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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

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 number 1-13883

 

CALIFORNIA WATER SERVICE GROUP

(Exact name of registrant as specified in its charter)

 

 

1720 North First Street, San Jose, CA.		95112
(Address of principal executive offices)		(Zip Code)

 

408-367-8200

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No 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):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act) Yes o No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common shares outstanding as of October 28, 2014 — 47,806,190

 

 

Table of Contents

 

TABLE OF CONTENTS

 

	Page
PART I Financial Information	3
Item 1 Financial Statements	3
Condensed Consolidated Balance Sheets (unaudited) as of September 30, 2014 and December 31, 2013	3
Condensed Consolidated Statements of Income (unaudited) For the Three Months Ended September 30, 2014 and 2013	4
Condensed Consolidated Statements of Income (unaudited) For the Nine months Ended September 30, 2014 and 2013	5
Condensed Consolidated Statements of Cash Flows (unaudited) For the Nine months Ended September 30, 2014 and 2013	6
Notes to Unaudited Condensed Consolidated Financial Statements	7
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3 Quantitative and Qualitative Disclosure about Market Risk	34
Item 4 Controls and Procedures	35
PART II Other Information	35
Item 1 Legal Proceedings	35
Item 1A Risk Factors	36
Item 6 Exhibits	36
Signatures	37
Index to Exhibits	38

 

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PART I FINANCIAL INFORMATION

 

Item 1.

 

FINANCIAL STATEMENTS

 

The condensed consolidated financial statements presented in this filing on Form 10-Q have been prepared by management and are unaudited.

 

CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATED BALANCE SHEETS

 

Unaudited

(In thousands, except shares and per share data)

 

		September 30, 2014			December 31, 2013
ASSETS
Utility plant:
Utility plant		$	2,306,427		$	2,213,328
Less accumulated depreciation and amortization		(745,742		)	(697,497		)
Net utility plant		1,560,685			1,515,831
Current assets:
Cash and cash equivalents		29,485			27,506
Receivables:
Customers		37,070			31,468
Regulatory balancing accounts		45,073			30,887
Other		15,759			18,700
Unbilled revenue		29,489			17,034
Materials and supplies at weighted average cost		5,912			5,571
Taxes, prepaid expenses and other assets		14,490			8,324
Total current assets		177,278			139,490
Other assets:
Regulatory assets		277,476			251,681
Goodwill		2,615			2,615
Other assets		51,026			50,238
Total other assets		331,117			304,534
		$	2,069,080		$	1,959,855
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, $.01 par value; 68,000,000 shares authorized, 47,806,000 and 47,741,000 outstanding in 2014 and 2013, respectively		$	478		$	477
Additional paid-in capital		329,840			328,364
Retained earnings		291,964			269,915
Total common stockholders’ equity		622,282			598,756
Long-term debt, less current maturities		422,825			426,142
Total capitalization		1,045,107			1,024,898
Current liabilities:
Current maturities of long-term debt		6,619			7,908
Short-term borrowings		61,715			46,815
Accounts payable		71,867			55,087
Regulatory balancing accounts		6,791			1,827
Accrued interest		9,748			4,245
Accrued expenses and other liabilities		58,674			50,702
Total current liabilities		215,414			166,584
Unamortized investment tax credits		2,106			2,106
Deferred income taxes, net		210,357			183,245
Pension and postretirement benefits other than pensions		153,085			145,451
Regulatory and other liabilities		91,713			86,455
Advances for construction		182,172			183,393
Contributions in aid of construction		169,126			167,723
Commitments and contingencies (Note 10)		—			—
		$	2,069,080		$	1,959,855

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

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CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

 

Unaudited

(In thousands, except per share data)

 

For the three months ended		September 30, 2014			September 30, 2013
Operating revenue		$	191,184		$	184,404
Operating expenses:
Operations:
Water production costs		66,980			70,614
Administrative and general		23,765			24,670
Other operations		15,692			17,657
Maintenance		4,800			4,575
Depreciation and amortization		14,648			14,505
Income taxes		19,233			11,165
Property and other taxes		5,232			5,414
Total operating expenses		150,350			148,600
Net operating income		40,834			35,804
Other income and expenses:
Non-regulated revenue		4,409			3,649
Non-regulated expenses, net		(4,812		)	(2,825		)
Income tax benefit (expense) on other income and expenses		169			(330		)
Net other (loss) income		(234		)	494
Interest expense:
Interest expense		7,221			7,687
Less: capitalized interest		(271		)	(540		)
Net interest expense		6,950			7,147
Net Income		$	33,650		$	29,151
Earnings per share
Basic		$	0.70		$	0.61
Diluted		0.70			0.61
Weighted average shares outstanding
Basic		47,803			47,737
Diluted		47,840			47,770
Dividends declared per share of common stock		$	0.1625		$	0.1600

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

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CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

 

Unaudited

(In thousands, except per share data)

 

For the nine months ended		September 30, 2014			September 30, 2013
Operating revenue		$	460,115		$	450,403
Operating expenses:
Operations:
Water production costs		174,297			171,956
Administrative and general		72,702			73,106
Other operations		48,072			50,332
Maintenance		14,793			12,896
Depreciation and amortization		46,788			43,625
Income taxes		22,584			19,567
Property and other taxes		15,601			16,564
Total operating expenses		394,837			388,046
Net operating income		65,278			62,357
Other income and expenses:
Non-regulated revenue		12,163			10,386
Non-regulated expenses, net		(11,184		)	(8,482		)
Income tax (expense) on other income and expenses		(391		)	(765		)
Net other income		588			1,139
Interest expense:
Interest expense		21,373			23,527
Less: capitalized interest		(851		)	(1,619		)
Net interest expense		20,522			21,908
Net Income		$	45,344		$	41,588
Earnings per share
Basic		$	0.95		$	0.91
Diluted		0.95			0.90
Weighted average shares outstanding
Basic		47,787			45,927
Diluted		47,825			45,957
Dividends declared per share of common stock		$	0.4875		$	0.4800

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

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CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

Unaudited

(In thousands)

 

For the nine months ended:		September 30, 2014			September 30, 2013
Operating activities
Net income		$	45,344		$	41,588
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		48,481			45,067
Changes in value of life insurance contracts		(501		)	(1,147		)
Changes in operating assets and liabilities:
Receivables		(13,781		)	(24,636		)
Accounts payable		7,239			7,719
Other current assets		(6,859		)	(751		)
Other current liabilities		6,904			20,558
Other changes in noncurrent assets and liabilities		13,340			13,501
Net cash provided by operating activities		100,167			101,899
Investing activities:
Utility plant expenditures		(86,258		)	(94,782		)
Purchase of life insurance contracts		(3,207		)	(3,204		)
Changes in restricted cash and other changes		354			1,148
Net cash used in investing activities		(89,111		)	(96,838		)
Financing activities:
Short-term borrowings		99,900			35,315
Repayment of short-term borrowings		(85,000		)	(113,275		)
Proceeds from long-term debt		—			48
Repayment of long-term debt		(4,604		)	(3,058		)
Advances and contributions in aid of construction		8,780			7,577
Refunds of advances for construction		(4,858		)	(5,230		)
Issuance of common stock		—			110,688
Common stock issuance costs		—			(5,088		)
Dividends paid		(23,295		)	(21,981		)
Net cash (used in) provided by financing activities		(9,077		)	4,996
Change in cash and cash equivalents		1,979			10,057
Cash and cash equivalents at beginning of period		27,506			38,790
Cash and cash equivalents at end of period		$	29,485		$	48,847
Supplemental information
Cash paid for interest (net of amounts capitalized)		$	14,102		$	15,141
Cash paid for income taxes		—			—
Income tax refunds		(6,000		)	—
Supplemental disclosure of non-cash activities:
Accrued payables for investments in utility plant		$	16,308		$	11,739
Utility plant contribution by developers		8,148			10,196

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

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CALIFORNIA WATER SERVICE GROUP

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2014

(Amounts in thousands, except share and per share amounts)

 

Note 1. Organization and Operations and Basis of Presentation

 

California Water Service Group (the 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 herein 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 unaudited interim financial information has been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (SEC) and therefore do not contain all of the information and footnotes required by GAAP and the SEC for annual financial statements. The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements for the year ended December 31, 2013, included in its annual report on Form 10-K as filed with the SEC on February 27, 2014.

 

The preparation of the Company’s condensed 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 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.

 

In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals that are necessary to provide a fair presentation of the results for the periods covered. The results for interim periods are not necessarily indicative of the results for any future period.

 

Due to the seasonal nature of the water business, the results for interim periods are not indicative of the results for a 12-month period. Revenue and income are generally higher in the warm, dry summer months when water usage and sales are greater. Revenue and income are generally lower in the winter months when cooler temperatures and rainfall curtail water usage and sales.

 

Note 2. Summary of Significant Accounting Policies

 

Revenue

 

Revenue generally includes monthly cycle customer billings for regulated water and wastewater services at rates authorized by regulatory commissions (plus an estimate for water used between the customer’s last meter reading and the end of the accounting period) and billings to certain non-regulated customers at rates authorized by contract with government agencies.

 

The Company’s regulated water and waste water revenue requirements are authorized by the Commissions in the states in which it operates. The revenue requirements are intended to provide the Company an opportunity to recover its operating costs and earn a reasonable return on investments.

 

For metered customers, Cal Water recognizes revenue from rates which are designed and authorized by the California Public Utilities Commission (CPUC). Under the Water Revenue Adjustment Mechanism (WRAM), Cal Water records the adopted level of volumetric revenues, which would include recovery of cost of service and a return on investments, 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 regulatory asset or liability balancing account (tracked individually for each Cal Water district) subject to certain criteria under the accounting for regulated operations being met. The variance amount may be positive or negative and represents amounts that will be billed or refunded to customers in the future.

 

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Cost-recovery rates are designed to permit full recovery of certain costs. Cost-recovery rates such as the Modified Cost Balancing Account (MCBA) provides for recovery of adopted expense levels for purchased water, purchased power and pump taxes, as established by the CPUC. In addition, cost-recovery rates include recovery of cost related to water conservation programs and certain other operation expenses adopted by the CPUC. There is no markup for return or profit for cost-recovery expenses and are generally recognized when expenses are incurred.  Variances (which include the effects of changes in both rate and volume for the MCBA) between adopted and actual costs are recorded as a component of revenue, as the amount of such variances will be recovered from or refunded to Cal Water customers at a later date.  The variance between adopted costs and actual costs for metered accounts is recorded as a component of revenue with an offsetting entry to a regulatory asset or liability balancing account (transferred individually for each Cal Water District) subject to certain criteria under the accounting for regulated operations being met.

 

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. At the end of any calendar year, Cal Water files with the CPUC to refund or collect the balance in the accounts. Most undercollected net WRAM and MCBA receivable balances are collected over 12 or 18 months. Cal Water defers net WRAM and MCBA operating revenues and associated costs whenever the net receivable balances are estimated to be collected more than 24 months after the respective reporting periods in which it was recognized. The deferred net WRAM and MCBA revenues and associated costs were determined using forecasts of rate payer consumption trends in future reporting periods and the timing of when the CPUC will authorize Cal Water’s filings to recover the undercollected balances. Deferred net WRAM and MCBA revenues and associated costs will be recognized as revenues and costs in future periods when collection is within twenty-four months of the respective reporting period.

 

The net WRAM and MCBA balances included in regulatory balancing account, assets, and liabilities were:

 

		September 30, 2014			December 31, 2013
Net short-term receivable		$	27,927		$	30,887
Net long-term receivable		16,608			15,423
Total receivable		$	44,535		$	46,310
Net short-term payable		$	423		$	1,032
Net long-term payable		1,385			906
Total payable		$	1,808		$	1,938

 

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 sheets and recognized as revenue when earned in the subsequent accounting period. The unearned revenue liability was $1.5 million as of September 30, 2014 and as of December 31, 2013. This liability is included in “accrued expenses and other liabilities” on the condensed consolidated balance sheets.

 

Cash and Cash Equivalents

 

Cash equivalents include highly liquid investments with maturities of three months or less.  Cash and cash equivalents was $29.5 million and $27.5 million as of September 30, 2014 and December 31, 2013, respectively.  Restricted cash was included on the condensed consolidated balance sheets as “taxes, prepaid expenses and other assets” and was $0.8 million and $1.2 million as of September 30, 2014 and December 31, 2013, respectively.

 

Accounting Standards Update

 

On May 28, 2014 the Financial Accounting Standards Board issued an accounting standards update (ASU) 2014-09, Revenue from Contracts with Customers.  This update creates a single, principles based framework for revenue recognition and is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when goods or services are transferred to customers.  ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016. Early adoption is not permitted.  The Company is currently evaluating the impact of adopting the new revenue standard on its consolidated financial statements and related disclosures.

 

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Note 3. Stock-based Compensation

 

Equity Incentive Plan

 

The Company’s equity incentive plan was originally approved by stockholders on April 27, 2005 and again on May 20, 2014.  Under the equity incentive plan, the Company is authorized to issue up to 2,000,000 shares of common stock awards as defined in the Plan to employees and directors.

 

The Restricted Stock Awards (RSAs) granted in 2014 and 2013 to employees vest over 36 months.  Director RSAs generally vest at the end of 12 months.  During the first nine months of 2014, the RSAs granted were valued at $23.61 per share, based upon the fair market value of the Company’s common stock on the date of grant.

 

During the nine months ended September 30, 2014 and 2013, the Company also granted performance-based Restricted Stock Unit Awards (RSUs) of 37,143 shares and 50,267 shares of common stock, respectively, to officers.  Each award reflects a target number of shares that may be issued to the award recipient.  The 2014 and 2013 awards may be earned upon the completion of the three-year performance period ending on March 4, 2017 and March 5, 2016, respectively.  Whether RSUs are earned at the end of the performance period will be determined based on the achievement of certain performance objectives set by the Board of Director Compensation Committee in connection with the issuance of the RSUs.  The performance objectives are based on the Company’s business plan covering the performance period.  The performance objectives include achieving the budgeted return on equity, budgeted investment in utility plant, customer service standards, water quality standards, and/or safety standards.  Depending on the results achieved during the three-year performance period, the actual number of shares that a grant recipient receives at the end of the performance period may range from 0% to 200% of the target shares granted, provided that the grantee is continuously employed by the Company through the vesting date.  If, prior to the vesting date, employment is terminated by reason of death, disability or normal retirement, then a pro rata portion of this award will vest.  RSUs were not dilutive as of September 30, 2014 and 2013 and will not be included in diluted shares for financial reporting until they are either dilutive or earned.  The 2014 and 2013 RSUs are recognized as expense ratably over the three year performance period using a fair market value of $23.61 per share and $20.62 per share, respectively, and an estimate of RSUs earned during the performance period.

 

The Company has recorded compensation costs for the RSAs and RSUs in operating expense in the amount of $1.5 million and $1.3 million for the nine months ended September 30, 2014 and September 30, 2013, respectively.

 

Note 4. Equity

 

The Company’s changes in equity for the nine months ended September 30, 2014 were as follows:

 

		Total Stockholders’ Equity
Balance at December 31, 2013		$	598,756
Common stock issued		1
Share-based compensation expense		1,476
Common stock dividends paid		(23,295		)
Net income		45,344
Balance at September 30, 2014		$	622,282

 

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Note 5. Net Income Per Share Calculations

 

The computations of basic and diluted net income per weighted average common shares are noted below. Basic net income per share is computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding during the period. RSAs are included in the weighted average common shares outstanding because the shares have all the same voting and dividend rights as issued and unrestricted common stock. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts were exercised or converted into common stock.

 

A total of 185,420 shares and 283,856 shares of Stock Appreciation Rights were vested and outstanding and all were dilutive as of September 30, 2014 and September 30, 2013, respectively, as shown in the table below.

 

		Three Months Ended September 30
		2014			2013
Net Income available to common stockholders		$	33,650		$	29,151
Weighted average common shares outstanding, basic (in thousands)		47,803			47,737
Dilutive stock appreciation rights (treasury method) (in thousands)		37			33
Weighted average common shares outstanding, dilutive (in thousands)		47,840			47,770
Net Income per share - basic		$	0.70		$	0.61
Net Income per share - diluted		$	0.70		$	0.61

 

		Nine months Ended September 30
		2014			2013
Net Income available to common stockholders		$	45,344		$	41,588
Weighted average common shares outstanding, basic (in thousands)		47,787			45,927
Dilutive stock appreciation rights (treasury method) (in thousands)		38			30
Weighted average common shares outstanding, dilutive (in thousands)		47,825			45,957
Net Income per share - basic		$	0.95		$	0.91
Net Income per share - diluted		$	0.95		$	0.90

 

Note 6. Pension Plan and Other Postretirement Benefits

 

The Company provides a qualified, defined-benefit, non-contributory pension plan for substantially all employees. The Company makes annual contributions to fund the amounts accrued for the qualified pension plan. The Company also maintains an unfunded, non-qualified, supplemental executive retirement plan. The costs of the plans are charged to expense or are capitalized in utility plant as appropriate.

 

The Company offers medical, dental, vision, and life insurance benefits for retirees and their spouses and dependents. Participants are required to pay a premium, which offsets a portion of the cost.

 

Cash payments by the Company related to pension plans and other postretirement benefit plans was $14.0 million and $2.4 million, respectively, for the nine months ended September 30, 2014 and was $23.4 million to pension plans and $4.7 million to other postretirement benefit plans during the nine months ended September 30, 2013. The 2014 estimated cash contribution to the pension plans is $26.8 million and to the other postretirement benefit plans is $9.6 million.

 

The following table lists components of net periodic benefit costs for the pension plans and other postretirement benefits. The data listed under “pension plan” includes the qualified pension plan and the non-qualified supplemental executive retirement plan. The data listed under “other benefits” is for all other postretirement benefits.

 

		Three Months Ended September 30
		Pension Plan						Other Benefits
		2014			2013			2014			2013
Service cost		$	3,539		$	4,019		$	1,398		$	1,636
Interest cost		4,737			4,140			1,321			1,121
Expected return on plan assets		(4,091		)	(3,559		)	(832		)	(600		)
Recognized net initial APBO (1)		N/A			N/A			—			3
Amortization of prior service cost		1,527			1,542			11			21
Recognized net actuarial loss		1,002			2,404			656			961
Net periodic benefit cost		$	6,714		$	8,546		$	2,554		$	3,142

 

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		Nine months Ended September 30
		Pension Plan						Other Benefits
		2014			2013			2014			2013
Service cost		$	11,973		$	13,335		$	4,637		$	5,025
Interest cost		14,190			12,266			3,995			3,339
Expected return on plan assets		(12,449		)	(10,689		)	(2,339		)	(1,796		)
Recognized net initial APBO (1)		N/A			N/A			—			7
Amortization of prior service cost		4,547			4,624			33			61
Recognized net actuarial loss		3,008			6,852			2,206			2,794
Net periodic benefit cost		$	21,269		$	26,388		$	8,532		$	9,430

 

(1)  APBO - Accumulated postretirement benefit obligation

 

Note 7. Short-term and Long-term Borrowings

 

On June 29, 2011, the Company and Cal Water entered into Syndicated Credit Agreements, which provide for unsecured revolving credit facilities of up to an initial aggregate amount of $400 million.  The Syndicated Credit Facilities amend, expand, and replace the Company’s and its subsidiaries’ credit facilities originally entered into on October 27, 2009.  The new credit facilities extended the terms until June 29, 2016, increased the Company’s and Cal Water’s unsecured revolving lines of credit, and lowered interest rates and fees.  The Company and subsidiaries that it designates may borrow up to $100 million under the Company’s revolving credit facility. Cal Water may borrow up to $300 million under its revolving credit facility; however, all borrowings need to be repaid within 12-months unless otherwise authorized by the CPUC.  The proceeds from the revolving credit facilities may be used for working capital purposes, including the short-term financing of capital projects.  The base loan rate may vary from LIBOR plus 72.5 basis points to LIBOR plus 95 basis points, depending on the Company’s total capitalization ratio.  Likewise, the unused commitment fee may vary from 8 basis points to 12.5 basis points based on the same ratio.

 

Both short-term 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 September 30, 2014 and December 31, 2013, the outstanding borrowings on the Company and Cal Water lines of credit were $61.7 million and $46.8 million, respectively.  For the nine months ended September 30, 2014, the average borrowing rate was 1.16% compared to 2.20% for the same period last year.

 

Note 8. 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.

 

The Company anticipates that future rate actions 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 the Company 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.

 

During 2012, the Company filed an application for a change in tax accounting method with the IRS to implement tangible property regulations specifically in regards to repairs and maintenance deductions.  On September 13, 2013, the U.S. Department of the Treasury and Internal Revenue Service (IRS) issued the final and re-proposed tangible property regulations for repairs and maintenance deductions with an effective date of January 1, 2014.  These tax regulations allowed the Company to deduct a

 

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significant amount of linear asset costs previously capitalized for book and tax purposes.  The Company filed a tax accounting method change on its 2013 tax return for the repair and maintenance of linear assets within the guidance of the tangible property regulations.  The Company’s total federal net operating loss (NOL) was $67.1 million and state net operating loss NOL was $106.0 million as of December 31, 2013.  The NOL carry-forward amounts are more likely than not to be recovered and therefore require no valuation allowance.  The NOL carry-forward does not begin to expire until 2033.

 

As of September 30, 2014 the Company had unrecognized tax benefits of approximately $7.3 million.  Included in the balance of  unrecognized tax benefits is approximately $1.6 million of tax benefits that, if  recognized, would result in an adjustment to the Company’s effective tax rate. The Company does not expect its unrecognized tax benefits to change significantly within the next twelve months.

 

The State of Hawaii Department of Taxation is presently auditing the Company’s 2010, 2011 and 2012 Hawaii state income tax returns.  The State of California Board of Equalization is presently auditing the Company’s 2010, 2011, and 2012 sales and use tax filings. The State of California Franchise Tax Board is presently auditing the Company’s 2008 through 2011 enterprise zone filings.   It is uncertain when the state audits will be completed.  The Company believes that the final resolution of the state audits will not have a material impact on its financial condition or results of operations.

 

Note 9. Regulatory Assets and Liabilities

 

During 2013, the assigned Administrative Law Judge granted Cal Water’s request to continue applying existing rates on and after January 1, 2014 as interim rates and allowed Cal Water to track the difference between interim rates and the new authorized rates in a memorandum account.   The Commission issued a final order for Cal Water’s 2012 General Rate Case (GRC) on August 14, 2014. The 2012 GRC covers the years 2014, 2015, 2016 and replaces the 2009 GRC which covered the years 2011, 2012 and 2013.  The difference between Cal Water’s interim rates and the adopted new rates for the first eight months of 2014 resulted in a regulatory receivable of $30.6 million.  On September 30, 2014, the Commission authorized recovery of this regulatory receivable through ratepayer surcharges over the next three years.  As of September 30, 2014, the interim rates memorandum account balance was recorded as a regulatory balancing account asset of $17.1 million and a regulatory asset of $13.0 million, net of deferred revenues of $0.5 million.

 

As part of the Cal Water GRC decision, a balancing account for Cal Water’s employee and retiree health care plans was authorized with an effective date of January 1, 2014.   The health care balancing account is a two-way balancing account that tracks the differences between the adopted rate recovery and actual medical expenses.  The health care balancing account allows Cal Water to recover from ratepayers eighty-five percent of any actual medical costs that exceed the adopted rate recovery.   If the adopted rate recovery exceeds actual medical costs, Cal Water is required to refund eighty-five percent of the excess to ratepayers.  As of September 30, 2014 the health care balancing account was recorded as a regulatory asset of $1.9 million.

 

The Commission authorized balancing accounts for Cal Water’s pension plans and conservation program in the 2009 and 2012 GRC decisions.  The pension plan’s balancing account is a two-way balancing account that tracks the differences between actual expenses and adopted rate recovery which will result in either a regulatory asset or liability. The conservation program is a one-way balancing account that tracks the difference between actual expenses and adopted rate recovery which may result in a regulatory liability if actual conservation expenses are less than adopted.  During 2014, the Commission authorized a $6.3 million ratepayer refund for the conservation program balancing account authorized in the 2009 GRC.  As of September 30, 2014, the 2009 GRC pension balancing account was recorded as a regulatory asset of $3.0 million and the 2012 GRC pension balancing account was recorded as a regulatory liability of $3.5 million. As of September 30, 2014, the 2009 conservation balancing account was recorded as a regulatory balancing account liability of $4.9 million and the 2012 GRC conservation balancing account was recorded in regulatory and other liabilities of $2.0 million.

 

Note 10. Commitments and Contingencies

 

Commitments

 

The Company has significant commitments to lease certain office spaces and water systems and to purchase water from water wholesalers. These commitments are described in Form 10-K for the year ended December 31, 2013.  As of September 30, 2014, there were no significant changes from December 31, 2013.

 

Contingencies

 

Groundwater Contamination

 

The Company has undertaken litigation against third parties to recover past and future costs related to ground water contamination in the Company’s service areas. The cost of litigation is expensed as incurred and any settlement is first offset against such costs. The Commission’s general policy requires all proceeds from contamination litigation to be used first to pay transactional expenses, then to make ratepayers whole for water treatment costs to comply with the Commission’s water quality standards. The Commission allows for a risk-based consideration of contamination proceeds which exceed the costs of the remediation described above and may result in some sharing of proceeds with the shareholders, determined on a case by case basis. The Commission has authorized various memorandum accounts that allow the Company to track significant litigation costs to request recovery of these costs in future filings and uses of proceeds to comply with Commission’s general policy.

 

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Other Legal Matters

 

From time to time, the Company is involved in various disputes and litigation matters that arise in the ordinary course of business. The status of each significant matter is reviewed and assessed for potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount of the range of loss can be estimated, a liability is accrued for the estimated loss in accordance with the accounting standards for contingencies. Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based on the best information available at the time. While the outcome of these disputes and litigation matters cannot be predicted with any certainty, management does not believe when taking into account existing reserves the ultimate resolution of these matters will materially affect the Company’s financial position, results of operations, or cash flows.  The Company recognized a liability of $2.7 million and $1.3 million for all known legal matters as of September 30, 2014 and December 31, 2013, respectively.  The cost of litigation is expensed as incurred and any settlement is first offset against such costs.  Any settlement in excess of the cost to litigate is accounted for on a case by case basis, dependent on the nature of the settlement.

 

Note 11. Fair Value of Financial Assets and Liabilities

 

The accounting guidance for fair value measurements and disclosures provides a single definition of fair value and requires certain disclosures about assets and liabilities measured at fair value. A hierarchal framework for disclosing the observability of the inputs utilized in measuring assets and liabilities at fair value is established by this guidance. The three levels in the hierarchy are as follows:

 

Level 1 -                         Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. The types of assets and liabilities included in Level 1 are highly liquid and actively traded instruments with quoted prices.

 

Level 2 -                         Pricing inputs are other than quoted prices in active markets, but are either directly or indirectly observable as of the reporting date. The types of assets and liabilities included in Level 2 are typically either comparable to actively traded securities or contracts, or priced with discounted cash flow or option pricing models using highly observable inputs.

 

Level 3 -                         Significant inputs to pricing have little or no observability as of the reporting date. The types of assets and liabilities included in Level 3 are those valued with models requiring significant management judgment or estimation.

 

Specific valuation methods include the following:

 

Cash equivalents, accounts receivable, accounts payable, and short-term borrowings carrying amounts approximated the fair value because of the short-term maturity of the instruments.

 

Long-term debt fair values were estimated using the published quoted market price, if available, or the discounted cash flow analysis, based on the current rates available using a risk-free rate (a U.S. Treasury securities yield curve) plus a risk premium of 1.19%.

 

Advances for construction fair values were estimated using broker quotes from companies that frequently purchase these investments.

 

		September 30, 2014
					Fair Value
		Cost			Level 1			Level 2			Level 3			Total
Long -term debt, including current maturities		$	429,444		—			$	526,733		—			$	526,733
Advances for construction		182,172			—			74,389			—			74,389
Total		$	611,616		$	—		$	601,122		$	—		$	601,122

 

					December 31, 2013
					Fair Value
		Cost			Level 1			Level 2			Level 3			Total
Long -term debt, including current maturities		$	434,050		$	—		$	511,146		$	—		$	511,146
Advances for construction		183,393			—			73,389			—			73,389
Total		$	617,443					$	584,535		$	—		$	584,535

 

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Note 12. Condensed Consolidating Financial Statements

 

On April 17, 2009, Cal Water issued $100 million aggregate principal amount of 5.875% First Mortgage Bonds due 2019, and on November 17, 2010, Cal Water issued $100 million aggregate principal amount of 5.500% First Mortgage Bonds due 2040, all of which are fully and unconditionally guaranteed by the Company.  As a result of these guarantee arrangements, we are required to present the following condensed consolidating financial information.

 

The following tables present the condensed consolidating balance sheets as of September 30, 2014 and December 31, 2013, the condensed consolidating statements of income for the three months ended September 30, 2014 and 2013, the condensed consolidating statements of income for the nine months ended September 30, 2014 and 2013 and the condensed consolidating statements of cash flows for the nine months ended September, 2014 and 2013 of (i) California Water Service Group, the guarantor of the first mortgage bonds and the parent company; (ii) California Water Service Company, the issuer of the first mortgage bonds and a 100% owned consolidated subsidiary of California Water Service Group; and (iii) the other 100% owned non-guarantor consolidated subsidiaries of California Water Service Group.

 

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CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATING BALANCE SHEET

As of September 30, 2014

(In thousands)

 

		Parent Company			Cal Water			All Other Subsidiaries			Consolidating Adjustments			Consolidated
ASSETS
Utility plant:
Utility plant		$	1,318		$	2,120,177		$	192,129		$	(7,197	)	$	2,306,427
Less accumulated depreciation and amortization		(320		)	(705,851		)	(41,266		)	1,695			(745,742		)
Net utility plant		998			1,414,326			150,863			(5,502		)	1,560,685
Current assets:
Cash and cash equivalents		1,316			26,218			1,951			—			29,485
Receivables and unbilled revenue		(756		)	118,265			9,976			(94		)	127,391
Receivables from affiliates		22,242			977			95			(23,314		)	—
Other current assets		107			19,078			1,217			—			20,402
Total current assets		22,909			164,538			13,239			(23,408		)	177,278
Other assets:
Regulatory assets		—			274,509			2,967			—			277,476
Investments in affiliates		633,705			—			—			(633,705		)	—
Long-term affiliate notes receivable		25,516			—			—			(25,516		)	—
Other assets		1,037			48,729			4,287			(412		)	53,641
Total other assets		660,258			323,238			7,254			(659,633		)	331,117
		$	684,165		$	1,902,102		$	171,356		$	(688,543	)	$	2,069,080
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stockholders’ equity		$	622,282		$	564,803		$	74,304		$	(639,107	)	$	622,282
Affiliate long-term debt		—			—			25,516			(25,516		)	—
Long-term debt, less current maturities		—			421,909			916			—			422,825
Total capitalization		622,282			986,712			100,736			(664,623		)	1,045,107
Current liabilities:
Current maturities of long-term debt		—			6,164			455			—			6,619
Short-term borrowings		61,715						—			—			61,715
Payables to affiliates		—			1,813			21,501			(23,314		)	—
Accounts payable		—			68,659			3,208						71,867
Accrued expenses and other liabilities		168			71,269			3,818			(42		)	75,213
Total current liabilities		61,883			147,905			28,982			(23,356		)	215,414
Unamortized investment tax credits		—			2,106			—			—			2,106
Deferred income taxes, net		—			206,552			4,369			(564		)	210,357
Pension and postretirement benefits other than pensions		—			153,085			—			—			153,085
Regulatory and other liabilities		—			82,757			8,956			—			91,713
Advances for construction		—			181,514			658			—			182,172
Contributions in aid of construction		—			141,471			27,655			—			169,126
		$	684,165		$	1,902,102		$	171,356		$	(688,543	)	$	2,069,080

 

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CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATING BALANCE SHEET

As of December 31, 2013

(In thousands)

 

		Parent Company			Cal Water			All Other Subsidiaries			Consolidating Adjustments			Consolidated
ASSETS
Utility plant:
Utility plant		$	1,318		$	2,034,935		$	184,272		$	(7,197	)	$	2,213,328
Less accumulated depreciation and amortization		(164		)	(661,780		)	(37,168		)	1,615			(697,497		)
Net utility plant		1,154			1,373,155			147,104			(5,582		)	1,515,831
Current assets:
Cash and cash equivalents		5,280			20,790			1,436			—			27,506
Receivables and unbilled revenue		(756		)	90,008			8,931			(94		)	98,089
Receivables from affiliates		16,747			5,755			—			(22,502		)	—
Other current assets		—			13,011			884			—			13,895
Total current assets		21,271			129,564			11,251			(22,596		)	139,490
Other assets:
Regulatory assets		—			248,938			2,743			—			251,681
Investments in affiliates		565,347			—			—			(565,347		)	—
Long-term affiliate notes receivable		26,255			—			—			(26,255		)	—
Other assets		1,120			44,827			7,111			(205		)	52,853
Total other assets		592,722			293,765			9,854			(591,807		)	304,534
		$	615,147		$	1,796,484		$	168,209		$	(619,985	)	$	1,959,855
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stockholders’ equity		$	598,756		$	500,290		$	70,548		$	(570,838	)	$	598,756
Affiliate long-term debt		—			—			26,255			(26,255		)	—
Long-term debt, less current maturities		—			424,854			1,288			—			426,142
Total capitalization		598,756			925,144			98,091			(597,093		)	1,024,898
Current liabilities:
Current maturities of long-term debt		—			6,137			1,771			—			7,908
Short-term borrowings		16,815			30,000			—			—			46,815
Payables to affiliates		48			—			22,454			(22,502		)	—
Accounts payable		—			51,764			3,323			—			55,087
Accrued expenses and other liabilities		107			55,346			1,321			—			56,774
Total current liabilities		16,970			143,247			28,869			(22,502		)	166,584
Unamortized investment tax credits		—			2,106			—			—			2,106
Deferred income taxes, net		(579		)	179,870			4,344			(390		)	183,245
Pension and postretirement benefits other than pensions		—			145,451			—			—			145,451
Regulatory and other liabilities		—			77,627			8,828			—			86,455
Advances for construction		—			182,776			617			—			183,393
Contributions in aid of construction		—			140,263			27,460			—			167,723
		$	615,147		$	1,796,484		$	168,209		$	(619,985	)	$	1,959,855

 

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