lien of an Indenture of Mortgage and Deed of Trust dated April 17, 2009 (the California Indenture), securing Cal Water’s first mortgage bonds, of which $466.4 million was outstanding at December 31, 2010. The California Indenture contains certain restrictions common to such types of instruments regarding the disposition of property and includes various covenants and restrictions. At December 31, 2010, our California utility was in compliance with the covenants of the California Indenture.
 
Washington Water has long-term bank loans that are secured primarily by utility plant owned by Washington Water. New Mexico Water has a long-term loan that is secured by utility plant owned by New Mexico Water.
 
Cal Water owns 636 wells and operates 5 leased wells. There are 425 owned storage tanks with a capacity of 488 million gallons, 3 leased storage tanks with a capacity of 0.7 million gallons, 37 managed storage tanks with a capacity of 30 million gallons, and 3 reservoirs with a capacity of 220 million gallons. Cal Water owns and operates 6 surface water treatment plants with a combined capacity of 42 million gallons per day. There are 5,683 miles of supply and distribution mains in the various systems.
 
Washington Water owns 342 wells and manages 110 wells. There are 127 owned storage tanks and 44 managed storage tanks with a storage capacity of 9 million gallons. There are 328 miles of supply and distribution lines.
 
New Mexico Water owns 17 wells. There are 12 storage tanks with a storage capacity of 4 million gallons. There are 134 miles of supply and distribution lines. New Mexico operates two waste water treatment facilities with a combined capacity to process 0.5 million gallons per day. There are 34 miles of sewer collection mains.
 
Hawaii Water owns 18 wells and manages 5 irrigation wells. There are 25 storage tanks with a storage capacity of 20 million gallons. There are 70 miles of supply and distribution lines. Hawaii Water operates 5 wastewater treatment facilities with a combined capacity to process approximately 1.7 million gallons per day. There are 24 miles of sewer collection mains.
 
In the leased City of Hawthorne and City of Commerce systems or in systems that are operated under contract for municipalities or private companies, title to the various properties is held exclusively by the municipality or private company.
 
Item 3.   Legal Proceedings.
 
Information with respect to this item may be found under the subheading “Contingencies” in Note 15 to the consolidated Financial Statements in Item 8, which is incorporated herein by reference.
 
Item 4.   Submission of Matters to a Vote of Security Holders.
 
Reserved.


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PART II
 
Item 5.   Market for Registrant’s Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Our common stock is traded on the New York Stock exchange under the symbol “CWT.” At December 31, 2010, there were 20,833,303 common shares outstanding. There were 2,499 common stockholders of record as of February 7, 2011.
 
During 2010, we paid a cash dividend of $1.19 per common share, or $0.2975 per quarter. During 2009, we paid a cash dividend of $1.18 per common share, or $0.2950 per quarter. In January 2011, our Board of Directors declared a cash dividend of $0.3075 per common share payable on February 18, 2011, to stockholders of record on February 7, 2011. This represents our 44th consecutive year of increasing the annual dividend and marks the 264th consecutive quarterly dividend.
 
We presently intend to pay quarterly cash dividends in the future consistent with past practices, subject to our earnings and financial condition, restrictions set forth in our debt instruments, regulatory requirements and such other factors as our Board of Directors may deem relevant.
 
During 2010 and 2009, the common stock market price range and dividends per share for each quarter were as follows:
 
                                 
2010
  First   Second   Third   Fourth
 
Common stock market price range:
                               
High
  $ 38.09     $ 39.70     $ 37.74     $ 38.50  
Low
    35.25       33.81       33.85       36.02  
Dividends paid per common share
    0.2975       0.2975       0.2975       0.2975  
 
                                 
2009
  First   Second   Third   Fourth
 
Common stock market price range:
                               
High
  $ 46.43     $ 40.87     $ 39.27     $ 40.11  
Low
    37.83       33.54       35.52       35.18  
Dividends paid per common share
    0.2950       0.2950       0.2950       0.2950  


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Five-Year Performance Graph
 
The following performance graph compares the changes in the cumulative shareholder return on California Water Services Group’s common stock with the cumulative total return on the Robert W. Baird Water Utility Index and the Standard & Poor’s 500 Index during the last five years ended December 31, 2010. The comparison assumes $100 was invested on January 1, 2005, in California Water Service Group’s common stock and in each of the forgoing indices and assumes reinvestment of dividends.
 
(COMPANY LOGO)
 
Performance Graph Data
 
The following descriptive data is supplied in accordance with Rule 304(d) of Regulations S-T:
 
                                                             
      2005     2006     2007     2008     2009     2010
California Water Services Group
      100         108         102         132         108         113  
S&P 500
      100         114         120         76         96         110  
RW Baird Water Utility Index
      100         117         118         100         105         119  
                                                             
 
An initial $10,000 investment in the common stock of California Water Service Group on January 1, 2005 would have resulted in a cumulative total return of $11,298 over the 5-year period.


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Item 6.   Selected Financial Data.
 
The following selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements and the Notes thereto and the information contained in Item 7, “Managements Discussion and Analysis of Financial Condition and Results of Operations.”
 
Historical results are not necessarily indicative of future results.
 
FIVE YEAR FINANCIAL REVIEW
 
                                         
    2010     2009     2008     2007     2006  
    (Dollars in thousands, except common share and other data)  
 
Summary of Operations
                                       
Operating revenue
                                       
Residential
  $ 335,833     $ 315,617     $ 284,913     $ 253,745     $ 232,811  
Business
    90,992       86,766       75,620       65,457       60,366  
Industrial
    20,733       18,963       18,932       17,403       16,286  
Public authorities
    23,904       22,408       21,042       17,952       15,728  
Other
    11,666       14,798       12,745       12,525       9,526  
MCBA net adjustment to increase (reduce) adopted revenue
    (22,729 )     (9,180 )     (2,940 )     —       —  
                                         
Total operating revenue
    460,399       449,372       410,312       367,082       334,717  
Operating expenses
    398,586       391,253       352,843       322,912       294,411  
Interest expense, other income and expenses, net
    24,157       17,565       17,664       13,011       14,726  
                                         
Net income
  $ 37,656     $ 40,554     $ 39,805     $ 31,159     $ 25,580  
                                         
Common Share Data
                                       
Earnings per share — diluted
  $ 1.81     $ 1.95     $ 1.90     $ 1.50     $ 1.34  
Dividend paid
    1.19       1.18       1.17       1.16       1.15  
Dividend payout ratio
    66 %     61 %     62 %     77 %     86 %
Book value per share
  $ 20.91     $ 20.26     $ 19.44     $ 18.66     $ 18.31  
Market price at year-end
    37.27       36.82       46.43       37.02       40.40  
Common shares outstanding at year-end (in thousands)
    20,833       20,765       20,723       20,666       20,657  
Return on average common stockholders’ equity
    9.0 %     9.8 %     10.2 %     8.1 %     8.2 %
Long-term debt interest coverage
    3.59       4.04       4.72       3.70       3.17  
Balance Sheet Data
                                       
Net utility plant
  $ 1,294,297     $ 1,198,077     $ 1,112,367     $ 1,010,196     $ 941,475  
Total assets
    1,692,066       1,525,581       1,418,107       1,184,499       1,165,019  
Long-term debt including current portion
    481,561       387,222       290,316       291,921       293,592  
Capitalization ratios:
                                       
Common stockholders’ equity
    47.5 %     52.1 %     58.1 %     56.9 %     56.0 %
Preferred stock
    —       —       —       0.5 %     0.5 %
Long-term debt
    52.5 %     47.9 %     41.9 %     42.6 %     43.5 %
Other Data
                                       
Estimated water production (million gallons)
                                       
Wells and surface supply
    65,288       71,266       72,228       70,708       70,094  
Purchased
    56,654       60,292       65,529       70,530       62,320  
                                         
Total estimated water production
    121,942       131,558       137,757       141,238       132,414  
                                         
Metered customers
    438,600       426,600       417,208       412,432       407,762  
Flat-rate customers
    59,300       68,100       73,285       75,123       76,131  
                                         
Customers at year-end**
    497,900       494,700       490,493       487,555       483,893  
                                         
New customers added
    3,200       4,207       2,938       3,662       4,892  
Revenue per customer
  $ 925     $ 908     $ 837     $ 753     $ 692  
Utility plant per customer
    3,706       3,455       3,228       2,968       2,778  
Employees at year-end
    1,127       1,013       929       891       869  
 
 
** Includes customers of the City of Hawthorne and City of Commerce


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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Overview
 
For 2010, net income was $37.7 million compared to $40.6 million in 2009, or a decrease of 7.1%. The decrease in net income was primarily caused by a decrease in net other income and an increase in interest expense. Net operating income increased $3.7 million to $61.8 million, or a 6.4% increase over 2009 levels. Net other income reflected a net decrease from the prior year of $1.5 million due primarily to lower gains on the cash surrender value of life insurance held for certain benefit plans, a $0.6 million expense in 2010 for construction costs excluded from rate base in the final 2009 GRC settlement, a reduction in gain on sale of property, and less interest income earned in 2010. Diluted earnings per share for 2010 were $1.81 compared to $1.95 in 2009, or a decrease of 7.2%.
 
As a result of the 2007 General Rate Case (2007 GRC) and corresponding approved rates which were effective the first of July 2008, we recognized a significant increase in net income in 2008, 2009, and 2010. The rate increases authorized additional annual revenues of $57.7 million (see discussion in the Regulatory Matters section of this annual report).
 
The 2007 GRC included recovery of certain conservation expenses. Company conservation program expenses were $2.7 million in 2010 and $3.2 million in 2009, and are expected to increase significantly in future years.
 
We plan to continue to seek rate relief to recover our operating cost increases and receive reasonable returns on invested capital. We expect to fund our long-term capital needs through a combination of debt, common stock offerings, and cash flow from operations.
 
Critical Accounting Policies and Estimates
 
We maintain our accounting records in accordance with accounting principles generally accepted in the United States of America and as directed by the Commissions to which our 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. A summary of our significant accounting policies is listed in Note 2 of the Notes to Consolidated Financial Statements. The following sections describe those policies where the level of subjectivity, judgment, and variability of estimates could have a material impact on the financial condition, operating performance, and cash flows of the business.
 
Revenue Recognition
 
Revenue includes monthly cycle customer billings for regulated water and wastewater services at rates authorized by regulatory commissions and billings to certain non-regulated customers at rates authorized by contract with government agencies.
 
Revenue from metered customers includes billings to customers based on monthly meter readings plus an estimate for water used between the customer’s last meter reading and the end of the accounting period. The unbilled revenue amount is generally higher during the summer months when water sales are higher. 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 period is included in that period’s revenue, with the balance recorded as unearned revenue on the balance sheet and recognized as revenue when earned in the subsequent accounting period. Our unearned revenue liability was $1.6 million and $2.6 million as of December 31, 2010 and 2009, respectively. This liability is included in “other accrued liabilities” on our consolidated balance sheets.
 
Effective July 1, 2008, Cal Water is operating under a Water Rate Adjustment Mechanism (WRAM) approved in February 2008 by the California Public Utilities Commission (CPUC). Under the WRAM, Cal Water records the adopted level of volumetric revenues as established by the CPUC for metered accounts (adopted volumetric revenues). In addition to volumetric-based revenues, the revenue requirements approved by the CPUC include service charges, flat rate charges, and other items not subject to the WRAM. The adopted volumetric revenue considers the seasonality of consumption of water based upon historical averages. The variance between adopted volumetric revenues and actual billed volumetric revenues for metered accounts is recorded as a component of revenue with an offsetting entry to a current asset or liability balancing account (tracked individually for each Cal


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Water district). The variance amount may be positive or negative and represents amounts that will be billed or refunded to customers in the future.
 
Also effective July 1, 2008, Cal Water is operating under a Modified Cost Balancing Account (MCBA). We track authorized expense levels for purchased water, purchased power and pump taxes, as established by the CPUC. Variances (which include the effects of changes in both rate and volume) between adopted and actual purchased water, purchased power, and pump taxes expenses will be recorded as a component of revenue, as the amount of such variances will be recovered from or refunded to our customers at a later date. Any recovery or refund of the MCBA would be netted against the WRAM revenue over- or under-recovery for the corresponding district. The monthly balances accrue interest (payable or receivable) based upon the 90 day commercial paper rate.
 
The balances in the WRAM and MCBA assets and liabilities accounts will fluctuate on a monthly basis depending upon the variance between adopted and actual results. The recovery or refund of the WRAM is netted against the MCBA over- or under-recovery for the corresponding district and is interest bearing at the current 90 day commercial paper rate. When the net amount for any district achieves a pre-determined level at the end of any calendar year (i.e., at least 2.5 percent over- or under-recovery of the approved revenue requirement), Cal Water will file with the CPUC to refund or collect the balance in the accounts. Account balances less than those levels may be refunded or collected in Cal Water’s general rate case proceedings or aggregated with future calendar year balances for comparison with the recovery level. As of December 31, 2010, included in the net regulatory balancing accounts, current and long-term assets were $14.8 million and $16.8 million, respectively, and the net regulatory balancing accounts current and long-term liabilities were $3.0 million and $0.6 million, respectively. As of December 31, 2009, included in the net regulatory balancing accounts current and long-term assets were $10.5 million and $5.1 million, respectively, and the current net regulatory balancing accounts, current and long-term liabilities were $2.4 million and $0.9 million, respectively.
 
Regulated Utility Accounting
 
Because we operate extensively in a regulated business, we are subject to the accounting standards for regulated utilities. Regulators establish rates that are designed to permit the recovery of the cost of service and a return on investment. Based upon past practices and decisions by the Commissions, we assess the probability of future recovery from rate payers of certain items, including the probability of return of amounts collected to rate payers. If it is probable that rates will recover an item in the future, a regulatory asset will be reported. If it is probable that rates will reflect a reduction in future rates for an item, a regulatory liability will be reported. We assess the probability of recovery of the regulatory assets and regulatory liabilities in each reporting period. In addition, if a regulatory commission determined that a portion of our assets used in utility operations were not recoverable in customer rates, we would be required to determine if we had suffered an asset impairment that would require a write-down in the assets’ valuation. The 2009 GRC settlement included a $0.6 million asset impairment which was booked during 2010, and there was not an asset impairment during 2009.
 
Goodwill Accounting and Evaluation for Impairment
 
During 2008, we acquired three privately held companies on the island of Hawaii: Waikoloa Resort Utilities, Inc; Waikoloa Water Company, Inc.; Waikoloa Sewer Company, Inc. (jointly referred to herein as the “Waikoloa Companies”). Total assets acquired were $26.9 million (including cash of $6.3 million), with liabilities assumed of $10.2 million (net of $12.6 million, which was paid at close of escrow) and initial goodwill of $3.9 million. During 2009 and after the completion of the evaluation of tax benefits of the Waikoloa Companies’ net tax operating loss carryovers, goodwill was reduced by $1.3 million.
 
In November of 2010, we performed an annual impairment test of the remaining goodwill balance of $2.6 million by comparing the fair value of Hawaii Water Service Company, the reporting unit, with its carrying amount, including goodwill. Our analysis considered the approval of future rate case proceedings for the various operations of Hawaii Water Service Company based on historical rate of return filings allowed by the Hawaii Public Utilities Commission. To the extent the approved rate of return filings allowed by the Hawaii Public Utilities Commission are less than expected, an impairment of the recorded goodwill may occur.


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Income Taxes
 
We account for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities 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. We recognize the effect on the deferred tax assets and liabilities of a change in tax rate in the period that includes the enactment date. We must also assess the likelihood that deferred tax assets will be recovered in future taxable income and, to the extent recovery is not probable, 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, 2010 or December 31, 2009.
 
We anticipate that future rate action by the regulatory commissions will reflect revenue requirements for the tax effects of temporary differences recognized, which have previously been passed through to customers. The regulatory commissions have granted us rate increases to reflect the normalization of the tax benefits of the federal accelerated methods and available Investment Tax Credits (ITCs) for all assets placed in service after 1980. ITCs are deferred and amortized over the lives of the related properties for book purposes.
 
The Company filed Form 3115, Application for Change in Accounting Method, during December 2010, related to California income tax depreciation deductions. The filing requests a change from the double declining depreciation method to the straight-line method. The impact could result in an additional $28 million of depreciation deductions on the Company’s California state income tax filing, which would result in tax savings.
 
Pension Benefits
 
We incur costs associated with our pension and postretirement health care benefits plans. To measure the expense of these benefits, our 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 our 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. We use an investment advisor to provide advice in managing the plan’s investments. With the 2009 GRC settlement, we anticipate any increases in funding for the pension and postretirement health care benefits plans will be recovered in future rate filings, thereby mitigating the financial impact. We believe it is probable that future costs will be recovered in future rates and therefore have recorded a regulatory asset in accordance with generally accepted accounting standards.
 
Workers’ Compensation and Other Claims
 
We are self-insured for a portion of workers’ compensation and other claims. Excess amounts are covered by insurance policies. For workers’ compensation, we work with an independent actuary firm to estimate the discounted liability associated with claims submitted and claims not yet submitted based on historical data. These estimates could vary significantly from actual claims paid, which could impact earnings and cash flows. For other claims, management estimates the cost incurred but not yet paid using historical information. Actual costs could vary from these estimates. Management believes actual costs incurred would be allowed in future rates, mitigating the financial impact.
 
Results of Operations
 
Earnings
 
Net income in 2010 was $37.7 million compared to $40.6 million in 2009 and $39.8 million in 2008. Diluted earnings per common share were $1.81 in 2010, $1.95 in 2009, and $1.90 in 2008. The weighted average number of common shares outstanding used in the diluted earnings per share calculation was 20,819,000 in 2010, 20,766,000 in 2009, and 20,734,000 in 2008. The decrease in 2010 earnings per share resulted from a decrease in other income and an increase in interest expense.


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Dividends
 
At the January 2011 meeting, the Board of Directors declared the quarterly dividend, increasing it for the 44th consecutive year. The quarterly dividend was raised from $0.2975 to $0.3075 per common share, or an annual rate of $1.23 per common share. Dividends have been paid for 66 consecutive years. The annual dividends paid per common share in 2010, 2009, and 2008 were $1.19, $1.18, and $1.17, respectively. Earnings not paid as dividends are reinvested in the business for the benefit of stockholders. The dividend payout ratio was 66% in 2010, 61% in 2009, and 62% in 2008, for an average of 63% over the three-year period. Our long-term targeted dividend payout ratio is 60%
 
Operating Revenue
 
Operating revenue in 2010 was $460.4 million, an increase of $11.0 million, or 2.5%, over 2009. Operating revenue in 2009 was $449.4 million, an increase of $39.1 million, or 9.5%, over 2008. The estimated sources of changes in operating revenue were:
 
                 
    2010     2009  
    Dollars in millions  
 
Rate increases
  $ 28.5     $ 50.6  
Usage by new customers
    2.3       10.7  
Net change due to actual versus adopted results, usage, and other
    (19.8 )     (22.2 )
                 
Net change
  $ 11.0     $ 39.1  
                 
 
The usage by existing customers can materially change based upon current weather patterns, influenced both by temperature and rainfall. However, with the adoption of the WRAM and MCBA for California customers on July 1, 2008, the impact of weather on gross margin has been minimized.
 
In 2010, rate relief increased revenues by $28.5 million with a significant portion due to purchased water offsets and balancing account activity. See the “Rates and Regulation” section of this annual report for more information on regulatory activity occurring in 2009, 2010, and through February 28, 2011.
 
Water Production Expenses
 
Water production expenses, which consist of purchased water, purchased power, and pump taxes, comprise the largest segment of total operating expenses. Water production costs accounted for 42.6%, 40.8%, and 41.5% of total operating costs in 2010, 2009, and 2008, respectively. The rates charged for wholesale water supplies, electricity, and pump taxes are established by various public agencies. As such, these rates are beyond our control.
 
The table below provides the amount of increases and percent changes in water production costs during the past two years:
 
                                                 
    2010     2009  
    Amount     Change     % Change     Amount     Change     % Change  
    Dollars in millions  
 
Purchased water
  $ 125.9     $ 4.2       3.5 %   $ 121.7     $ 10.0       9 %
Purchased power
    29.6       1.3       4.6 %     28.3       2.4       9 %
Pump taxes
    8.6       (0.9 )     (9.5 )%     9.5       0.6       7 %
                                                 
Total water production expenses
  $ 164.1     $ 4.6       2.9 %   $ 159.5     $ 13.0       9 %
                                                 
 
The principal factors affecting water production expenses are the quantity, price and source of the water. Generally, water from wells costs less than water purchased from wholesale suppliers.


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The table below provides the amounts, percentage change, and source mix for the respective years:
 
                                                 
    2010   2009   2008
    MG   % of Total   MG   % of Total   MG   % of Total
    Millions of gallons (MG)
 
Source:
                                               
Wells
    58,609       48.1 %     64,685       49.2 %     67,041       48.7 %
% change from prior year
    (9 )%             (4 )%             2 %        
Purchased
    56,654       46.5 %     60,292       45.8 %     65,529       47.5 %
% change from prior year
    (6 )%             (8 )%             (7 )%        
Surface
    6,679       5.4 %     6,581       5.0 %     5,187       3.8 %
% change from prior year
    1 %             27 %             1 %        
                                                 
Total
    121,942       100.0 %     131,558       100.0 %     137,757       100.0 %
                                                 
% change from prior year
    (7.3 )%             (4.5 )%             (2 )%        
 
Purchased water expenses are affected by changes in quantities purchased, supplier prices, and cost differences between wholesale suppliers. For 2010, the $4.2 million increase in purchased water is due to wholesaler water rate increases between 5% and 24% despite a 6% decrease in purchased quantities. On an overall blended basis, wholesale water rates increased 10% on a cost-per-million-gallon basis in 2010. Purchased water expense for 2010 was partially offset by lease water rights credits of $1.9 million. For 2009, purchased water expense increased by $10.0 million and was due to wholesaler water rate increases between 4% and 38% despite an 8% decrease in purchased quantities. Purchased water expense for 2009 was partially offset by lease water rights credits of $1.8 million. The impact of variation of actual water production expense from the adopted expense, effective July 1, 2008, is recorded as a component of revenue under the MCBA. See Item 1, “Rates and Regulation” of this annual report.
 
Purchased power expenses are affected by the quantity of water pumped from wells and moved through the distribution system, rates charged by electric utility companies, and rate structures applied to usage during peak and non-peak times of the day or season. The purchased power expense increase of $1.3 million was primarily due to power supplier rate increases during 2010.
 
The cost of purchased power in the future may be impacted by climate change legislation that would impact the rates our power suppliers charge us. Any change in pricing of our purchase power in California would be recovered from our rate payers by the MCBA. Any change in power costs in other states would be requested to be recovered by the rate payers in those states. The impact of such legislation, is dependent upon the enacted date, the factors that impact our suppliers cost structure, and their ability to pass the costs to us in their approved tariffs. These items are not known at this time.
 
Administrative and General Expenses
 
Administrative and general expenses include payroll related to administrative and general functions, all employee benefits charged to expense accounts, insurance expenses, legal fees, expenses associated with being a public company, and general corporate expenses.
 
During 2010, administrative and general expenses were flat as compared to last year. Pension costs, employee benefit costs, and payroll cost increases of $4.0 million in 2010 were offset by an increase in the proportion of labor and benefit costs included in capital projects, reductions to outside service costs, and reductions to employee relocation expenses.
 
During 2009, administrative and general expenses increased $15.8 million, or 26.6%, compared to 2008. Pension expense increased $8.6 million over the prior year and legal expense increased $1.0 million. Increase in labor expense and other administrative costs were offset by a reduction in recording of expense of fees paid to the Commission of $2.3 million. (Fees paid to the Commission by our customers were previously recorded as a component of revenue and expense. Effective July 1, 2008, the revenues are recorded net of fees with the adoption of


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the WRAM). Other expense elements contributed to the balance of the change, but none were individually significant.
 
Other Operations Expenses
 
The components of other operations expenses include payroll, material and supplies, and contract service costs of operating the regulated water systems, including the costs associated with water transmission and distribution, pumping, water quality, meter reading, billing, and operations of district offices.
 
For 2010, other operations expenses did not increase from 2009. The net costs for water treatment, water quality testing, chemicals, labor, and conservation expense were approximately flat compared to 2009.
 
For 2009, other operations expenses increased $5.4 million, or 10.5%, from 2008. The cost of operating the production and distribution systems increased $1.1 million, or 9.3% over the prior year and the cost for water treatment and water quality testing and chemicals increased by $1.4 million, or 13.8%. These increases were primarily due to an increase in the cost of labor. The other major contributing factor was an increase in conservation expense of $1.7 million, or 110% over the prior year. Other expense elements contributed to the balance of the change, but none were individually significant.
 
Maintenance
 
Maintenance expenses increased $1.1 million, or 6.2%, in 2010, compared to 2009 due to increased costs for repairs of mains, services, meters, hydrants, and other structures. For 2009, maintenance expenses decreased $0.4 million, or 2.3%, compared to 2008, due to decreased costs for maintenance of mains and services.
 
Depreciation and Amortization
 
Depreciation and amortization increased $3.1 million in 2010 and $2.4 million in 2009 due to capital additions from the previous year.
 
Our capital expenditures in California will be impacted by certain California environmental legislation passed in prior years. The CEQA permitting process involved in certain capital projects has increased the administrative cost of certain projects. California emission controls are expected to increase the cost of vehicle acquisitions. Certain existing vehicles will also have to be retrofitted to comply with the current legislation. The costs will be recovered via depreciation expense by our rate payers upon the filing of future general rate cases.
 
Income Taxes
 
For 2010, income taxes decreased $2.8 million as compared to 2009. For 2009, income taxes increased $3.2 million as compared to 2008. The decrease in income tax for 2010, as compared to 2009, was due to lower pretax income and a lower effective tax rate. The effective tax rate was 39.6%, 40.4%, and 37.7% in 2010, 2009, and 2008, respectively. The effective tax rate is impacted by the allowable tax benefit from an additional tax deduction for the qualified production activity deduction (QPAD) for income attributed to the production of water. The tax rate is also affected by the flow through method of accounting for income taxes which resulted from differences between tax depreciation and book depreciation on both pre-1982 assets, as well as all California assets. The flow through method of accounting is described in the Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements. We anticipate the reversal of federal tax depreciation on pre-1982 assets to continue in future years; however, its effect on our tax provision is uncertain due to the offsetting flow-through of state tax depreciation, which continues to increase with capital additions and the impact of cost to remove of pre-1982 assets. In September of 2010, bonus depreciation for federal income tax filings was extended through 2011. The additional bonus depreciation is expected to reduce our QPAD during our 2010 and 2011 federal income tax filings.
 
Property and Other Taxes
 
For 2010, property and other tax expenses increased $0.3 million, or 1.7% from 2009. The increase is primary due to increased payroll taxes due to higher taxable wages and additional property taxes due to 2010 utility plant


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additions. For 2009, tax expenses increased $2.0 million, or 13.4% from 2008. The increase is primary due to increased public service company tax due to the acquisitions in Hawaii in September 2008, increased payroll tax due to increased gross pay, increased local franchise tax, which is based upon revenue, and increased property tax, which is primary based upon our utility plant in service.
 
Non-Regulated Revenue and Expense, Net
 
The major components of non-regulated income are revenue and operating expenses related to the following activities:
 
  •  operating and maintenance services (O&M) and meter reading and billing services;
 
  •  antenna site leases;
 
  •  Extended Service Protection (ESP) services;
 
  •  design and construction services;
 
  •  interest income;
 
  •  selling surplus property;
 
  •  change in cash surrender value of life insurance; and
 
  •  non-regulated and new business expenses.
 
Revenues from antenna site leases to telecommunication companies were $2.2 million, $2.0 million, and $2.0 million in 2010, 2009, and 2008, respectively. Revenues from ESP were $2.0 million, $1.7 million, and $1.5 million in 2010, 2009, and 2008, respectively. Changes to the cash surrender value (CSV) of life insurance contracts associated with our benefit plans have had a significant impact to non-regulated expenses. There were unrealized gains of $2.6 million and $4.1 million in 2010 and 2009, respectively, and an unrealized loss of $3.8 million in 2008. The CSV is determined in part by the market of certain underlining funds, the value of which reflects the changes in the stock market. In addition, we expensed $1.3 million of acquisition costs associated with non-regulated operations and maintenance contracts during the last three years. For 2010, non-regulated income net of expenses decreased $1.5 million, or 4.1%, compared to 2009. The decrease was primarily due to a lower unrealized gain on the life insurance contracts associated with our benefit plans during 2010 and a $0.6 million expense for construction costs not allowed in ratebase in accordance with our 2009 GRC settlement during 2010. See Note 3 of the Notes to Consolidated Financial Statements for additional information.
 
Gain on Sale of Non-Utility Property
 
For 2010, 2009, and 2008, there were no significant non-utility property sales. Earnings and cash flow from these transactions are sporadic and may or may not continue in future periods, depending upon market conditions. The Company has other non-utility properties that may be marketed in the future based on real estate market conditions.
 
Interest Expenses
 
In 2010, interest expense increased $3.5 million compared to 2009. This increase was attributable to higher interest expense on the $100 million First Mortgage Bonds issued in November 2010, and $100 million First Mortgage Bonds issued in April 2009, and borrowings on our short-term line of credit. In addition, in 2010 there was a reduction to capitalized interest expense. The decrease in capitalized interest was due to booking an adjustment in the fourth quarter to reverse capitalized interest on completed projects due to retroactive in-service dates. The adjustment booked in the fourth quarter of 2010 reduced the amount of capitalized interest transferred to utility plant by $1.6 million. See the “Liquidity and Capital Resources” section for more information.


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Rates and Regulation
 
The state regulatory commissions have plenary powers setting rates and operating standards. As such, state commission decisions significantly impact our revenues, earnings, and cash flows. The amounts discussed herein are generally annual amounts, unless specifically stated, and the financial impact to recorded revenue is expected to occur over a 12-month period from the effective date of the decision. In California, water utilities are required to make several different types of filings. Most filings result in rate changes that remain in place until the next General Rate Case (GRC). As explained below, surcharges and surcredits to recover balancing and memorandum accounts as well as general rate case interim rate catch-up surcharges are temporary rate changes, which have specific time frames for recovery.
 
GRCs, escalation rate increase filings, and offset filings change rates to amounts that will remain in effect until the next GRC. The CPUC follows a rate case plan, which requires Cal Water to file a GRC for each of its 24 regulated operating districts every three years. In a GRC proceeding, the CPUC not only considers the utility’s rate setting requests, but may also consider other issues that affect the utility’s rates and operations. Effective in 2004, Cal Water’s GRC schedule was shifted from a calendar year to a fiscal year with test years commencing on July 1st of each year. Effective with the 2009 GRC, the schedule was shifted back to a calendar year. The CPUC is generally required to issue its GRC decision prior to the first day of the test year or authorize interim rates. In accordance with the rate case plan, the Commission issued a decision on Cal Water’s 2009 general rate case filing in the fourth quarter of 2010 with rates effective on January 1, 2011.
 
Between GRC filings utilities may file escalation rate increases, which allow the utility to recover cost increases, primarily from inflation and incremental investment, during the second and third years of the rate case cycle. However, escalation rate increases are subject to a weather-normalized earnings test. Under the earnings test, the CPUC may reduce the escalation rate increase if, in the most recent 12-month period, this earnings test reflects earnings in excess of authorized for that district.
 
In addition, utilities are entitled to file offset filings. Offset filings may be filed to adjust revenues for construction projects authorized in GRCs when the plant is placed in service or for rate changes charged to the Company for purchased water, purchased power, and pump taxes (referred to as “offsettable expenses”). Such rate changes approved in offset filings remain in effect until a GRC is approved.
 
Surcharges and surcredits to amortize balances in the WRAM and MCBA accounts, which are interest bearing, will be filed in April of each year based on the district balances for the last calendar year. Under current procedures, surcharges are expected to be amortized over 12 months for balances less than 5% of district gross revenue, 24 months for balances greater than 5% and less than 10% of district gross revenue, and 36 months for balances greater than 10% of district gross revenue. In the event the combined WRAM and MCBA balance for a district is less than 2.5% of revenue, the amount will not be amortized at that time. The WRAM and MCBA amounts are cumulative, so if they are not amortized in a given calendar year, the balance will be rolled forward and reviewed with the following year balance.


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The following is a summary of 2010 rate filings and the anticipated annual impact on revenues. California decisions and resolutions may be found on the CPUC website at www.cpuc.ca.gov.
 
                             
            Increase
  CA District/
Type of Filing
  Decision/Resolution   Approval Date   Annual Revenue   Subsidiary
 
GRC, Step Rate and Offset Filings
                           
Expense Offsets
    Various(1 )     Mar 2010     $ 5.4 million     3 districts
Expense Offsets
    Various(2 )     Apr 2010     $ 10.4 million     3 districts
Expense Offsets
    AL 1982       May 2010     $ 1.3 million     Stockton
Expense Offsets
    Various(3 )     July 2010     $ 5.7 million     5 districts
Expense Offsets
    Various(4 )     Sept 2010     $ 1.4 million     3 districts
Rate Base Offsets
    Various(5 )     Dec 2010     $ 0.8 million     7 districts
Escalation Rate Increase
    AL 1993C       July 2010     $ 4.2 million     7 districts
Surcharges and Surcredits
                           
General Office synergies memo account surcharge
    AL 1972       Feb 2010     $ 0.7 million     8 districts
 
 
(1) Increases result from advice letters 1976, 1977, and 1978.
 
(2) Increases result from advice letters 1979, 1980, and 1981.
 
(3) Increases result from advice letters 1988, 1989, 1990, 1991, and 1992.
 
(4) Increases result from advice letters 1999, 2000, and 2001.
 
(5) Increases result from advice letters 2007A, 2008A, 2009A, 2010A, 2011A, 2012A, and 2014.
 
The estimated impact of current and prior year rate changes on operating revenues compared to prior years is listed in the following table:
 
                         
    2010     2009     2008  
    Dollars in millions  
 
General Rate Case (GRC)(a)
  $ 0.4     $ 26.3     $ 31.0  
Step rate increases
    6.3       5.9       3.3  
Offset (purchased water/pump taxes)
    19.9       16.2       4.9  
Balancing accounts, net
    0.1       0.9       2.9  
Other rate increases
    1.8       1.3       0.0  
                         
Total rate increases
  $ 28.5     $ 50.6     $ 42.1  
                         
 
 
(a) GRC activity was lower during 2010 because all 24 districts are filed once every three years. The 2009 GRC was the first filing for all 24 districts with rate increases effective January 1, 2011. The 2010 rate increases were a carry-over from the 2007 GRC rate changes.
 
Remaining Unrecorded Balances from Previously Authorized Balancing Accounts Recoveries/Refunds
 
The total net under-collected incremental cost balancing accounts (ICBA) memorandum and balancing accounts was approximately $1.4 million as of December 31, 2010. Effective July 1, 2008, the ICBA memorandum and balancing accounts were replaced with the MCBA. In CPUC decision 10-12-017, Cal Water was authorized to file to recover its remaining balances in these accounts. This filing will occur in the first quarter of 2011 and is anticipated to collect a substantial portion of the remaining balance over a 12-month period.
 
Application to Resolve Commission’s Procedures for WRAM amortization
 
In 2010, Cal Water became aware of an inconsistency between the Commission’s authorized recovery periods for balancing accounts and the previously authorized 12-month and 18-month amortization periods. In order to maintain revenue neutrality as customers respond to aggressive conservation rates and programs, a “full WRAM”


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(offset by an MCBA) was crafted for most of Cal Water’s ratemaking units to ensure that Cal Water would continue to recover the revenue amounts authorized for that unit by the CPUC. In 2010, the CPUC applied periods of up to 24 and 36 months to amortize some WRAM/MCBA balances. Cal Water, along with four other investor-owned water utilities filed a joint application in September 2010 to modify the enabling language of the WRAM/MCBA accounts to change the amortization periods to 24 months or less. It is anticipated a favorable decision will be made in 2011 to recover WRAM and MCBA accounts within 24 months or less.
 
2010 Regulatory Activity
 
2007 California GRC Escalation Rate Increase
 
On July 3, 2007, Cal Water filed its 2007 GRC application covering eight districts and general office costs. On July 10, 2008, the CPUC approved a settlement between Cal Water and the Division of Ratepayer Advocates, and authorized annual rate increases for eight districts of $33.4 million. In its order, the CPUC allowed Cal Water to file immediately to recover its increased general costs in all other districts. The CPUC order also allows for additional rate increases, including escalation increases, which Cal Water requested in 2010, and offset increases after construction of certain large capital projects. In July 2010, Cal Water filed escalation rate increases in seven districts to increase rates by $4.2 million. These filings were approved effective in July 2010 as requested.
 
2008 California Cost of Capital Application
 
Cal Water received a decision in July 2009 in its 2008 Cost of Capital review which established a weighted cost of capital adjustment mechanism (WCCM). Under this mechanism, Cal Water is required to annually compare the October to September annual average Moody AA utility bond index with a 2008-2009 benchmark. If the average increased or decreased by 100 basis points from the benchmark, Cal Water would be required to file a rate change to reflect an increased or decreased return on equity. In 2009 and 2010 this mechanism was not triggered as the index did not change by 100 basis points.
 
Cal Water will file an application with the CPUC in May of 2011 to review its cost of capital for 2012 through 2014. We cannot predict if this or another adjustment mechanism will be adopted by the CPUC in that proceeding.
 
2009 California GRC Decision
 
On July 2, 2009, Cal Water filed its 2009 GRC application covering all 24 districts and general office costs. The GRC application requested an increase of $70.6 million or 16.75% in rates for 2011, $24.8 million or 5.04% in rates for 2012 and $24.8 million or 4.79% in rates for 2013. On December 2, 2010, the CPUC issued decision 10-12-017, which approved a settlement between Cal Water, the Division of Ratepayer Advocates, and several intervenors representing the interests of individual district customers. This decision allows for revenue increases of $25.4 million or 5.6% in 2011. Cal Water is also allowed to file for increases of $9.6 million or 2.0% for 2012, and $9.0 million or 2.0% for 2013 subject to adjustment for indexed inflation and contingent upon passing a weather normalized earnings test. This decision also allows for offset increases after construction of 77 large capital projects in various operating districts.
 
In addition, the Company was authorized to make a deviation from its escalation expense and exclude employee health care, retiree health insurance, and conservation expenses from it escalation filings in 2012 and 2013. Instead for these three significant expense items, the CPUC has enumerated fixed three-year budgets for these expenses. It is anticipated that the budgets for these areas will more closely align with the actual expenses now that this change has been initiated.
 
The CPUC also authorized a Pension Balancing Account to track the difference between authorized pension contributions included in rates and the costs actually incurred. It is anticipated that this account will allow Cal Water to reduce some of the volatility it experiences in regard to these costs.
 
The Company was also authorized to combine the rates and tariffs of the South San Francisco and the Mid Peninsula Districts, located on the San Francisco peninsula, into a single ratemaking area in 2011. This new ratemaking area is known as the Bayshore District. Previously, the 2 separate districts had been operated out of a combined location.


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Due to the transition between a phased rate case and a total company filing, the CPUC delayed the rate cases of 16 Cal Water districts. However, to compensate for this delay, the CPUC authorized interim rates from the authorized effective date under the old rate case plan. The difference between revenue requirements that were effective in the interim period and those calculated based on a final determination in the 2009 general rate case filing are being recovered as customer surcharges over a three-year period. Cal Water anticipates these surcharges will recover $3.3 million in 2011, $2.2 million in 2012, and $1.2 million in 2013.
 
Low Income Ratepayer Assistance Program
 
Cal Water currently administers a Low Income Ratepayer Assistance Program (LIRA) in accordance with decision 06-11-053. This program provides qualifying low income customers with a 50% discount on their service charge (up to a maximum of $10 per month). It imposes a surcharge on non-qualifying customers of $0.01 per hundred cubic feet of monthly water consumption for metered customers and between $0.24 and $0.41 per flat rate service per month. Due to a successful enrollment of over 41,000 customers, this account had accumulated an under collection of approximately $3.7 million as of December 31, 2010, and is recorded in non-current regulatory assets. In July 2010, Cal Water filed an advice letter to adjust the surcharge in order to resolve this undercollection situation. The CPUC rejected this filing and determined that this surcharge could only be adjusted during a GRC. Cal Water must either wait until the next GRC in 2012 to file this change in surcharge or file an application to modify the enabling language of the LIRA program. At this point, Cal Water believes this amount will be fully recoverable as the program is in line with CPUC policy and objectives. Cal Water will file an application to modify the enabling language to resolve the under-collection situation.
 
2010 Ka’anapali (Hawaii) GRC Filing
 
On December 30, 2010, Hawaii Water filed its 2010 GRC application for the Ka’anapali Service Area. The Hawaii Public Utilities Commission (HPUC) requires a separate rate application for all service areas and uses a historic based test year. The Ka’anapali GRC requested additional revenue of $1.5 million or an increase of 38.2 percent over the prior year. The HPUC has accepted this filing as complete and Hawaii Water anticipates a resolution in the second quarter of 2011.
 
Request for MTBE regulatory treatment
 
On July 8, 2009, Cal Water filed an application requesting that the CPUC adopt ratemaking treatment of proceeds from its partial settlement of MTBE contamination litigation. Cal Water requested that all of the proceeds be reinvested in infrastructure to treat or replace MTBE-contaminated facilities. In addition, Cal Water requested that 50% of the reinvestment be included in ratebase upon which Cal Water could earn its authorized fair and reasonable rate of return. The remaining 50% of the settlement proceeds would be included in ratebase as contributions in aid of construction which does not earn a return. Cal Water also requested specific regulatory treatment of future settlement or litigation proceeds that may occur in the consolidated MTBE cases. As an interim step, Cal Water and the CPUC’s Division of Ratepayer Advocates agreed to track all proceeds and remediation costs in a memorandum account for future disposition. This treatment removes from rate base the capital projects that will be constructed to replace or treat for MTBE. This treatment was reflected in the rates authorized in the 2009 GRC.
 
On October 14, 2010, in a separate industry-wide proceeding, the CPUC issued an interim decision in its review of general policies for accounting treatment of contamination proceeds. The interim decision would require all proceeds to be used first to pay transactional expenses, then to make ratepayers whole for costs to ensure the water system complies with the Commission’s water quality standards. The interim decision allows for a risk-based consideration of proceeds which exceed the costs of the remediation described above and may result in some sharing of excess, or “net” proceeds. The interim decision also allows the utility to track litigation and settlement proceeds, along with transactional costs and remediation costs, in a memorandum account. It directs the utility to include a request for disposition of its memorandum account in a general rate case.
 
Because treatment or replacement of Cal Water’s MTBE contaminated wells will occur over a number of years, and because litigation continues with remaining defendants, a final disposition of Cal Water’s memorandum account will occur at an unknown future date. Cal Water has filed a joint motion with the CPUC’s Division of


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Ratepayer Advocates to dismiss the July 2009 application and address the contamination proceeds after the conclusion of litigation and remediation. Cal Water cannot predict the timing or outcome of a ruling on that motion or on the outcome of the proceeding.
 
2010 Expense Offset filings
 
In 2010, Cal Water filed advice letters to offset increased purchased water and pump tax rates in eleven of its regulated districts totaling $24.2 million in annual revenue. Expense offsets are dollar-for-dollar increases in revenue to match increased expenses and interact with the WRAM and MCBA mechanisms so that net operating income is not affected by an offset increase.
 
In the future, Cal Water plans to file advice letters to offset expected increases in purchased water and pump tax charges in some districts. Cal Water cannot predict the exact timing or dollar amount of the changes.
 
2010 Ratebase Offset filings
 
In 2010, Cal Water filed advice letters to offset infrastructure improvements in seven of its regulated districts totaling $0.8 million in annual revenue. Companies are allowed to file ratebase offsets to increase revenues for construction projects authorized in GRCs when the plant is placed in service. The projects for these filings were authorized in the 2006 and 2007 GRCs.
 
Water Supply
 
Our source of supply varies among our operating districts. Certain districts obtain all of their supply from wells; some districts purchase all of their supply from wholesale suppliers; and other districts obtain supply from a combination of wells and wholesale suppliers. A small portion of supply comes from surface sources and is processed through Company-owned water treatment plants. To the best of management’s knowledge, we are meeting water quality, environmental, and other regulatory standards for all company-owned systems.
 
California’s normal weather pattern yields little precipitation between mid-spring and mid-fall. The Washington Water service areas receive precipitation in all seasons, with the heaviest amounts during the winter. New Mexico Water’s rainfall is heaviest in the summer monsoon season. Hawaii Water receives precipitation throughout the year, with the largest amounts in the winter months. 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 aquifers and fill reservoirs, providing the water supply for subsequent delivery to customers. To date, snowpack water content and rainfall accumulation during the 2010 — 2011 water year is 121% of normal (as of February 23, 2011 per the California Department of Water Resources). Precipitation in 2010 was above average. Management believes that supply pumped from underground aquifers and purchased from wholesale suppliers will be adequate to meet customer demand during 2011 and beyond. However, water rationing may be required in future periods, if declared by the state or local jurisdictions. Long-term water supply plans are developed for each of our districts to help assure an adequate water supply under various operating and supply conditions. Some districts have unique challenges in meeting water quality standards, but management believes that supplies will meet current standards using current treatment processes.
 
Liquidity and Capital Resources
 
Cash flow from Operations
 
During 2010, we generated cash flow from operations of approximately $75.5 million, compared to $72.0 million during 2009, and $95.7 million during 2008. Cash flow from operations is primarily generated by net income, non-cash expenses for depreciation and amortization, deferred income taxes and changes to the net unbilled WRAM and MCBA account balances. Cash generated by operations varies during the year.
 
The water business is seasonal. Billed 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 highest. This seasonality results in the possible need for short-term borrowings under the bank lines of credit in the event cash is not sufficient to cover operating and capital costs during the winter period. The increase in cash flow during the summer allows short-term borrowings to


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be paid down. Customer water usage can be lower than normal in years when more than normal precipitation falls in our service areas or temperatures are lower than normal, especially in the summer months. The reduction in water usage reduces cash flow from operations and increases the need for short-term bank borrowings. In addition, short-term borrowings are used to finance capital expenditures until long-term financing is arranged.
 
Investing Activities
 
During 2010, we used $123.9 million of cash for capital expenditures, both company-funded and developer-funded. Capital expenditures were budgeted at approximately $140 million. Annual expenditures fluctuate each year due to the availability of construction resources and our ability to obtain construction permits in a timely manner.
 
Included in investing activities in 2008 was the receipt of $34.2 million from our MTBE litigations. We are working with the CPUC to finalize regulatory treatment for these proceeds and have used $9.2 million in our 2009 federal income tax return to replace infrastructure damage in accordance with Section 1033 of the Internal Revenue Code. While we have not yet determined the final regulatory accounting treatment of the proceeds, we anticipate using the proceeds on infrastructure improvements.
 
Financing Activities
 
During 2010, Cal Water issued $100 million aggregate principal amount of its 5.50% First Mortgage Bonds due in 2040, which are fully and unconditionally guaranteed by the Company.
 
During 2009, Cal Water issued $100 million aggregate principal amount of its 5.875% First Mortgage Bonds due in 2019, which are fully and unconditionally guaranteed by the Company. Pursuant to the note purchase agreements and supplements thereto under which Cal Water’s outstanding unsecured senior notes had been issued, Cal Water was required to issue a new series of First Mortgage Bonds in exchange for each outstanding series of unsecured senior notes with a like aggregate principal amount. The offering triggered this exchange provision. Accordingly, upon the closing of the offering, Cal Water was required to issue an additional series of First Mortgage Bonds under the mortgage indenture with a like aggregate principal amount to the holders of each series of its outstanding unsecured senior notes in exchange for each such series of notes.
 
First Mortgage Bonds with an aggregate principal amount of $10 million matured during 2010. In addition, $1.7 million of First Mortgage Bond payments were made during 2010.
 
Short-Term Financing
 
Short-term liquidity is provided by credit facilities extended to us and to certain of our subsidiaries and by internally generated funds. Long-term financing is accomplished through use of both debt and equity. Short-term bank borrowings were $23.8 million at December 31, 2010 and $12.0 million at December 31, 2009. Cash and cash equivalents were $42.3 million at December 31, 2010, and $9.9 million at December 31, 2009. Given our ability to access our lines of credit on a daily basis, cash balances are managed to levels required for daily cash needs and excess cash is invested in short-term or cash equivalent instruments. Minimal operating levels of cash are maintained for Washington Water, New Mexico Water, and Hawaii Water. During 2010, short-term borrowings were $85.8 million to finance capital projects and operations. During the fourth quarter of 2010, $74 million of these short-term borrowings were repaid after the issuance of the $100 million first Mortgage Bond. See “Financing Activities” section above.
 
On October 27, 2009, the Company and Cal Water entered into three-year syndicated unsecured revolving line of credit agreements with sixteen banks to provide an unsecured revolving line of credit of $50 million and $250 million, respectively. The base loan rate can vary from prime plus 50 basis points to prime plus 125 basis points depending on the Company’s total capitalization ratio. Likewise, the unused commitment fee can vary from 25 basis points to 35 basis points based on the same ratio. Based on the Company’s planned capitalization during 2010 and future years, the Company expects its pricing to be prime plus 75 basis points with a 25 basis point unused commitment fee. California Water Service Group and subsidiaries which it designates may borrow under the Company’s facilities. Borrowings by Cal Water under its revolving credit agreement are required to be repaid within


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12 months unless otherwise authorized by the CPUC. Bank of America was selected as lead bank and administrative agent, with CoBank and Bank of China as co-syndication agents.
 
These unsecured credit agreements contain affirmative and negative covenants and events of default customary for credit facilities of this type including, among other things, limitations and prohibitions relating to additional indebtedness, liens, mergers, and asset sales. Also, these unsecured credit agreements contain financial covenants governing the Company and its subsidiaries’ consolidated total capitalization ratio and interest coverage ratio. The availability on the Company’s and Cal Water’s short-term credit facilities at December 31, 2010 and 2009 were $250 million and $26.2 million, respectively. As of December 31, 2010, we have met all of the covenant requirements and are eligible to use the full amount of the commitment.
 
Long-Term Financing
 
Long-term financing, which includes first mortgage bonds, other debt securities, and common stock, has been used to replace short-term borrowings and fund capital expenditures. Internally generated funds, after making dividend payments, provide positive cash flow, but have not been at a level to meet the needs of our capital expenditure requirements. Management expects this trend to continue given our capital expenditures plan for the next five years. Some capital expenditures are funded by payments received from developers for contributions in aid of construction or advances for construction. Funds received for contributions in aid of construction are non-refundable, whereas funds classified as advances in construction are refundable. Management believes long-term financing is available to meet our cash flow needs through issuances in both debt and equity markets.
 
On January 7, 2010, Cal Water filed an application for additional financing authority with the CPUC. This request was approved on September 23, 2010, and the CPUC decision authorizes Cal Water to issue $350 million of debt and common stock to finance capital projects and operations. In November 2010, Cal Water issued $100 million of First Mortgage Bonds pursuant to the CPUC decision.
 
In 2010, we utilized cash generated from operations, borrowings on the lines of credit, and the First Mortgage Bond financings. We did not issue any significant common stock in 2010. In future periods, management anticipates funding our capital needs through a relatively balanced approach between long term debt and equity.
 
Additional information regarding the bank borrowings and long-term debt is presented in Notes 8 and 9 in the Notes to Consolidated Financial Statements.
 
Off-Balance Sheet Transactions
 
We do not utilize off-balance-sheet financing or utilize special purpose entity arrangements for financing. We do not have equity ownership through joint ventures or partnership arrangements.
 
Contractual Obligations
 
                                         
          Less than
                After
 
    Total     1 Year     1-3 Years     3-5 Years     5 Years  
    (In thousands)  
 
Long-term debt
  $ 479,852     $ 2,783     $ 52,303     $ 12,974     $ 411,792  
Interest payments
    441,405       29,049       56,438       54,231       301,687  
Advances for construction
    186,899       6,672       19,866       13,126       147,235  
Office leases
    3,465       833       1,217       648       767  
System leases
    8,341       922       1,810       1,810       3,799  
Water supply contracts
    513,425       17,163       34,342       34,336       427,584  
                                         
TOTAL
  $ 1,633,387     $ 57,422     $ 165,976     $ 117,125     $ 1,292,864  
 
Our contractual obligations are summarized in the table above. For pension and post retirement benefits other than pension obligations see Note 12 of the Notes to the consolidated Financial Statements. 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


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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. System and office leases include obligations associated with leasing water systems and rents for office space.
 
Cal Water has water supply contracts with wholesale suppliers in 14 of its operating districts and for the two leased systems in Hawthorne and Commerce. For each contract, the cost of water is established by the wholesale supplier and is generally beyond our control. The amount paid annually to the wholesale suppliers is charged to purchased water expense on our statement of income. Most contracts do not require minimum annual payments and vary with the volume of water purchased.
 
We have a contract with the Santa Clara Water District, which contains minimum purchase obligations. The contract payment varies with the volume of water purchased above the minimum purchase levels. Management plans to continue to purchase and use at least the minimum quantity of water that is required to purchase under this contract in the future. Total paid under this contract was $5.3 million in 2010, $5.4 million in 2009, and $6.7 million in 2008.
 
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. Due to the fixed price arrangement, we utilize 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 $6.2 million in 2010, $5.5 million in 2009, and $5.7 million in 2008. Pricing under the contract varies annually. Estimated annual contractual obligations in the above table are based on the same payment level as 2010. Future cost increases by SEWD are expected to be offset by a decline in the allocation of costs to us as more of these costs are expected to be allocated to other SEWD customers due to growth within their service areas.
 
On September 21, 2005, we entered into an agreement with Kern County Water Agency (Agency) to obtain treated water for our operations. The term of the agreement is to January 1, 2035, or until the Agency’s bonds are repaid. The Agency’s bonds are described below. Under the terms of the agreement, we were obligated to purchase approximately 11,500 acre feet of treated water in 2010 and an incrementally higher volume of water for each subsequent year until 2017, when we are obligated to purchase 20,500 acre feet of treated water per year. We are obligated to pay a capital facilities charge and a treated water charge, both of which will be expensed as invoiced, regardless of whether we can use the water in our operation, and we are obligated for these charges even if the Agency cannot produce an adequate amount to supply the 20,500 acre feet in the year. This agreement supersedes a prior agreement with Kern County Water Agency for the supply of 11,500 acre feet of water per year. Total paid, under the prior agreement, was $5.5 million, $5.5 million, and $4.4 million in 2010, 2009 and 2008, respectively.
 
Three other parties, including the City of Bakersfield, are also obligated to purchase a total of 32,500 acre feet per year under separate agreements with the Agency. Further, the Agency has the right to proportionally reduce the water supply provided to all of the participants if it cannot produce adequate supplies. The participation of all parties in the transaction for expansion of the Agency’s facilities, including its water purification plant, purchase of the water, and payment of interest and principal on the bonds being issued by the Agency to finance the transaction, is required as a condition to the obligation of the Agency to proceed with expansion of the Agency’s facilities. If any of the other parties does not use its allocation in a given year, that party is still obligated to pay its contracted amount.
 
The Agency has issued bonds to fund the project and will use the payments of the capital facilities charges by us and the other contracted parties to meet the Agency’s obligations to pay interest and repay principal on the bonds. If any of the parties were to default on making payments of the capital facilities charge, then the other parties are obligated to pay for the defaulting party’s share on a pro-rata basis. If there is a payment default by a party and the remaining parties have to make payments, they are also entitled to a pro-rata share of the defaulting party’s water allocation.
 
We expect to use all of its entitled water in our operations every year. If additional treated water is available, all parties have an option to purchase this additional treated water, subject to the Agency’s right to allocate the water among the parties. If we were to pay for and receive additional amounts of water due to a default of another participating party, we believe we could use this additional water in our operations without incurring substantial increases in incremental costs.


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The total obligation of all parties, excluding us, is approximately $82.4 million to the Agency. Based on the credit worthiness of the other participants, which are government entities, our management believes it to be highly unlikely that we would be required to assume any other parties’ obligations under the contract due to their default. If a party defaults, we would receive entitlement to the additional water for assuming the additional obligation.
 
Once the project is complete, we are obligated to pay a capital facilities charge and a treated water charge that together total $6.1 million annually, which equates to $297 dollars per acre foot. Annual payments of $3.6 million for the capital facilities charge began when the Agency issued bonds to fund the project. Total treated water charge for 2010 was $2.5 million. Once the entire expansion project is completed, the full annual payments will be $6.1 million which will continue through the term of the agreement. As treated water is being delivered, we will also be obligated for our portion of the operating costs; that portion is currently estimated to be $7 dollars per acre foot. The actual amount will vary due to variations from estimates, inflation, and other changes in the cost structure. Our overall estimated cost of $297 dollars per acre foot is less than the estimated cost of procuring untreated water (assuming water rights could be obtained) and then providing treatment.
 
Capital Requirements
 
Capital requirements consist primarily of new construction expenditures for expanding and replacing utility plant facilities and the acquisition of water systems. They also include refunds of advances for construction.
 
Company-funded and developer-funded utility plant expenditures were $123.9 million, $110.6 million, and $107.8 million in 2010, 2009, and 2008, respectively. A majority of capital expenditures was associated with mains and water treatment equipment.
 
For 2011, the Company is estimating its capital expenditures to be between $125 and $135 million. We do not expect significant increases or declines in annual capital expenditure for the next five years.
 
Management expects us to incur non-company funded expenditures in 2010. These expenditures will be financed by developers through refundable advances for construction and non-refundable contributions in aid of construction. Developers are required to deposit the cost of a water construction project with us prior to our commencing construction work, or the developers may construct the facilities themselves and deed the completed facilities to us. Funds are generally received in advance of incurring costs for these projects. Advances are normally refunded over a 40-year period without interest. Future payments for advances received are listed under contractual obligations above. Because non-company-funded construction activity is solely at the discretion of developers, we cannot predict the level of future activity. The cash flow impact is expected to be minor due to the structure of the arrangements.
 
Capital Structure
 
Common stockholders’ equity was $435.5 million compared to $420.6 million at December 31, 2010 and 2009, respectively. As noted above, the Company incurred additional long-term debt in 2010.
 
Total capitalization, including the current portion of long-term debt, at December 31, 2010, was $917.1 million and $807.9 million at December 31, 2009. The Company intends to issue common stock and long-term debt to finance our operations. The capitalization ratios will vary depending upon the method we choose to finance our operations.
 
At December 31, capitalization ratios were:
 
                 
    2010   2009
 
Common equity
    47.5 %     52.1 %
Long-term debt
    52.5 %     47.9 %
 
The return (from both regulated and non-regulated operations) on average common equity was 9.0% in 2010 compared to 9.8% in 2009.


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Acquisitions
 
In 2010, there were no acquisitions.
 
In 2009, after receiving regulatory approval, Cal Water acquired two water utility systems with no increase to the allowed rate base. In addition, as part of the acquisition Cal Water assumed cash of $0.5 million and an obligation of equal amount to fund future capital projects on behalf of rate payers. No other assets or liabilities were assumed.
 
In 2008, the Company’s wholly-owned subsidiary HWS Utility Services, LLC, acquired contracts to operate and maintain water and wastewater systems in Hawaii. The purchase price of $1.3 million was amortized over calendar years 2008, 2009, and 2010.
 
On September 2, 2008, after receiving regulatory approval, the Company’s wholly-owned subsidiary, Hawaii Water Service Company, Inc. acquired all the outstanding stock of three related privately held companies (Waikoloa Resort Utilities, Inc.; Waikoloa Water Company, Inc.; Waikoloa Sewer Company, Inc.) on the Island of Hawaii with water and wastewater operations. The combined purchase price was $20.6 million. Assets acquired were $26.9 million, including cash of $6.3 million. Liabilities assumed were $10.2 million (net of $12.6 million which was paid at close of escrow). Goodwill of $3.9 million was initially recorded. In 2010, the goodwill was reduced by $1.3 million in recognition of the tax benefits of the acquired net operating loss carryforwards. On December 19, 2008, after receiving regulatory approval, Hawaii Water acquired the water and wastewater assets of two other privately held company (Kukio Utility Company and WB Maninowali) for a cash price of $10.6 million which was the assigned value of the assets. No liabilities were assumed.
 
Real Estate Program
 
We own real estate. From time to time, certain parcels are deemed no longer used or useful for water utility operations. Most surplus properties have a low cost basis. We developed a program 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. Property sales produced pretax gains of less than $0.1 million, $0.6 million and less than $0.1 million in 2010, 2009, and 2008, respectively. As sales are dependent on real estate market conditions, future sales, if any, may or may not be at prior year levels.
 
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk
 
We do not participate in hedge arrangements, such as forward contracts, swap agreements, options, or other contractual agreements to mitigate the impact of market fluctuations on our assets, liabilities, production, or contractual commitments. We operate only in the United States and, therefore, are not subject to foreign currency exchange rate risks.
 
Interest Rate Risk
 
We are subject to interest rate risk, although this risk is lessened because we operate in a regulated industry. If interest rates were to increase, management believes customer rates would increase accordingly, subject to Commission approval in future GRC filings. The majority of our debt is long-term at a fixed rate. Interest rate risk does exist on short-term borrowings within our credit facilities, as these interest rates are variable. We also have interest rate risk on new financing, as higher interest cost may occur on new debt if interest rates increase.
 
Over the next 12 months, approximately $2.8 million of the $479.9 million of existing long-term debt instruments will mature. Applying a hypothetical 10 percent increase in the rate of interest charged on those borrowings would not have a material effect on our earnings.


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Item 8.   Financial Statements and Supplementary Data.
 
Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Stockholders of
California Water Service Group
San Jose, California
 
We have audited the accompanying consolidated balance sheets of California Water Service Group and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of income, common stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2010. We also have audited the Company’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
 
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
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, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
/s/ Deloitte & Touche LLP
 
San Francisco, California
February 28, 2011


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CALIFORNIA WATER SERVICE GROUP
 
Consolidated Balance Sheets
 
                 
    December 31,  
    2010     2009  
    In thousands, except per share data  
 
ASSETS
Utility plant:
               
Land
  $ 21,355     $ 19,422  
Depreciable plant and equipment
    1,695,075       1,575,756  
Construction work in progress
    103,214       89,908  
Intangible assets
    24,122       23,976  
                 
Total utility plant
    1,843,766       1,709,062  
Less accumulated depreciation and amortization
    (549,469 )     (510,985 )
                 
Net utility plant
    1,294,297       1,198,077  
                 
Current assets:
               
Cash and cash equivalents
    42,277       9,866  
Receivables: net of allowance for doubtful accounts of $804 and $847, respectively
               
Customers
    25,813       25,567  
Regulatory balancing accounts
    14,784       10,513  
Other
    5,386       9,043  
Unbilled revenue
    13,925       13,417  
Materials and supplies at weighted average cost
    6,058       5,530  
Prepaid income taxes
    10,168       7,192  
Taxes, prepaid expenses, and other assets
    7,799       11,113  
                 
Total current assets
    126,210       92,241  
                 
Other assets:
               
Regulatory assets
    229,577       204,104  
Unamortized debt premium and expense
    6,489       4,756  
Goodwill
    2,615       2,615  
Other
    32,878       23,788  
                 
Total other assets
    271,559       235,263  
                 
    $ 1,692,066     $ 1,525,581  
                 
CAPITALIZATION AND LIABILITIES
Capitalization:
               
Common stock, $0.01 par value; 25,000 shares authorized, 20,833 and 20,765, outstanding in 2010 and 2009, respectively
  $ 208     $ 208  
Additional paid-in capital
    217,517       215,528  
Retained earnings
    217,801       204,898  
                 
Total common stockholders’ equity
    435,526       420,634  
Long-term debt, less current maturities
    479,181       374,269  
                 
Total capitalization
    914,707       794,903  
                 
Current liabilities:
               
Current maturities of long-term debt
    2,380       12,953  
Short-term borrowings
    23,750       12,000  
Accounts payable
    39,505       43,689  
Regulatory balancing accounts
    3,025       2,430  
Accrued other taxes
    3,079       4,369  
Accrued interest
    4,651       4,258  
Other accrued liabilities
    30,958       30,659  
                 
Total current liabilities
    107,348       110,358  
                 
Unamortized investment tax credits
    2,244       2,318  
Deferred income taxes
    107,084       91,851  
Regulatory liabilities
    17,079       19,669  
Pension and postretirement benefits other than pension
    155,224       137,127  
Advances for construction
    186,899       185,027  
Contributions in aid of construction
    136,356       118,217  
MTBE settlement
    34,443       34,375  
Other long-term liabilities
    30,682       31,736  
Commitments and contingencies
    —       —  
                 
    $ 1,692,066     $ 1,525,581  
                 
 
See accompanying Notes to Consolidated Financial Statements.


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CALIFORNIA WATER SERVICE GROUP
 
Consolidated Statements of Income
 
                         
    For the Years Ended December 31,  
    2010     2009     2008  
    In thousands, except per share data  
 
Operating revenue
  $ 460,399     $ 449,372     $ 410,312  
                         
Operating expenses:
                       
Operations:
                       
Purchased water
    125,930       121,695       111,726  
Purchased power
    29,577       28,252       25,939  
Pump taxes
    8,600       9,537       8,899  
Administrative and general
    75,276       75,243       59,429  
Other
    56,518       56,577       51,196  
Maintenance
    19,685       18,537       18,969  
Depreciation and amortization
    42,828       39,778       37,339  
Income taxes
    23,069       24,812       24,507  
Property and other taxes
    17,103       16,822       14,839  
                         
Total operating expenses
    398,586       391,253       352,843  
                         
Net operating income
    61,813       58,119       57,469  
                         
Other income and expenses:
                       
Non-regulated revenue
    15,993       18,190       14,230  
Non-regulated expense
    (12,312 )     (12,452 )     (15,097 )
Gain on sale of non-utility property
    22       560       7  
Income tax (expense) benefit on other income and expenses
    (1,487 )     (2,550 )     376  
                         
Net other income (expense)
    2,216       3,748       (484 )
                         
Interest expense:
                       
Interest expense
    27,936       24,394       20,591  
Less: capitalized interest
    (1,563 )     (3,081 )     (3,411 )
                         
Net interest expense
    26,373       21,313       17,180  
                         
Net income
  $ 37,656     $ 40,554     $ 39,805  
                         
Earnings per share:
                       
Basic
  $ 1.81     $ 1.95     $ 1.90  
Diluted
  $ 1.81     $ 1.95     $ 1.90  
Weighted average number of common shares outstanding:
                       
Basic
    20,806       20,745       20,710  
Diluted
    20,819       20,766       20,734  
 
See accompanying Notes to Consolidated Financial Statements.


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CALIFORNIA WATER SERVICE GROUP
 
Consolidated Statements of Common Stockholders’ Equity
For the Years Ended December 31, 2010, 2009 and 2008
 
                                         
                Additional
          Total
 
    Common Stock     Paid-in
    Retained
    Stockholders’
 
    Shares     Amount     Capital     Earnings     Equity  
    In thousands  
 
Balance at December 31, 2007
    20,666     $ 207     $ 211,885     $ 173,617     $ 385,709  
Net income
    —       —       —       39,805       39,805  
Issuance of common stock
    57       —       2,037       —       2,037  
Premium on retirement of preferred stock
    —       —       —       (253 )     (253 )
Dividends paid:
                                       
Preferred stock
    —       —       —       (115 )     (115 )
Common stock
    —       —       —       (24,234 )     (24,234 )
                                         
Total dividends paid
    —       —       —       (24,349 )     (24,349 )
                                         
Balance at December 31, 2008
    20,723       207       213,922       188,820       402,949  
Net income
    —       —       —       40,554       40,554  
Issuance of common stock
    42       1       1,606       —       1,607  
Dividends paid on common stock
    —       —       —       (24,476 )     (24,476 )
                                         
Balance at December 31, 2009
    20,765       208       215,528       204,898       420,634  
Net income
    —       —       —       37,656       37,656  
Issuance of common stock
    68       —       1,989       —       1,989  
Dividends paid on common stock
    —       —       —       (24,753 )     (24,753 )
                                         
Balance at December 31, 2010
    20,833     $ 208     $ 217,517     $ 217,801     $ 435,526  
                                         
 
See accompanying Notes to Consolidated Financial Statements.


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CALIFORNIA WATER SERVICE GROUP
 
Consolidated Statements of Cash Flows
 
                         
    For the Years Ended December 31,  
    2010     2009     2008  
    In thousands  
 
Operating activities:
                       
Net income
  $ 37,656     $ 40,554     $ 39,805  
                         
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization
    45,265       41,643       39,485  
Amortization of debt premium and expenses
    979       970       673  
Other changes in noncurrent assets and liabilities
    3,725       3,688       10,659  
Change in value of life insurance contracts
    (2,641 )     (4,107 )     3,763  
Gain on sale of non-utility property
    (22 )     (560 )     (7 )
Changes in operating assets and liabilities:
                       
Receivables
    (860 )     (9,557 )     (6,069 )
Unbilled revenue
    (508 )     (305 )     (201 )
Taxes, prepaid expenses, and other assets
    (2,842 )     (2,332 )     (4,421 )
Accounts payable
    220       1,340       2,610  
Material and supplies
    (528 )     (460 )     (322 )
Other current liabilities
    (598 )     734       8,109  
Other changes, net
    (4,336 )     816       1,646  
                         
Net adjustments
    37,854       31,870       55,925  
                         
Net cash provided by operating activities
    75,510       72,424       95,730  
                         
Investing activities:
                       
Utility plant expenditures
    (123,926 )     (110,608 )     (107,804 )
MTBE settlement received
    —       —       34,217  
Proceeds from sale of non-utility assets
    34       810       7  
Acquisitions
    —       —       (24,924 )
Purchase of life insurance
    (1,891 )     (1,813 )     (1,373 )
Changes in restricted cash
    3,169       (3,104 )     —  
                         
Net cash used in investing activities
    (122,614 )     (114,715 )     (99,877 )
                         
Financing activities:
                       
Short-term borrowings
    85,750       20,000       56,000  
Repayment of short-term borrowings
    (74,000 )     (48,000 )     (16,000 )
Issuance of common stock, net of expenses
    912       614       —  
Issuance of long-term debt, net of expenses
    106,173       97,980       655  
Advances and contributions in aid of construction
    5,313       4,981       8,227  
Refunds of advances for construction
    (6,188 )     (6,039 )     (6,662 )
Retirement of long-term debt
    (13,692 )     (6,772 )     (2,871 )
Redemption of preferred stock
    —       —       (3,718 )
Dividends paid
    (24,753 )     (24,476 )     (24,349 )
                         
Net cash provided by financing activities
    79,515       38,288       11,282  
                         
Change in cash and cash equivalents
    32,411       (4,003 )     7,135  
Cash and cash equivalents at beginning of year
    9,866       13,869       6,734  
                         
Cash and cash equivalents at end of year
  $ 42,277     $ 9,866     $ 13,869  
                         
Supplemental disclosures of cash flow information:
                       
Cash paid during the year for:
                       
Interest (net of amounts capitalized)
  $ 24,425     $ 20,351     $ 16,284  
Income taxes
    9,815       14,003       22,586  
Supplemental disclosure of non-cash activities:
                       
Accrued payables for investments in utility plant
    6,565       9,570       10,967  
Purchase of intangible assets with Company common stock
    —       —       1,300  
Utility plant contributed by developers
    31,422       24,198       10,222  
 
See accompanying Notes to Consolidated Financial Statements.


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CALIFORNIA WATER SERVICE GROUP

Notes to Consolidated Financial Statements
December 31, 2010, 2009, and 2008
Amounts in thousands, except share data
 
1   ORGANIZATION AND OPERATIONS
 
California Water Service Group (Company) is a holding company that provides water utility and other related services in California, Washington, New Mexico, and Hawaii through its wholly-owned subsidiaries. California Water Service Company (Cal Water), Washington Water Service Company (Washington Water), New Mexico Water Service Company (New Mexico Water), and Hawaii Water Service Company, Inc. (Hawaii Water) provide regulated utility services under the rules and regulations of their respective state’s regulatory commissions (jointly referred to as the Commissions). CWS Utility Services and HWS Utility Services LLC provide non-regulated water utility and utility-related services.
 
The Company operates in one reportable segment, providing water and related utility services.
 
Basis of Presentation
 
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and include the Company accounts and those of its wholly owned subsidiaries. All intercompany transactions have been eliminated from the consolidated financial statements. In the opinion of management, the consolidated financial statements reflect all adjustments that are necessary to provide a fair presentation of the results for the periods covered.
 
The preparation of the Company’s consolidated financial statements in accordance with GAAP 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 consolidated balance sheet dates and the reported amounts of revenues and expenses for the periods presented. These include, but are not limited to, estimates and assumptions used in determining the Company’s regulatory asset and liability balances based upon probability assessments of regulatory recovery, revenues earned but not yet billed, asset retirement obligations, allowance for doubtful accounts, pension and other employee benefit plan liabilities, and income tax-related assets and liabilities. Actual results could differ from these estimates.
 
2   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Revenue
 
Revenue includes monthly cycle customer billings for regulated water and wastewater services at rates authorized by regulatory commissions and billings to certain non-regulated customers. Revenue from metered customers includes billings to customers based on monthly meter readings plus an estimate for water used between the customer’s last meter reading and the end of the accounting period. 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, with the balance recorded as unearned revenue on the balance sheet and recognized as revenue when earned in the subsequent accounting period.
 
Effective July 1, 2008 with the adoption of the Water Revenue Adjustment Mechanism (WRAM) and the Modified Cost Balancing Account (MCBA), Cal Water records the difference between what is billed to its regulated customers and that which is authorized by the California Public Utilities Commission (CPUC).
 
Under the WRAM, Cal Water records the adopted level of volumetric revenues as authorized by the CPUC for metered accounts (adopted volumetric revenues). In addition to volumetric-based revenues, the revenue requirements approved by the CPUC include service charges, flat rate charges, and other items that are not subject to the WRAM. The adopted volumetric revenue considers the seasonality of consumption of water based upon historical averages. The variance between adopted volumetric revenues and actual billed amounts for metered accounts is recorded as a component of revenue with an offsetting entry to a current and long-term asset or liability regulatory


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
balancing account (tracked individually for each Cal Water district). The variance amount may be positive or negative and represents amounts that will be billed or refunded to customers in the future.
 
Under the MCBA, Cal Water will track adopted expense levels for purchased water, purchased power and pump taxes, as established by the CPUC. Variances (which include the effects of changes in both rate and volume) between adopted and actual purchased water, purchased power, and pump tax expenses are recorded as a component of revenue, as the amount of such variances will be recovered from or refunded to the Company’s customers in the future. This is reflected with an offsetting entry to a current and long-term asset or liability regulatory balancing account (tracked individually for each Cal Water district).
 
The balances in the WRAM and MCBA assets and liabilities accounts will fluctuate on a monthly basis depending upon the variance between adopted and actual results. The recovery or refund of the WRAM is netted against the MCBA over- or under-recovery for the corresponding district and is interest bearing at the current 90 day commercial paper rate. When the net amount for any district achieves a pre-determined level at the end of any calendar year (i.e., at least 2.5 percent over- or under-recovery of the approved revenue requirement), Cal Water will file with the CPUC to refund or collect the balance in the accounts. Account balances less than those levels may be refunded or collected in Cal Water’s general rate case proceedings or aggregated with future calendar year balances for comparison with the recovery level. As of December 31, 2010, included in the net regulatory balancing accounts, current and long-term assets were $14,784 and $16,786, respectively, and the net regulatory balancing accounts current and long-term liabilities were $3,025 and $578, respectively. As of December 31, 2009, included in the net regulatory balancing accounts, current and long-term assets were $10,513 and $5,077, respectively, and the net regulatory balancing accounts current and long-term liabilities were $2,430 and $864, respectively.
 
Allowance for Doubtful Accounts
 
The Company provides an allowance for doubtful accounts receivable. The allowance is based upon specific identified accounts plus an estimate of uncollectible accounts based upon historical percentages. The balance of customer receivables is net of the allowance for doubtful accounts at December 31, 2010 and 2009 of $804 and $847, respectively.
 
The activities in the allowance for doubtful accounts are as follows:
 
                 
    2010     2009  
 
Beginning Balance
  $ 847     $ 1,210  
Provision for uncollectible accounts
    1,500       1,462  
Net write off of uncollectible accounts
    (1,543 )     (1,825 )
                 
Ending Balance
  $ 804     $ 847  
                 
 
Non-Regulated Revenue
 
Revenues from non-regulated operations and maintenance agreements are recognized when services have been rendered to companies or municipalities under such agreements. For construction and design services, revenue is generally recognized on the completed contract method, as most projects are completed in less than three months. Other non-regulated revenue is recognized when title has transferred to the buyer, or ratably over the term of the lease.
 
Utility Plant
 
Utility plant is carried at original cost when first constructed or purchased, or at fair value when acquired through acquisition. When depreciable plant is retired, the cost is eliminated from utility plant accounts and such costs are charged against accumulated depreciation. Maintenance of utility plant is charged to operating expenses as


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
incurred. Maintenance projects are not accrued for in advance. Interest is capitalized on plant expenditures during the construction period and amounted to $1,563 in 2010, $3,081 in 2009, and $3,411 in 2008.
 
Intangible assets acquired as part of water systems purchased are recorded at fair value. All other intangibles have been recorded at cost and are amortized over their useful life. Included in intangible assets is $6,515 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.
 
The following table represents depreciable plant and equipment as of December 31:
 
                 
    2010     2009  
 
Equipment
  $ 321,958     $ 314,351  
Transmission and distribution plant
    1,263,895       1,159,998  
Office buildings and other structures
    109,222       101,407  
                 
Total
  $ 1,695,075     $ 1,575,756  
                 
 
Depreciation of utility plant for financial statement purposes is computed on a straight-line basis over the assets’ estimated useful lives including cost of removal of certain assets as follows:
 
         
    Useful Lives
 
Equipment
    5 to 50 years  
Transmission and distribution plant
    40 to 65 years  
Office Buildings and other structures
    50 years  
 
The provision for depreciation expressed as a percentage of the aggregate depreciable asset balances was 2.8% in 2010, 2.8% in 2009, and 2.8% 2008. For income tax purposes, as applicable, the Company computes depreciation using the accelerated methods allowed by the respective taxing authorities.
 
Asset Retirement Obligation
 
The Company has a legal obligation to retire wells in accordance with Department of Public Health regulations. In addition, upon decommission of a wastewater plant or lift station certain wastewater infrastructure would need to be retired in accordance with Department of Public Health regulations. The Company has collected retirement obligation costs from ratepayers through depreciation expense. As of December 31, 2010 and 2009 the retirement obligation is estimated to be $10,582 and $9,611, respectively.
 
Cash Equivalents
 
Cash equivalents include highly liquid investments with remaining maturities of three months or less at the time of acquisition.
 
Restricted Cash
 
Restricted cash primarily represents the 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. All restricted cash is included in prepaid expenses. At December 31, 2010 and 2009, restricted cash was $1,183 and $4,352, respectively.
 
Regulatory Assets and Liabilities
 
The Company operates extensively in a regulated business, and as such is subject to the accounting standards for regulated utilities. As such, the Company defers costs and credits on the balance sheet as regulatory assets and liabilities when it is probable that those costs and credits will be recognized in the ratemaking process in a period


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
different from the period in which they would have been reflected in income by an unregulated company. In determining the probability of costs being recognized in other periods, the Company considers regulatory rules and decisions, past practices, and other facts or circumstances that would indicate if recovery is probable. These deferred regulatory assets and liabilities are then reflected in the income statement in the period in which the same amounts are reflected in the rates charged for service. In the event that a portion of the Company’s operations were no longer subject to the accounting standards for regulated utilities, the Company would be required to write off related regulatory assets and liabilities. If a commission determined that a portion of the Company’s assets were not recoverable in customer rates, the Company would be required to determine if the Company had suffered an asset impairment that would require a write-down in the assets’ valuation. In the 2009 GRC settlement, construction costs of $634 were removed from rate base and booked as a non-regulated expense during 2010. There were no asset impairments in 2009 or 2008. The income tax temporary differences relate primarily to the difference between book and federal income tax depreciation on utility plant that was placed in service before the regulatory Commissions adopted normalization for rate making purposes. Previously, the tax benefit of tax depreciation was passed on to customers (flow-through). For state income tax purposes, the Commission continues to use the flow-through method. As such timing differences reverse, the Company will be able to include the impact of such differences in customer rates. These federal tax differences will continue to reverse over the remaining book lives of the related assets.
 
In addition, regulatory assets include expense items that are capitalized for financial statement purposes, because they will be recovered in future customer rates. The capitalized expenses relate to pension benefits, postretirement benefits other than pensions (Retiree Group Health), asset retirement obligations, accrued benefits for vacation, self-insured workers’ compensation, and directors retirement benefits. Asset retirement obligations are recorded net of depreciation which has been recorded and recognized through the regulatory process.
 
Regulatory liabilities represent future benefits to ratepayers for tax deductions that will be allowed in the future. Regulatory liabilities also reflect timing differences provided at higher than the current tax rate, which will flow-through to future ratepayers.
 
Regulatory assets and liabilities were comprised of the following as of December 31:
 
                 
    2010     2009  
 
Regulatory Assets
               
Pension and Retiree Group Health
  $ 145,451     $ 129,879  
Income tax temporary differences
    30,934       36,017  
Net WRAM and MCBA accounts receivable
    16,786       5,124  
Asset retirement obligations, net
    6,487       5,819  
Other accrued benefits
    29,919       27,265  
                 
Total Regulatory Assets
  $ 229,577     $ 204,104  
                 
Regulatory Liabilities
               
Future tax benefits due ratepayers
    15,253       17,523  
Other liabilities
    1,826       2,146  
                 
Total Regulatory Liabilities
  $ 17,079     $ 19,669  
                 
 
The short-term regulatory assets and liabilities are for the WRAM/MCBA programs. The short-term portion of the regulatory assets for 2010 and 2009 were $14,784 and $10,513, respectively. The short-term portion of the regulatory liabilities for 2010 and 2009 were $3,025 and $2,430, respectively.


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
Impairment of Long-Lived Assets, Intangibles and Goodwill
 
The Company regularly reviews its long-lived assets, intangible assets and goodwill for impairment annually or when events or changes in business circumstances have occurred that 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 the asset. If assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying value of the asset exceeds its fair value. In the 2009 GRC settlement, construction costs of $634 were removed from rate base and expensed to non-regulated expense during 2010.
 
Goodwill is measured as the excess of the cost of an acquisition over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed. Goodwill and other identifiable intangible assets are accounted for in accordance with ASC 350-20. Goodwill is not amortized but instead is reviewed annually for impairment or more frequently if impairment indicators arise.
 
Company tests for impairment at November 30th of each year and whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. The test is performed at the reporting unit level using a two-step, fair-value based approach. The first step determines the fair value of the reporting unit and compares it to the reporting unit’s carrying value. If the fair value of the reporting unit is less than its carrying amount, a second step is performed to measure the amount of impairment loss, if any. The second step allocates the fair value of the reporting unit to the Company’s tangible and intangible assets and liabilities. This derives an implied fair value for the reporting unit’s goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized equal to the excess.
 
The recorded goodwill balance as of December 31, 2010 and 2009, relate to the Hawaii Water Service Company reporting unit. Based on our annual goodwill impairment test, no impairment was recorded in 2010 or 2009.
 
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 on a straight-line basis which approximates the effective interest method. Premiums paid on the early redemption of certain debt and the unamortized original issuance discount and expense are amortized over the life of new debt issued in conjunction with the early redemption. Amortization expense included in interest expense was $979, $970, and $673 for 2010, 2009, and 2008, respectively.
 
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. Advances of $185,332, and $183,555 at December 31, 2010, and 2009, respectively, will be refunded primarily over a 40-year period in equal annual amounts. In addition, other Advances for Construction totaling $1,567 and $1,472 at December 31, 2010, and 2009, respectively, are refundable based upon customer connections. Estimated refunds of advances for each succeeding year (2011 through 2015) are approximately $6,672, $6,598, $6,596, $6,592, $6,535 and $153,906 thereafter.
 
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 assets acquired from contributions is charged to the Contributions in Aid of Construction account.


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
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.
 
Historically the Commissions have allowed revenue requirements for the tax effects of temporary differences recognized, which have previously been flowed through to customers. The Commissions have granted the Company 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. ITCs 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 contributions of fire services from taxable income.
 
The accounting standards for accounting for uncertainty in income taxes also requires the inclusion of interest and penalties related to uncertain tax positions as a component of income taxes. See note 11 “Income Taxes”.
 
Workers’ Compensation, General Liability and Other Claims
 
For workers’ compensation, the Company estimates the liability associated with claims submitted and claims not yet submitted based on historical data. For general liability claims and other claims, the Company estimates the cost incurred but not yet paid using historical information.
 
Collective Bargaining Agreements
 
As of December 31, 2010, the Company had 1,127 employees, including 702 non-supervisory employees who are represented by the Utility Workers Union of America, AFL-CIO, except certain engineering and laboratory employees who are represented by the International Federation of Professional and Technical Engineers, AFL-CIO. The union agreements expire at the end of 2011.
 
Earnings Per Share
 
The computations of basic and diluted earnings per share are noted below. Basic earnings per share are computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Restricted Stock Awards are included in the weighted stock outstanding as the shares have all voting and dividend rights as issued and unrestricted common stock.
 
Common stock options outstanding to purchase common shares were 32,500, 62,750, and 84,000 at December 31, 2010, 2009, and 2008, respectively. The Company did not grant any Stock Appreciation Rights (SAR) in 2010. 180,210, 180,210, and 108,710 shares of SARs were outstanding as of December 31, 2010, 2009, and 2008, respectively.


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
All options are dilutive and the SARs are antidilutive. The dilutive effect is shown in the table below.
 
                         
    2010     2009     2008  
    (In thousands, except per share data)  
 
Net income, as reported
  $ 37,656     $ 40,554     $ 39,805  
Less preferred dividends and premium paid upon retirement of preferred stock
    —       —       368  
                         
Net income available to common stockholders
  $ 37,656     $ 40,554     $ 39,437  
                         
Weighted average common shares, basic
    20,806       20,745       20,710  
Dilutive common stock equivalents (treasury method)
    13       21       24  
                         
Shares used for dilutive calculation
    20,819       20,766       20,734  
                         
Earnings per share — basic
  $ 1.81     $ 1.95     $ 1.90  
Earnings per share — diluted
  $ 1.81     $ 1.95     $ 1.90  
 
Stock-based Compensation
 
The Company follows accounting standards for stock-based compensation. Compensation cost is measured at the grant date based on the fair value of the award. The Company recognizes compensation as expense on a straight-line basis over the requisite service period, which is the vesting period.
 
Accumulated Other Comprehensive Income or Loss
 
The Company did not have any accumulated other comprehensive income or loss transactions for 2010, 2009, and 2008.
 
3   OTHER INCOME AND EXPENSES
 
The Company conducts various non-regulated activities as reflected in the table below.
 
                                                 
    2010     2009     2008  
    Revenue     Expense     Revenue     Expense     Revenue     Expense  
 
Operating and maintenance
  $ 9,237     $ 9,713     $ 11,210     $ 11,525     $ 7,180     $ 7,327  
Meter reading and billing
    1,207       990       1,205       929       1,150       898  
Leases
    2,162       877       2,026       805       2,048       690  
Design and construction
    1,306       1,041       1,717       1,515       1,292       887  
Interest income
    28       —       106       —       423       —  
Change in value of life insurance contracts
    —       (2,641 )     —       (4,107 )     —       3,763  
Other non-regulated income and expenses
    2,053       2,332       1,926       1,785       2,137       1,532  
                                                 
Total
  $ 15,993     $ 12,312     $ 18,190     $ 12,452     $ 14,230     $ 15,097  
                                                 
 
Operating and maintenance services and meter reading and billing services are provided for water and wastewater systems owned by private companies and municipalities. The agreements call for a fee-per-service or a flat-rate amount per month. Leases have been entered into with telecommunications companies for cellular phone antennas placed on the Company’s property. Design and construction services are for the design and installation of water mains and other water infrastructure for others outside the Company’s regulated service areas.


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
4   ACQUISITIONS
 
In 2010 there were no acquisitions.
 
In 2009, after receiving regulatory approval, Cal Water acquired two water utility systems with no increase to the allowed rate base. In addition, as part of the acquisition Cal Water assumed cash of $457 and an obligation of equal amount to fund future capital projects on behalf of rate payers. No other assets or liabilities were assumed.
 
In 2008, the Company’s wholly-owned subsidiary HWS Utility Services, LLC, acquired contracts to operate and maintain water and wastewater systems in Hawaii. The purchase price of $1,300 was amortized over calendar years 2008, 2009, and 2010.
 
On September 2, 2008, after receiving regulatory approval, the Company’s wholly-owned subsidiary, Hawaii Water Service Company, Inc. acquired all the outstanding stock of three related privately held companies (Waikoloa Resort Utilities, Inc.; Waikoloa Water Company, Inc.; Waikoloa Sewer Company, Inc.) on the Island of Hawaii with water and wastewater operations. The combined purchase price was $20,582. Assets acquired were $26,885, including cash of $6,268. Liabilities assumed were $10,209 (net of $12,608 which was paid at close of escrow). Goodwill of $3,906 was initially recorded. In 2009, the goodwill was reduced by $1,291 in recognition of the tax benefits of the acquired net operating loss carryforwards. On December 19, 2008, after receiving regulatory approval, Hawaii Water acquired the water and wastewater assets of two other privately held companies (Kukio Utility Company and WB Maninowali) for an aggregate cash price of $10,619 which was the assigned value of the acquired assets. No liabilities were assumed.
 
Condensed balance sheets and pro forma results of operations for these acquisitions have not been presented since the impact of the purchases were not material.
 
5   INTANGIBLE ASSETS
 
As of December 31, 2010 and 2009, intangible assets that will continue to be amortized and those not amortized were:
 
                                                         
    Weighted
    2010     2009  
    Average
    Gross
          Net
    Gross
          Net
 
    Amortization
    Carrying
    Accumulated
    Carrying
    Carrying
    Accumulated
    Carrying
 
    Period     Value     Amortization     Value     Value     Amortization     Value  
 
Amortized intangible assets:
                                                       
Hawthorne lease
    15     $ 6,515     $ 6,463     $ 52     $ 6,515     $ 5,985     $ 530  
Water pumping rights
    usage       1,084       14       1,070       1,084       14       1,070  
Water planning studies
    11       11,066       2,812       8,254       10,704       2,062       8,642  
Leasehold improvements and other
    21       2,252       1,747       505       2,441       1,655       786  
                                                         
Total
    13     $ 20,917     $ 11,036     $ 9,881     $ 20,744     $ 9,716     $ 11,028  
                                                         
Unamortized intangible assets:
                                                       
Perpetual water rights and other
          $ 3,221       —     $ 3,221     $ 3,232       —     $ 3,232  
 
For the years ended December 31, 2010, 2009, and 2008, amortization of intangible assets was $1,894, $1,310, and $1,838, respectively. Estimated future amortization expense related to intangible assets for the succeeding five years is approximately $1,166, $1,076, $1,007, $921, $864, and $4,837 thereafter.


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
6   PREFERRED STOCK
 
The Company is authorized to issue 241,000 shares of Preferred Stock as of December 31, 2010. No shares of Preferred Stock were issued and outstanding at December 31, 2010 or 2009.
 
7   COMMON STOCKHOLDERS’ EQUITY
 
The Company is authorized to issue 25 million shares of $0.01 par value common stock. As of December 31, 2010 and 2009, 20,833,303 shares and 20,765,452 shares, respectively, of common stock were issued and outstanding.
 
Dividend Reinvestment and Stock Repurchase Plan
 
The Company has a Dividend Reinvestment and Stock Purchase Plan (DRIP Plan). Under the DRIP Plan, stockholders may reinvest dividends to purchase additional Company common stock without commission fees. The Plan also allows existing stockholders and other interested investors to purchase Company common stock through the transfer agent up to certain limits. The Company’s transfer agent operates the DRIP Plan and purchases shares on the open market to provide shares for the Plan.
 
8   SHORT-TERM BORROWINGS
 
On October 27, 2009, the Company and Cal Water entered into three-year syndicated unsecured revolving line of credit agreements with sixteen banks to provide an unsecured revolving line of credit of $50 million and $250 million, respectively. The base loan rate can vary from prime plus 50 basis points to prime plus 125 basis points depending on the Company’s total capitalization ratio. Likewise, the unused commitment fee can vary from 25 basis points to 35 basis points based on the same ratio. California Water Service Group and subsidiaries which it designates may borrow under the facilities. Borrowings by California Water Service Company will be repaid within 12 months unless otherwise authorized by the CPUC.
 
These unsecured credit agreements contain affirmative and negative covenants and events of default customary for credit facilities of this type including, among other things, limitations and prohibitions relating to additional indebtedness, liens, mergers, and asset sales. Also, these unsecured credit agreements contain financial covenants governing the Company and its subsidiaries’ consolidated total capitalization ratio and interest coverage ratio.
 
As of December 31, 2010, the outstanding borrowings on the Company line of credit were $23,750.
 
The following table represents borrowings under the bank lines of credit:
 
                 
    2010   2009
 
Maximum short-term borrowings
  $ 80,250     $ 60,000  
Average amount outstanding
  $ 43,224     $ 16,751  
Weighted average interest rate
    3.01 %     2.77 %
Interest rate at December 31
    2.74 %     2.15 %


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
9   LONG-TERM DEBT
 
As of December 31, 2010 and 2009, long-term debt outstanding was:
 
                                     
        Interest
                   
    Series   Rate     Maturity Date     2010     2009  
 
First Mortgage Bonds
  PPP     5.500%       2040     $ 100,000     $ —  
    LL     5.875%       2019       100,000       100,000  
    AAA     7.280%       2025       20,000       20,000  
    BBB     6.770%       2028       20,000       20,000  
    CCC     8.150%       2030       20,000       20,000  
    DDD     7.130%       2031       20,000       20,000  
    EEE     7.110%       2032       20,000       20,000  
    FFF     5.900%       2017       20,000       20,000  
    GGG     5.290%       2022       20,000       20,000  
    HHH     5.290%       2022       20,000       20,000  
    III     5.540%       2023       10,000       10,000  
    JJJ     5.440%       2018       7,273       7,273  
    KKK     4.580%       2010       —       10,000  
    LLL     5.480%       2018       10,000       10,000  
    MMM     5.520%       2013       20,000       20,000  
    NNN     5.550%       2013       20,000       20,000  
    OOO     6.020%       2031       20,000       20,000  
    CC     9.860%       2020       17,600       17,700  
    K     6.940%       2012       1,500       2,200  
                                     
Total First Mortgage Bonds
                      $ 466,373     $ 377,173  
California Department of Water Resources Loans
        2.6% to 8%       2010-32       9,106       3,721  
Other Long-term debt
                        6,082       6,328  
                                     
Total long-term debt
                      $ 481,561     $ 387,222  
Less current maturities
                        2,380       12,953  
                                     
Long-term debt excluding current maturities
                      $ 479,181     $ 374,269  
                                     
 
On November 17, 2010, Cal Water completed the sale and issuance of $100 million aggregate principal amount of its 5.50% First Mortgage Bonds PPP due 2040, which are fully and unconditionally guaranteed by the Company.
 
On April 17, 2009, Cal Water completed the sale and issuance of $100 million aggregate principal amount of its 5.875% First Mortgage Bonds due 2019, which are fully and unconditionally guaranteed by the Company.


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
10   OTHER ACCRUED LIABILITIES
 
As of December 31, 2010 and 2009, other accrued liabilities were:
 
                 
    2010     2009  
 
Accrued and deferred compensation
  $ 13,419     $ 12,052  
Accrued benefit and workers’ compensation claims
    4,959       5,492  
Other
    12,580       13,115  
                 
    $ 30,958     $ 30,659  
                 
 
11   INCOME TAXES
 
Income tax expense consisted of the following:
 
                         
    Federal     State     Total  
 
2010
                       
Current
  $ 4,027     $ 3,020     $ 7,047  
Deferred
    15,730       1,779       17,509  
                         
Total
  $ 19,757     $ 4,799     $ 24,556  
                         
2009
                       
Current
  $ 10,105     $ 4,382     $ 14,487  
Deferred
    12,056       819       12,875  
                         
Total
  $ 22,161     $ 5,201     $ 27,362  
                         
2008
                       
Current
  $ 15,233     $ 4,679     $ 19,912  
Deferred
    4,486       (267 )     4,219  
                         
Total
  $ 19,719     $ 4,412     $ 24,131  
                         
 
Income tax expense computed by applying the current federal 35% tax rate to pretax book income differs from the amount shown in the Consolidated Statements of Income. The difference is reconciled in the table below:
 
                         
    2010     2009     2008  
 
Computed “expected” tax expense
  $ 21,774     $ 23,771     $ 22,378  
Increase (reduction) in taxes due to:
                       
State income taxes net of federal tax benefit
    3,577       3,903       3,674  
Investment tax credits
    (74 )     (32 )     (32 )
Other
    (721 )     (280 )     (1,889 )
                         
Total income tax
  $ 24,556     $ 27,362     $ 24,131  
                         
 
Included in Other in the above table is the recognition of the flow-through accounting for Federal depreciation expense on assets acquired prior to 1982 and retirement costs of such assets. For assets acquired prior to 1982, the benefit of excess tax depreciation was previously passed through to the ratepayers. The tax benefit is now reversing and a higher tax expense is being recognized and is included in customer rates. Offsetting the flow-through depreciation in 2010 and 2009 was the impact of cost to remove pre-1982 assets. Also included is the federal income tax deduction from qualified U.S. production activities, which started in 2006. Qualified production activities include production of potable water, but exclude the transmission and distribution of the potable water. The impact


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
of the deduction is being reported in the year in which the deduction is claimed on the Company’s tax return. The qualified U.S. production activities deduction (QPAD) is limited to the lesser of 9% of taxable income in 2010, or 50% of taxable gross wages, and 6% of taxable income during 2009 and 2008, or 50% of taxable wages. The QPAD impact was to lower the income tax provision by $420, $560, and $1,276 in 2010, 2009, and 2008, respectively.
 
The tax effects of differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2010 and 2009 are presented in the following table:
 
                 
    2010     2009  
 
Deferred tax assets:
               
Developer deposits for extension agreements and contributions in aid of construction
  $ 46,421     $ 47,553  
Other
    4,378       5,804  
                 
Total deferred tax assets
    50,799       53,357  
                 
Deferred tax liabilities:
               
Utility plant, principally due to depreciation differences
    143,165       140,266  
WRAM/MCBA balancing accounts
    13,463       6,651  
Other
    5,977       2,414  
                 
Total deferred tax liabilities
    162,605       149,331  
                 
Net deferred tax liabilities
  $ 111,806     $ 95,974  
                 
 
The current portion of our Deferred Income Tax is $4,722 and $4,123 for years 2010 and 2009, respectively, which includes prepaid expenses and billed WRAM/MCBA surcharge, expected to reverse in the following 12 months.
 
A valuation allowance was not required at December 31, 2010 and 2009. 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.
 
The following table reconciles the changes in unrecognized tax benefits (at gross):
 
         
    December 31, 2010
 
Balance at beginning of year
  $ —  
Additions for tax positions taken during prior year
    2,040  
Additions for tax positions taken during current year
    —  
Reductions for tax positions taken during a prior year
    —  
Lapse of statute of limitations
    —  
         
Balance at end of year
  $ 2,040  
         
 
As of December 31, 2010, the total amount of net unrecognized tax benefits was $2,040 none of which, if recognized, would affect the Company’s effective tax rate. The Company accrues interest and penalties related to unrecognized tax benefits in its provision for income taxes. The total amount of penalties and interest was $114 as of December 31, 2010. Additionally, the Company does not expect a material change in its unrecognized tax benefits within the next 12 months.
 
Tax years of 2007, 2008, 2009, and 2010 are subject to examination by the federal and state taxing authorities, respectively. An income tax examination of our California income tax filings for 2008 and 2009 currently is in


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
progress. Management is unable to assess the potential impact on the Company’s California state income tax as a result of this audit.
 
12   EMPLOYEE BENEFIT PLANS
 
Savings Plan
 
The Company sponsors a 401(k) qualified, defined contribution savings plan that allows participants to contribute up to 20% of pre-tax compensation. Effective January 1, 2010, the Company matches seventy-five cents for each dollar contributed by the employee up to a maximum Company match of 6.0% of base salary. In the prior year, the Company matched fifty cents for each dollar contributed up to a maximum Company match of 4.0% of base salary. Company contributions were $3,232, $1,953, and $1,786, for the years 2010, 2009, and 2008, respectively.
 
Pension Plans
 
The Company provides a qualified, defined-benefit, non-contributory pension plan for substantially all employees. The accumulated benefit obligations of the pension plan are $196,184 and $161,449 as of December 31, 2010 and 2009, respectively. The fair value of pension plan assets was $139,034 and $105,639 as of December 31, 2010 and 2009, respectively.
 
Prior to 2009, pension payment obligations were generally funded by the purchase of an annuity from a life insurance company. In 2009, the Company paid monthly benefits to retirees, rather than the purchase of an annuity. Payments are expected to be made in each year from 2011 to 2015 are $2,666, $3,621, $4,756, $5,933, and $7,189, respectively. The aggregate benefits expected to be paid in the five years 2016 through 2020 are $58,597. The expected benefit payments are based upon the same assumptions used to measure the Company’s benefit obligation at December 31, 2010, and include estimated future employee service.
 
The Company also maintains an unfunded, non-qualified, supplemental executive retirement plan. The unfunded supplemental executive retirement plan accumulated benefit obligations were $21,767 and $16,981 as of December 31, 2010 and 2009, respectively. Benefit payments under the supplemental executive retirement plan are paid currently and are included in the preceding paragraph.
 
The costs of the pension and retirement plans are charged to expense and utility plant. The Company makes annual contributions to fund the amounts accrued for pension cost.
 
Other Postretirement Plan
 
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, along with their spouses and dependents, continue participation in the plan by payment of a premium. Plan assets are invested in mutual funds, short-term money market instruments and commercial paper based upon the same asset mix as the pension plan. Retired employees are also provided with a five thousand dollar life insurance benefit.
 
The Company records the costs of postretirement benefits other than pension (PBOP) during the employees’ years of active service. Postretirement benefit expense recorded in 2010, 2009, and 2008, was $4,782, $4,926, and $3,246, respectively. Prior to 2006, the Company recorded a regulatory asset for the difference between the Company-funded amount and the net periodic benefit cost. The remaining net periodic benefit cost was $9,790 at December 31, 2006, and is being recovered through future customer rates and is recorded as a regulatory asset. The expected benefit payments, net of retiree premiums and Medicare part D subsidies, for the years from 2011 to 2015 are $1,047, $1,178, $1,352, $1,522, and $1,700, respectively.


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
Benefit Plan Assets
 
The Company actively manages pensions and PBOP trust (Plan) assets. The Company’s investment objectives are:
 
  •  Maximize the return on the assets of the Plan, commensurate with the risk that the Company deem appropriate to, meet the obligations of the Plan, minimize the volatility of the pension expense, and account for contingencies;
 
  •  Generate a rate of return for the total portfolio that equals or exceeds the actuarial investment rate assumption;
 
  •  Additionally, the rate of return of the total fund shall be measured periodically against a special index comprised of 35% of the Standard & Poor’s Index, 15% of the Russell 2000 Index, 10% of the MSCI EAFE Index, and 40% of the Lehman Aggregate Bond Index. The special index is consistent with the rate of return objective and indicates the Company’s long-term asset allocation objective.
 
The Company applies a risk management framework for managing the risks associated with employee benefit plan trust assets and uses a nationally recognized independent investment advisor. The guiding principles of this risk management framework are the clear articulation of roles and responsibilities, appropriate delegation of authority, and proper accountability and documentation. Trust investment policies and investment manager guidelines include provisions to ensure prudent diversification, manage risk through appropriate use of physical direct asset holdings and derivative securities, and identify permitted and prohibited investments.
 
The Company’s target asset allocation percentages for major categories of the pension plan is reflected in the table below:
 
                         
    Minimum
      Maximum
    Exposure   Target   Exposure
 
Fixed Income
    35 %     40 %     45 %
Total Domestic Equity
    40 %     50 %     60 %
Small Cap Stocks
    10 %     15 %     20 %
Large Cap Stocks
    30 %     35 %     45 %
Non-U.S. Equities
    5 %     10 %     15 %
 
The fixed income category includes money market funds, short-term bond funds, and cash. The majority of fixed income investments range in maturities from less than one to five years.
 
The Company’s target allocation percentages for the PBOP trust is similar to the pension plan except for an increased allocation of 18% in fixed income investments with the difference allocated to domestic equity investments.
 
We use the following criteria to select investment funds:
 
  •  Fund past performance;
 
  •  Fund meets criteria of Employee Retirements Income Security Act (ERISA);
 
  •  Timeliness and completeness of fund communications and reporting to investors;
 
  •  Stability of fund management company;
 
  •  Fund management fees; and
 
  •  Administrative costs incurred by the Plan.


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CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
 
The fair value measurements standard establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under the standard are described below:
 
Level 1 — Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that the Plan has the ability to access.
 
Level 2 — Inputs to the valuation methodology include:
 
  •  Quoted market prices for similar assets or liabilities in active markets;
 
  •  Quoted prices for identical or similar assets or liabilities in inactive markets;
 
  •  Inputs other than quoted prices that are observable for the asset or liability; and
 
  •  Inputs that are derived principally from or corroborated by observable market data by correlation or other means.
 
If the asset or liability has a specified (contractual) term, the level 2 input must be observable for substantially the full term of the asset or liability.
 
Level 3 — Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
 
All Plan investments are level 1 investments in mutual funds and are valued at the net asset value (NAV) of the shares held by the Plan at December 31, 2010 and 2009:
 
                                                                 
    Pension Benefits     Other Benefits  
    2010     %     2009     %     2010     %     2009     %  
 
Fixed Income
  $ 60,961       44 %   $ 51,028       48 %   $ 11,184       53 %   $ 10,656       67 %
                                                                 
Domestic Equity
                                                               
Small Cap Stocks
    27,580               16,976               —               3,780          
Large Cap Stocks
    41,583               30,360               9,986               1,428          
                                                                 
Total Domestic Equity
    69,163       50 %     47,336       45 %     9,986       47 %     5,208       33 %
                                                                 
Non U.S. Equities
    8,910       6 %     7,275       7 %     —       0 %     —       0 %
                                                                 
Total Plan Assets
  $ 139,034       100 %   $ 105,639       100 %   $ 21,170       100 %   $ 15,864       100 %
                                                                 


72


Table of Contents

CALIFORNIA WATER SERVICE GROUP
 
Notes to Consolidated Financial Statements — (Continued)
 
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, 2010 and 2009:
 
                                 
    Pension Benefits     Other Benefits  
    2010     2009     2010     2009  
 
Change in projected benefit obligation:
                               
Beginning of year
  $ 219,730     $ 192,878     $ 39,353     $ 36,208  
Service cost
    10,076       9,119       2,491       2,261  
Interest cost
    13,701       12,352       2,329       2,161  
Assumption change
    23,820       (59 )     5,524       (512 )
Amendment
    —       6,216       —       —  
Experience (gain) loss
    5,364       345       (2,423 )     613  
Benefits paid, net of retiree premiums
    (2,751 )     (1,121 )     (1,330 )     (1,378 )
                                 
End of year
  $ 269,940     $ 219,730     $ 45,944     $ 39,353  
                                 
Change in plan assets:
                               
Fair value of plan assets at beginning of year
  $ 105,639     $ 66,941     $ 15,864     $ 6,300  
Actual return on plan assets
    13,893       12,319       1,204       1,012  
Employer contributions
    22,253       27,500       5,440       9,930  
Retiree contributions and Medicare part D subsidies
    —       —       1,139       1,062  
Benefits paid
    (2,751 )     (1,121 )     (2,469 )     (2,440 )
                                 
Fair value of plan assets at end of year
  $ 139,034     $ 105,639     $ 21,178     $ 15,864  
                                 
Funded status
  $ (130,906 )   $ (114,091 )   $ (24,766 )   $ (23,489 )
Unrecognized actuarial loss
    65,853       44,962       16,102       13,775  
Unrecognized prior service cost
    54,296       60,891       653       769  
Unrecognized transition obligation
    —       —       561       837  
                                 
Net amount recognized
  $ (10,757 )   $ (8,238 )   $ (7,450 )   $ (8,108 )