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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, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ___________________
Commission file number 1-13883
------------------------------
CALIFORNIA WATER SERVICE GROUP
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 77-0448994
- --------------------------------------------------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1720 North First Street, San Jose, CA. 95112
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
1-408-367-8200
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ___
Indicate by checkmark whether the Registrant is an accelerated filer (as defined
in rule 12b-2 of the Act) Yes _X_ No __
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
November 11, 2003 - 16,932,046.
TABLE OF CONTENTS
Page
PART I Financial Review - Condensed Consolidated Financial Statements
(unaudited) and Management's Discussion and Analysis .......... 3
Item 1 Condensed Consolidated Balance Sheets
September 30, 2003 and December 31, 2002....................... 4
Condensed Consolidated Statements of Income
For the Three Months Ended September 30, 2003 and 2002......... 5
Condensed Consolidated Statements of Income
For the Nine Months Ended September 30, 2003 and 2002.......... 6
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2003 and 2002.......... 7
Notes to Condensed Consolidated Financial Statements............. 8
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 16
Item 3 Quantitative and Qualitative Disclosure about Market Risk........ 30
Item 4 Controls and Procedures.......................................... 30
PART II Other Information
Item 1 Legal Proceedings................................................ 31
Item 6 Exhibits and Reports on Form 8-K................................. 32
Signatures....................................................... 33
Index to Exhibits................................................ 34
2
PART I FINANCIAL INFORMATION
Item 1.
Financial Statements
The financial information presented in this 10-Q filing has been
prepared by management and has not been audited.
3
CALIFORNIA WATER SERVICE GROUP
CONDENSED CONSOLIDATED BALANCE SHEETS
Unaudited
(In thousands, except per share data)
September 30, December 31,
2003 2002
----------- -----------
ASSETS
Utility plant:
Utility plant $ 1,063,323 $ 1,001,310
Less accumulated depreciation and amortization 320,594 304,322
----------- -----------
Net utility plant 742,729 696,988
----------- -----------
Current assets:
Cash and cash equivalents 12,396 1,063
Receivables 26,438 23,961
Unbilled revenue 12,684 7,969
Materials and supplies at average cost 2,934 2,760
Taxes and other prepaid expenses 8,086 7,234
----------- -----------
Total current assets 62,538 42,987
----------- -----------
Other assets:
Regulatory assets 53,017 46,089
Other assets 16,907 14,518
----------- -----------
Total other assets 69,924 60,607
----------- -----------
$ 875,191 $ 800,582
=========== ===========
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, $.01 par value $ 169 $ 152
Additional paid-in capital 93,773 49,984
Retained earnings 148,695 149,215
Accumulated other comprehensive loss (134) (134)
----------- -----------
Total common stockholders' equity 242,503 199,217
Preferred stock 3,475 3,475
Long-term debt, less current maturities 270,909 250,365
----------- -----------
Total capitalization 516,887 453,057
----------- -----------
Current liabilities:
Current maturities of long-term debt 900 1,000
Short-term borrowings 2,479 36,379
Accounts payable 29,020 23,706
Accrued expenses and other liabilities 44,070 30,456
----------- -----------
Total current liabilities 76,469 91,541
Unamortized investment tax credits 2,875 2,774
Deferred income taxes 38,414 31,371
Regulatory and other liabilities 34,123 28,804
Advances for construction 120,919 115,459
Contributions in aid of construction 85,504 77,576
Commitments and contingencies -- --
----------- -----------
$ 875,191 $ 800,582
=========== ===========
See accompanying Notes to Condensed Consolidated Financial Statements
4
CALIFORNIA WATER SERVICE GROUP
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Unaudited
(In thousands, except per share data)
For the three months ended: September 30, September 30,
2003 2002
-------- --------
Operating revenue $ 88,197 $ 81,440
-------- --------
Operating expenses:
Operations 58,398 54,190
Maintenance 3,172 3,010
Depreciation and amortization 5,830 5,263
Income taxes 5,587 5,047
Property and other taxes 2,691 2,333
-------- --------
Total operating expenses 75,678 69,843
-------- --------
Net operating income 12,519 11,597
-------- --------
Other income and expenses:
Non-regulated income, net 623 527
Gain/(loss) on sale of non-utility property 24 (13)
-------- --------
647 514
Interest expense:
Long-term debt interest 4,234 4,149
Other interest 345 287
-------- --------
Total interest expense 4,579 4,436
Net income $ 8,587 $ 7,675
======== ========
Earnings per share:
Basic $ 0.53 $ 0.50
======== ========
Diluted $ 0.53 $ 0.50
======== ========
Weighted average shares outstanding:
Basic 16,209 15,182
======== ========
Diluted 16,222 15,185
======== ========
Dividends per share of common stock $0.28125 $0.28000
======== ========
See accompanying Notes to Condensed Consolidated Financial Statements
5
CALIFORNIA WATER SERVICE GROUP
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Unaudited
(In thousands, except per share data)
For the nine months ended: September 30, September 30,
2003 2002
-------- --------
Operating revenue $207,502 $202,234
-------- --------
Operating expenses:
Operations 141,851 134,222
Maintenance 9,488 8,365
Depreciation and amortization 17,428 16,045
Income taxes 8,348 10,898
Property and other taxes 7,694 7,349
-------- --------
Total operating expenses 184,809 176,879
-------- --------
Net operating income 22,693 25,355
-------- --------
Other income and expenses:
Non-regulated income, net 1,792 1,417
Gain on sale of non-utility property 1,535 1,961
-------- --------
3,327 3,378
Interest expense:
Long-term debt interest 12,451 11,518
Other interest 1,165 994
-------- --------
Total interest expense 13,616 12,512
Net income $ 12,404 $ 16,221
======== ========
Earnings per share:
Basic $ 0.79 $ 1.06
======== ========
Diluted $ 0.79 $ 1.06
======== ========
Weighted average shares outstanding:
Basic
15,528 15,182
======== ========
Diluted
15,539 15,185
======== ========
Dividends per share of common stock $0.84375 $0.84000
======== ========
See accompanying Notes to Condensed Consolidated Financial Statements
6
CALIFORNIA WATER SERVICE GROUP
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(In thousands)
For the nine months ended: September 30, September 30,
2003 2002
-------- --------
Operating activities
Net income $ 12,404 $ 16,221
-------- --------
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 17,428 16,045
Deferred income taxes, investment tax credits
regulatory assets and liabilities, net 3,900 1,523
Gain on sale of non-utility assets (1,535) (1,961)
Changes in operating assets and liabilities:
Receivables (2,286) (6,866)
Unbilled revenue (4,715) (3,596)
Taxes and other prepaid expenses (764) (1,758)
Accounts payable 5,293 4,945
Other current assets and liabilities 13,438 11,790
Other changes, net (1,425) (2,986)
-------- --------
Net adjustments 29,334 17,136
-------- --------
Net cash provided by operating activities 41,738 33,357
-------- --------
Investing activities:
Utility plant expenditures
Company funded (39,845) (47,929)
Developer funded (13,527) (10,986)
Acquisitions (6,094) (2,300)
Proceeds from sale of non-utility assets 1,643 2,122
-------- --------
Net cash used by investing activities (57,823) (59,093)
-------- --------
Financing activities:
Net change in short-term borrowings (34,000) (11,000)
Net proceeds from issuance of long-term debt 19,630 39,753
Advances for construction 9,197 9,924
Refunds of advances for construction (3,603) (3,386)
Contributions in aid of construction 5,310 5,342
Proceeds from issuance of common stock, net 43,808 --
Dividends paid (12,924) (12,868)
-------- --------
Net cash provided by financing activities
27,418 27,765
-------- --------
Change in cash and cash equivalents 11,333 2,029
Cash and cash equivalents at beginning of period 1,063 953
-------- --------
Cash and cash equivalents at end of period $ 12,396 $ 2,982
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the nine months:
Interest (net of amounts capitalized) $ 9,459 $ 7,940
Income taxes $ 550 $ 5,005
See accompanying Notes to Condensed Consolidated Financial Statements
7
CALIFORNIA WATER SERVICE GROUP
Notes to Condensed Consolidated Financial Statements
September 30, 2003
Note 1. Organization and Operations
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. In
addition, these entities and CWS Utility Services provide non-regulated
water utility and utility-related services.
The Company operates primarily in one business segment providing water
utility services.
Note 2. Summary of Significant Accounting Policies
The interim financial information is unaudited. In the opinion of
management, the accompanying condensed consolidated financial
statements reflect all adjustments that are necessary to provide a fair
presentation of the results for the periods presented. The adjustments
consist only of normal recurring adjustments. The results for interim
periods are not necessarily indicative of the results of the entire
year. The condensed consolidated financial statements should be read in
conjunction with the Company's consolidated financial statements for
the year ended December 31, 2002 included in its Form 10-K as filed
with the Securities and Exchange Commission on March 25, 2003.
Note 3. Stock-based Compensation
The Company has a stockholder approved Long-Term Incentive Plan that
allows granting of non-qualified stock options. The Company has adopted
the disclosure requirements of Statement of Financial Accounting
Standards (SFAS) No. 123 "Accounting for Stock-Based Compensation," as
amended by SFAS No. 148 "Accounting for Stock-Based Compensation -
Transition Disclosure - An Amendment of FASB Statement No. 123," and as
permitted by SFAS No. 123, applies Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," for its plan. All
outstanding options had an exercise price equal to the market price on
the date they were granted. No compensation expense was recorded for
the three and nine-month periods ended September 30, 2003 and 2002
related to stock options. No options were granted during the three and
nine-month periods ended September 30, 2003.
8
The table below illustrates the effect on net income and earnings per
share as if the company had applied the fair value recognition
provision of SFAS No. 123 to employee compensation.
Three Months Ended September 30
-------------------------------
(in thousands, except per share data)
2003 2002
--------- ---------
Net income, as reported $ 8,587 $ 7,675
Deduct: Stock-based employee compensation
expense determined under fair value
method for all awards, net of related tax effects 21 21
--------- ---------
Pro forma net income $ 8,566 $ 7,554
========= =========
Earnings per share
Basic - as reported $ 0.53 $ 0.50
Basic - pro forma $ 0.53 $ 0.50
Diluted - as reported $ 0.53 $ 0.50
Diluted - pro forma $ 0.53 $ 0.49
Nine Months Ended September 30
------------------------------
(in thousands, except per share data)
2003 2002
---------- ----------
Net income, as reported $ 12,404 $ 16,221
Deduct: Stock-based employee compensation
expense determined under fair value
method for all awards, net of related tax effects 63 63
---------- ----------
Pro forma net income $ 12,341 $ 16,158
========== ==========
Earnings per share
Basic - as reported $ 0.79 $ 1.06
Basic - pro forma $ 0.79 $ 1.06
Diluted - as reported $ 0.79 $ 1.06
Diluted - pro forma $ 0.79 $ 1.06
Note 4. Seasonal Business
Due to the seasonal nature of the water business, the results for
interim periods are not indicative of the results for a twelve-month
period. Revenue and income are generally higher in the warm, dry summer
months when water usage and sales are greater. Revenue and income are
lower in the winter months when cooler temperatures and increased
rainfall curtail water usage and sales.
9
Note 5. Earnings Per Share Calculations
The computations of basic and diluted earnings per share are noted
below.
Options to purchase 107,000 shares of common stock for the three and
nine month periods ended September 30, 2002 were excluded from the
diluted per share calculation due to their anti-dilutive effect. No
exclusions from the diluted per share calculation were made for the
three and nine month periods ended September 30, 2003.
Three Months Ended
September 30
----------------------
(in thousands, except
per share data)
2003 2002
------- -------
Net income $ 8,587 $ 7,675
Less preferred dividends 38 38
------- -------
Net income available for common stock $ 8,549 $ 7,637
======= =======
Weighted average common shares 16,209 15,182
Dilutive common stock options (treasury method) 13 3
------- -------
Shares used for dilutive computation 16,222 15,185
======= =======
Net income per share - basic $ 0.53 $ 0.50
------- -------
Net income per share - diluted $ 0.53 $ 0.50
------- -------
Nine Months Ended
September 30
----------------------
(in thousands, except
per share data)
2003 2002
------- -------
Net income $12,404 $16,221
Less preferred dividends 115 115
------- -------
Net income available for common stock $12,289 $16,106
======= =======
Weighted average common shares 15,528 15,182
Dilutive common stock options (treasury method) 11 3
------- -------
Shares used for dilutive computation 15,539 15,185
======= =======
Net income per share - basic $ 0.79 $ 1.06
------- -------
Net income per share - diluted $ 0.79 $ 1.06
------- -------
10
Note 6. Allowance for Doubtful Accounts
Allowance for doubtful accounts was $290,000 and $180,000 at September
30, 2003 and December 31, 2002, respectively.
Note 7. Regulatory Assets and Liabilities
The following table presents the components of regulatory assets and
liabilities as of September 30, 2003 and December 31, 2002.
September 30, December 31,
2003 2002
------- -------
(in thousands) (in thousands)
Regulatory Assets
Related to income taxes $31,341 $31,341
Post-retirement benefits other
than pensions 5,840 5,165
Asset retirement obligation 6,253 --
Accrued vacation and workers
compensation insurance 9,583 9,583
------- -------
Total Regulatory Assets $53,017 $46,089
======= =======
Regulatory Liabilities
Related to Income taxes $16,263 $17,201
======= =======
(Included in Regulatory and other liabilities)
11
Note 8. Non-Regulated Revenue and Income
The following table presents the components of the "Non-regulated
income, net" line on the Consolidated Statements of Income for the
three-month and nine-month periods ended September 30 2003 and 2002.
Three Months Ended September 30
--------------------------------------------------
(in thousands)
2003 2002
--------------------- ---------------------
Revenue Income Revenue Income
------- ------ ------- ------
Operating & maintenance $1,017 $ 215 $1,006 $ 185
Meter reading & billing 394 137 365 100
Leases 266 173 199 124
Water rights brokerage 112 112 131 131
Design & construction 251 42 2,296 65
Other 79 (56) 92 (78)
------ ------ ------ ------
Total $2,119 $ 623 $4,089 $ 527
====== ====== ====== ======
Nine Months Ended September 30
--------------------------------------------------
(in thousands)
2003 2002
--------------------- ---------------------
Revenue Income Revenue Income
------- ------ ------- ------
Operating & maintenance $ 3,117 $ 752 $ 2,977 $ 574
Meter reading & billing 1,036 395 822 234
Leases 848 561 735 385
Water rights brokerage 112 112 270 270
Design & construction 880 111 4,685 172
Other 256 (139) 191 (218)
------- ------- ------- -------
Total $ 6,249 $ 1,792 $ 9,680 $ 1,417
======= ======= ======= =======
12
Note 9. Financing
Common Stock
On August 4, 2003, the Company issued 1,750,000 additional shares of
common stock from the previously reported $120,000,000 shelf
registration statement (See "LIQUIDITY - CAPITAL RESOURCES - Shelf
Registration Statement"). The shares were sold at $26.25 per share. The
net proceeds were $43.8 million and the transaction was closed on
August 7, 2003. The funds were used to pay down short-term borrowings
and to invest in short-term money market instruments pending their use
for general corporate purposes. After issuance of the 1,750,000 shares,
there remains $74,062,500 in securities under the shelf registration,
which are available for future issuance.
Long-term Debt
In February 2003, the Company completed the issuance of $10 million,
4.58%, 7-year Series K Senior Notes and $10 million, 5.48%, 15-year
Series L Senior Notes. Both notes were unsecured. The proceeds from
these borrowings were used to pay down short-term borrowings and to
fund capital expenditures.
On May 1, 2003, the Company issued $10 million, 5.54%, 20-year Series I
Senior Notes and $10 million, 5.44%, 15-year Series J Senior Notes.
Both notes were unsecured. The proceeds from these borrowings were used
to early terminate EE First Mortgage bonds that had an interest rate of
7.9%. The principal, call premiums and transaction costs were
approximately $20 million.
Note 10. Legal Proceedings
The Company is involved in various proceedings or litigation arising in
the ordinary course of operations. The Company believes the ultimate
resolution of such matters will not materially affect its financial
position, results of operations or cash flows.
Note 11. New Accounting Standards
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 143, "Accounting for Asset Retirement Obligations," which
applies to legal obligations associated with the retirement of
long-lived assets and the associated asset retirement costs. The
Statement was effective for the Company in the first quarter of 2003.
The adoption of SFAS No. 143 did not have a material impact to the
Company's results of operations or cash flows.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This Statement addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)." This Statement requires that a liability
for costs associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is
incurred. The provisions of this statement are effective for exit or
disposal activities that are initiated after
13
December 31, 2002. The adoption of SFAS No. 146 did not impact the
Company's financial position, results of operations or cash flows.
In November 2002, the FASB issued Interpretation No. 45, "Guarantors'
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." Interpretation No. 45
requires that a liability be recognized at the time a company issues a
guarantee for the fair value of the obligations assumed under certain
guarantee agreements. Interpretation No. 45 is effective for guarantees
issued or modified after December 31, 2002. The disclosure requirements
of the Interpretation expand existing disclosures required by a
guarantor about its obligations under a guarantee. The adoption of
Interpretation No. 45 did not impact the Company's financial position,
results of operations or cash flows.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities." Interpretation No. 46 provides guidance
for determining when a primary beneficiary should consolidate a
variable interest entity or equivalent structure that functions to
support the activities of the primary beneficiary. Interpretation No.
46 is effective for all new variable interest entities created or
acquired after January 31, 2003. For variable interest entities created
or acquired prior to February 1, 2003, the provisions of Interpretation
No. 46 must be applied during the first interim or annual period
beginning after June 15, 2003. The adoption of Interpretation No. 46
did not impact the Company's financial position, results of operations
or cash flows.
In April 2003, the FASB issued SFAS No. 149 "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." The Statement
impacts the accounting for certain derivative contracts entered into
after June 30, 2003. This Statement is effective for quarters beginning
after June 15, 2003. The Company currently does not enter into
derivative or hedging contracts. The adoption of SFAS No. 149 did not
have an impact on the Company's financial position, results of
operations or cash flows.
In May 2003, the FASB issued SFAS No. 150 "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity." The Statement establishes standards for the classification and
measurement of certain financial instruments with characteristics of
both liabilities and equity. The Statement is effective for financial
instruments entered into after May 31, 2003 and is otherwise effective
for quarters beginning after June 15, 2003. In November 2003, the FASB
issued a staff position, which deferred the application of several
provisions of SFAS 150. The Company has not issued financial
instruments that have characteristics of both liabilities and equity.
The adoption of SFAS No. 150 did not have nor is expected to have an
impact on the Company's financial position, results of operations or
cash flows.
14
Note 12. Subsequent Events
Financing
On October 24, 2003, the Company completed a transaction to refinance a
portion of its long-term debt. Senior Note Series N for $20 million was
issued by California Water Service Company in a private placement
transaction. The note is unsecured, accrues interest at a rate of 5.55%
per annum and matures on December 1, 2013. Payment of principal is due
at maturity. Funds received were used to prepay first mortgage bonds
Series FF, which accrued interest at a rate of 6.95% and had a
principal balance of $19.1 million. In addition to the pre-payment of
the principal balance, funds were used to pay a call premium related to
Series FF, transaction costs and general corporate purposes. This
transaction was a component of the Company's refinancing program
disclosed in prior filings.
On November 3, 2003, the Company completed an additional transaction to
refinance a portion of its long-term debt. Senior Note Series M for $20
million was issued by California Water Service Company in a private
placement transaction. The note is unsecured, accrues interest at a
rate of 5.52% per annum and matures on November 1, 2013. Payment of
principal is due at maturity. Funds received were used to prepay first
mortgage bonds Series GG, which accrued interest at a rate of 6.98% and
had a principal balance of $19.1 million. In addition to the
pre-payment of the principal balance, funds were used to pay a call
premium related to Series GG, transaction costs and general corporate
purposes. This transaction was a component of the Company's refinancing
program disclosed in prior filings. The refinancing program is now
complete.
15
Item 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
This quarterly report, including all documents incorporated by
reference, may contain forward-looking statements. The forward-looking
statements are intended to qualify for "safe-harbor" treatment
established by the Private Securities Reform Act of 1995.
Forward-looking statements are based on currently available
information, expectations, estimates, assumptions and projections, and
management's judgment about the company, the water utility industry and
general economic conditions. Words like "expects," "intends," "plans,"
"believes," "estimates," "assumes," "anticipates," "projects,"
"predicts," "forecasts" 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 expected or anticipated include: governmental and
regulatory commissions' decisions; changes in regulatory commissions'
policies and procedures; the timeliness of regulatory commissions'
actions concerning rate relief; new legislation; 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; the
ability to successfully implement business plans; changes in customer
water use patterns; the impact of weather on water sales and operating
results; access to sufficient capital on satisfactory terms; civil
disturbances or terrorist threats or acts, or apprehension about
possible future occurrences of acts of this type; the involvement of
the United States in war or other hostilities; restrictive covenants in
or changes to the credit ratings on our current or future debt that
could increase our financing costs or affect our ability to borrow,
make payments on debt or pay dividends; and, other risks and unforeseen
events. When considering forward-looking statements, you should keep in
mind the cautionary statements included in this paragraph. We assume no
obligation to provide public updates of forward-looking statements.
CRITICAL ACCOUNTING POLICIES
We maintain our accounting records in accordance with accounting
principles generally accepted in the United States of America and as
directed by the regulatory commissions to which we 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 historical experience and an understanding of current facts and
circumstances. Management believes that the following accounting
policies are critical because they involve a higher
16
degree of complexity and judgement and can have a material impact on
our results of operations and financial condition.
Revenue Recognition
Revenue from metered customers includes billings to customers based on
monthly meter readings plus an estimate for water used between the
customer's last meter reading and the end of the accounting period. The
unbilled revenue amount is recorded as a current asset on the balance
sheet under the caption "Unbilled revenue." At September 30, 2003, the
unbilled revenue amount was $12.7 million and at December 31, 2002 the
amount was $8.0 million. The unbilled revenue amount is generally
higher during the summer months when water sales are higher. The amount
recorded as unbilled revenue varies depending on water usage in the
preceding period, the number of days between meter reads for each
billing cycle, and the number of days between each cycle's meter
reading and the end of the accounting cycle.
Flat rate customers are billed in advance at the beginning of the
service period. The revenue is prorated so that the portion of revenue
applicable to the current accounting period is included in that
period's revenue. The portion related to a subsequent accounting period
is recorded as unearned revenue on the balance sheet and recognized as
revenue when earned in the subsequent accounting period. The unearned
revenue was $2.0 million at September 30, 2003 and $1.7 million at
December 31, 2002. This unearned revenue is included in "Accrued
expenses and other liabilities" on the balance sheet.
Revenues from non-regulated activities are recognized when services
have been rendered, when title has transferred to the buyer, or ratably
over the term of agreement for lease contracts. For construction and
design services, revenue is generally recognized on the completed
contract method, as most projects are completed in less than three
months. One construction and design project spanned multiple years and
revenue is recognized using the percentage-of-completion method based
on a zero profit margin until project completion.
Expense Balancing and Memorandum Accounts
Expense balancing accounts and memorandum accounts (offsetable
expenses) represent costs incurred, but not billed to our customers.
The amounts included in these accounts relate to rate increases charged
to us by suppliers of purchased water and purchased power, and
increases in pump taxes. We do not record expense balancing or
memorandum accounts in our financial statements as revenue, nor as a
receivable, until the California Public Utilities Commission ("CPUC")
has authorized recovery of the higher costs and customers have been
billed. Therefore, a timing difference occurs between when costs are
recognized and the recognition of associated revenues. The balancing
and memorandum accounts are only used to track the higher costs outside
of the financial statements. The cost increases, which are beyond our
control, are referred to as "offsetable expenses" because under certain
circumstances they are recoverable from customers in future offset rate
increases.
Historically, offset rate increases enabled water utilities to recover
as a pass-through, cost increases for offsetable expenses that were not
known or anticipated when customer rates were established and were
beyond the utility's control. In December 2001, the CPUC issued
17
a decision that designated certain offsetable expenses as frozen. These
were offsetable expenses incurred prior to November 29, 2001. In May
2003, we received approval to recover these expenses over a 24 month
period.
In June 2003, the CPUC issued a decision allowing water utility
companies to request recovery of "balancing-type memorandum accounts",
which are primarily comprised of higher electricity cost incurred
between November 29, 2001 and December 31, 2002. Unlike the recovery of
such costs prior to November 29, 2001, certain limitations will apply.
The primary limitation is that recovery will not be allowed if a
district earned more than its authorized rate of return during that
period. CPUC approval has not yet been received related to these
expenses.
For 2003, we have incurred certain expenses that may be eligible for
recovery in balancing-type memorandum accounts. As these costs will be
subject to limitation tests, we cannot estimate the amount that will be
recoverable at this time. Filings related to these expenses will be
made in 2004.
At September 30, 2003, the amount included in the offsetable expense
accounts not yet recovered was approximately $9.4 million, which
reflects approvals received and filings made. This amount may be
adjusted depending on decisions by the CPUC related to filings being
reviewed.
Regulated Utility Accounting
Because we operate extensively in a regulated business, we are subject
to the provisions of SFAS No. 71, "Accounting for the Effects of
Certain Types of Regulation." Regulators establish rates that are
expected to permit the recovery of the cost of service and a return on
investment. In the event a portion of our operations were no longer
subject to the provisions of SFAS No. 71, we would be required to write
off related regulatory assets and liabilities that are not specifically
recoverable and determine if other assets might be impaired. If a
regulatory commission determined that a portion of our assets was 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. There have been no such asset impairments as of
September 30, 2003.
Income Taxes
Significant judgment by management is required in determining the
provision for income taxes. The preparation of consolidated financial
statements requires the estimation of income tax expense. The process
involves the estimating of current tax exposure together with assessing
temporary differences resulting from different treatment of certain
items, such as depreciation, for tax and financial statement reporting.
These differences result in deferred tax assets and liabilities, which
are reported in the consolidated balance sheet. We must also assess the
likelihood that deferred tax assets will be recovered in future taxable
income, and to the extent recovery is unlikely, a valuation allowance
would be recorded. If a valuation allowance were required, it could
significantly increase income tax expense. In management's view, a
valuation allowance is not required as of September 30, 2003.
18
Pension Benefits
We incur costs associated with our defined benefit pension plan and
postretirement health care benefits plan. To measure the expense of
these benefits, management must estimate compensation increases,
mortality rates, future health cost increases and discount rates used
to value related liabilities and to determine appropriate funding.
Different estimates used by management could result in significant
variances in the cost recognized for these 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 expert advice in
managing the plans' investments. We anticipate any increase in funding
for the pension and postretirement health care benefits plans will be
recovered in future customer rates.
RESULTS OF THIRD QUARTER 2003 OPERATIONS
Third quarter net income was $8.6 million, equivalent to $0.53 per
common share on a diluted basis compared to the $7.7 million or $0.50
per share on a diluted basis earned in the third quarter of 2002.
Operating Revenue
Operating revenue increased $6.8 million or 8% to $88.2 million.
Weather had a positive influence on customer water usage for the
quarter. Average temperatures for our California service areas were
approximately 3% warmer than last year. Precipitation was higher
compared to last year in California, but the amount was minimal. In
Washington, precipitation was much lower, which had a positive effect
on revenue.
The factors impacting operating revenue for the third quarter of 2003
are presented in the following table (in thousands):
Increase usage by existing customers $1,540
Rate increases 3,242
Usage by new customers 1,975
------
Net operating revenue increase $6,757
======
Following are operating revenue changes from rate increases and their
estimated amounts: step rate increases ($0.6 million); increases for
the Bakersfield treatment plant ($0.6 million); increases for balancing
accounts ($0.8 million), increases related to the 2001 General Rate
Case ("GRC") ($0.9 million) and increases related to the 2001 GRC
"catch up" ($0.3 million). (See Regulatory Matters section for complete
descriptions.)
Usage by new customers includes $0.9 million for Hawaii Water, as these
operations were acquired on April 30, 2003. $1.1 million was from usage
by new customers in existing districts.
19
Total Operating Expenses
Total operating expenses were $75.6 million for the three months ended
September 30, 2003 versus $69.8 million for the same period in 2002, an
increase of $5.8 million or 8%. This category is comprised of
operations expense, maintenance, depreciation, amortization, income
taxes, property taxes and other taxes.
Operations expenses were $58.4 million and increased $4.2 million (8%)
from the prior year. A major component of this expense is water
production costs. Water production costs consists of purchased water,
purchased power and pump taxes. It represents the largest component of
operations expense. During the current quarter, these costs accounted
for 66% of total operations expense and increased 8% compared to last
year. Water production quantities increased 3% due to the higher water
usage by existing customers and increases from new customers. Well
production provided 53% of the water supply, 45% was purchased from
wholesale suppliers and 2% was developed through our surface water
treatment plants. The components of water production costs and changes
from the third quarter of last year are shown in the table below (in
thousands):
Third quarter
2003 Cost Change
--------- ------
Purchased water $27,412 $ 2,248
Purchased power 9,065 611
Pump taxes 2,325 70
------- -------
Total $38,802 $ 2,929
======= =======
Purchased water increased due to increased customer usage and due to
increased rates for purchased water in several of our districts.
Purchased power, which is used mainly for pumping equipment at wells
and distribution lines, increased due to the Hawaii Water Acquisition
and power costs related to distribution.
Other costs included in operations expense are wages, benefits, water
treatment, water quality, customer services costs and general corporate
expenses. Wages for union employees increased 1% effective January 1,
2003. Overall labor costs increased 3% due to a 2% increase in
headcount and wage increases. Payroll costs charged to operations
expense increased by $0.3 million or 5%. Benefit costs increased $0.4
million principally due to higher pension costs. Part of the agreement
with union employees included a change in the pension plan for the
minimum payment amounts. This change increased pension cost
substantially, increasing 45% from the prior year. At September 30,
2003, there were 814 employees and at September 30, 2002, there were
799 employees.
Other major items driving the increase in operations expenses were
water treatment/water quality expenses ($0.3 million) for increased
costs related to testing, chemicals and filters.
Maintenance expense was $0.2 million (5%) higher in the quarter ended
September 30, 2003 due to additional maintenance required for mains,
service line, meters and tank repairs.
20
Depreciation/amortization expense increased $0.6 million because of the
increases in utility plant. (See "LIQUIDITY - CAPITAL RESOURCES -
Utility Plant Expenditures" below in this report).
Federal and state income taxes increased $0.5 million due to the
increase in taxable income. The effective tax rate was 39% in the
current quarter and 40% for the same quarter in the prior year.
Other Income and Expense
Other income and expense was $0.6 million income compared to $0.5
million income in 2002, an increase of $0.1 million. The change is due
to increases in income from operating/maintenance arrangements, meter
reading/billing services and rental income from cellular antenna leases
(see Note 8 to the Condensed Consolidated Financial Statements). There
were minimal amounts related to property sales in either period.
Interest Expense
Total interest expense increased $0.1 million with long-term debt
interest increasing $0.1 million and short-term interest expense
increasing $0.1 million.
Long-term debt interest was impacted by three items: additional debt
outstanding caused interest expense to increase by $0.5 million
compared to the year earlier period; refinanced debt reduced interest
cost by $0.5 million; and debt amortization increased $0.1 million due
to additional and refinanced long-term debt. Capitalized interest did
not change between the periods.
Average borrowings under our short-term bank credit agreement were
higher during the third quarter of this year compared to the same
quarter in 2002. The average interest rate on short-term debt was
approximately 2.6% in 2003 compared to approximately 3.0% during the
third quarter in 2002. The higher borrowings caused short-term interest
expense to increase.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
Net income for the nine months ended September 30, 2003 was $12.4
million, equivalent to $0.79 per common share on a diluted basis
compared to the $16.2 million or $1.06 per share on a diluted basis
earned in 2002.
Operating Revenue
Operating revenue increased $5.3 million or 3% to $207.5 million.
Weather had a significant influence on customer water usage in the
first half of the year. Temperatures were slightly higher than the
prior year for our markets, but were believed to have only a minor
impact on our revenues. Precipitation was much higher, over two times
the prior year comparable period and had a negative influence on usage.
21
The factors impacting operating revenue for the nine months ended
September 30, 2003 are presented in the following table (in thousands):
Decreased usage by existing customers ($4,828)
Rate increases 5,919
Usage by new customers 4,177
-------
Net operating revenue increase $ 5,268
=======
Following are operating revenue changes from rate increases and their
estimated amounts: step rate increases ($1.7 million); increases for
the Bakersfield treatment plant ($1.4 million); increases for
Washington Water ($0.3 million); increases for balancing accounts ($1.3
million), increases related to the 2001 General Rate Case ("GRC") ($0.9
million) and increases related to the 2001 GRC "catch up" ($0.3
million). (See Regulatory Matters section for complete descriptions).
Usage by new customers includes $0.8 million for New Mexico Water,
acquired in July 2002, and $1.4 million for Hawaii Water, acquired in
April 2003. $2.0 million was from usage by new customers in existing
districts.
Total Operating Expenses
Total operating expenses were $184.8 million for the nine months ended
September 30, 2003 versus $176.9 million for the same period in 2002, a
4% increase. This category is comprised of operations expense,
maintenance, depreciation, amortization, income taxes, property taxes,
and other taxes.
Operations expenses were $141.9 million, increasing $7.6 million or 6%
from the prior year. A major component of this expense is water
production costs. Water production costs consists of purchased water,
purchased power and pump taxes. It represents the largest component of
operations expense. For the nine months, these costs accounted for 59%
of total operations expense. Water production costs increased 3%
compared to last year principally due to rate increases for purchased
water, which was partially offset by lower production. Water production
decreased 2% due to the lower water usage by existing customers and was
partially offset by sales to new customers. Well production provided
51% of the water supply, 47% was purchased from wholesale suppliers and
2% was developed through our surface water treatment plants. The
components of water production costs and changes from the nine-month
period of last year are shown in the table below (in thousands):
Nine Months
2003 Cost Change
--------- ------
Purchased water $61,110 $ 1,996
Purchased power 18,056 661
Pump taxes 4,830 (223)
------- -------
Total $83,996 $ 2,434
======= =======
22
Purchased water costs increased due to rate increases in several
districts. Purchased power, which is used mainly for pumping equipment
at wells and distribution lines increased due to the Hawaii Water
acquisition and due to power costs related to distribution. Pump taxes
were lower due to the decreased production at wells.
Other costs included in operations expense are wages, benefits, water
treatment, water quality, customer services costs and general corporate
expenses. Wages for union employees increased 1% effective January 1,
2003. Overall labor costs increased 4% due to increases in wages,
increased headcount and increases related to acquisitions. Payroll
costs charged to operations expense increased by $0.9 million or 5%.
Benefit costs increased $2.5 million mainly due to higher pension costs
and partially due to higher medical claim costs. Part of the agreement
with union employees included a change in the pension plan for the
minimum payment amounts. This change increased pension cost
substantially, increasing 63% from the prior year. At September 30,
2003, there were 814 employees and at December 31, 2002, there were 802
employees.
Other major items driving the increase in operations expenses were
water treatment/water quality expenses ($0.8 million) for costs related
to increased testing, chemicals and filters. Customer service expenses
increased $0.3 million caused by increases in bad debts.
Maintenance expense was $1.1 million (13%) higher in the nine-month
period ended September 30, 2003 due to additional maintenance required
for mains, service line, meters and tank repairs. Leaks incurring on
mains have increased over the prior year.
Depreciation/amortization expense increased $1.4 million (9%) because
of the increase in utility plant (see "LIQUIDITY - CAPITAL RESOURCES -
Utility Plant Expenditures" below in this report).
Federal and state income taxes decreased $2.6 million due to the
decrease in taxable income. The effective tax rate was 40% for the
nine-month period and 40% for the same period in the prior year.
Other Income and Expense
Other income and expense was $3.3 million income compared to $3.4
million income in 2002, a decrease of $0.1 million. The decrease was
driven by lower sales of surplus real estate, partially offset by
increases in income from operating/maintenance arrangements, meter
reading/billing services and rental income from cellular antenna leases
(See Note 8 to the Condensed Consolidated Financial Statements).
Interest Expense
Total interest expense increased $1.1 million with long-term debt
interest increasing $0.9 million and short-term interest expense
increasing $0.2 million.
23
Long-term debt interest was impacted by four items: additional debt
outstanding caused interest expense to increase by $2.0 million
compared to the year earlier period; refinanced debt reduced interest
cost by $1.1 million; debt amortization increased $0.1 million due to
additional and refinanced debt; and additional capitalized interest
impacted interest expense by $0.2 million due to increased construction
activity.
Average borrowings under our short-term bank credit agreement were
higher during the first nine months of this year compared to the same
period in 2002. Average interest rates on short-term debt was
approximately 2.6%. The higher borrowings caused short-term interest
expense to increase.
REGULATORY MATTERS
Rate Case Proceedings
Cal Water 2001 General Rate Case (GRC) Applications - This filing was
submitted in July 2001 and was approved by the CPUC in September 2003
for 14 of our 24 California districts. This GRC has an 8.9% return on
rate base and will add an estimated $12.8 million to annual revenues.
In addition, we received approval to collect an additional $5.0 million
in revenues over 12 months to reflect an effective date of April 3,
2003. The 2001 GRC also authorized the filing of step rate increases
for $2.2 million annually for 2004 and 2005 and, if approved, will
become effective January 1 of each year.
Washington Water 2002 GRC Application - Washington Water received
approval on its application effective April 2002 for approximately $1
million of increased rates annually to cover higher operating costs and
capital expenditures.
Cal Water 2002 GRC Applications - Applications have been filed for rate
increases of approximately $8 million on an annual basis relating to
seven districts. The amount of the filing may or may not be adjusted
when final decisions are issued by the CPUC. At this time, we are
unable to predict when the final decisions and rulings will be issued,
their composition or their financial impact on revenues for future
periods.
Cal Water 2003 GRC Applications - Applications have been filed for rate
increases of approximately $15 million on an annual basis relating to
five districts. The amount of the filing may or may not be adjusted
when final decisions are issued by the CPUC. At this time, we are
unable to predict when the final decisions and rulings will be issued,
their composition or their financial impact on revenues for future
periods.
Cal Water Advice Letters - Typically, advice letters are used to
request rate increases for substantial capital expenditures or
increases in costs outside of our control, such as purchased water. The
process for approving advice letter increases is less involved and
faster than for GRC applications.
Bakersfield advice letter filings - In June 2002, the CPUC authorized
an increase in rates for our Bakersfield district of $0.8 million on an
annual basis. In April 2003, the CPUC
24
authorized an additional increase in rates of $1.8 million on an annual
basis. In October 2003, we received approval for additional increase of
approximately $0.3 million in the 4th quarter of 2003 and approximately
$4.2 million annually effective January 2004. These increases are for
the new Bakersfield treatment plant that became operational in the
second quarter of 2003 and had a total project cost of approximately
$50 million.
Other Cal Water advice letter filings - Approval for advice letter
filings in two districts to cover higher purchased water costs were
received in September 2003 and is estimated to impact revenues
approximately $2 million annually. There are other pending advice
letter filings related to increased purchased water costs, which, if
approved, is estimated to increase revenues approximately $4 million
annually. Approval of these filings is expected by the first quarter of
2004.
Expense Balancing and Memorandum Accounts - approved. In May 2003, the
CPUC authorized the recovery of $5.4 million in offsetable expenses, of
which approximately $3.6 million will be collected from May 2003
through May 2004 and approximately $1.8 million will be collected from
May 2004 through May 2005. Partially offsetting this increase is a $0.8
million decrease for one district that will be in effect from June 2003
through June 2004.
Expense Balancing and Memorandum Accounts - pending. In the third
quarter of 2003, advice letters were filed for recovery of
approximately $6 million related to balancing-type memorandum accounts.
At this time, we cannot predict if adjustments will be made during the
CPUC review process nor can we predict the timing of the decision on
the filing.
Other rate increases - The City of Hawthorne granted an increase of
$0.2 million effective July 2003. This arrangement is not governed by
the CPUC.
Legislative Initiative
Regulatory delays in obtaining GRC decisions have been costly to
California regulated water utilities. In recent years, we have
experienced significant revenue losses due to these delays. We believe
the enactment of Assembly Bill 2838 will decrease the financial
exposure related to GRC decision delays.
Assembly Bill 2838 became effective on January 1, 2003 and will apply
for filings made in 2003. It is designed to preserve the cash flow of
regulated water utilities by providing interim rate relief if the CPUC
has not issued a decision for a requested GRC rate increase in a timely
manner. While the CPUC has not established formal procedures for
implementing the provisions of this bill, we believe interim rate
increases will be authorized if the CPUC does not issue a final rate
decision in a timely manner.
LIQUIDITY - CAPITAL RESOURCES
Short-term and Long-term Debt
Short-term bank borrowings were $2.5 million at September 30, 2003 and
$36.4 million at December 31, 2002. Cash and cash equivalents were
$12.4 million at September 30, 2003.
25
California Water Service Company has a $55 million credit facility. The
term of the agreement expires in April 2005. The amount is reduced to
$45 million after December 31, 2003. The agreement has a 30-day out of
debt compliance period that must be met by December 31, 2004. We met
this out of debt requirement in September 2003. Additionally, the
agreement requires the balance to be below $10 million for 30
consecutive days in 2004.
A $10 million credit facility exists for California Water Service
Group, CWS Utility Services and New Mexico Water Service Company. The
term of the agreement expires in April 2005. The agreement has a 30-day
out of debt compliance period that must be met annually. We have met
this requirement for 2003.
New Mexico Water Service Company has a $2.9 million facility that
expires May 2004 and does not have an out-of-debt compliance period.
$2.5 million was borrowed against this facility on September 30, 2003.
Washington Water Service Company has a $0.1 million credit facility
that is currently unused. Hawaii Water Service Company does not have a
credit facility at this time.
In February 2003, we completed the issuance of $10 million, 4.58%,
7-year Series K Senior Notes and $10 million, 5.48%, 15-year Series L
Senior Notes. Both notes were unsecured. The proceeds were used to pay
down short-term borrowings and to fund capital expenditures.
In 2002, we initiated a program to refinance portions of our
outstanding first mortgage bonds when economic conditions were
favorable. Transactions related to this program during and after the
period covered by this report are noted below:
On May 1, 2003, we issued $10 million, 5.54%, 20-year Series I Senior
Notes and $10 million, 5.44%, 15-year Series J Senior Notes. Both notes
were unsecured. The proceeds from these borrowings were used to early
terminate EE First Mortgage bonds that had an interest rate of 7.9%.
The principal, call premiums and transaction costs were approximately
$20 million.
On October 24, 2003, Senior Note Series N for $20 million was issued by
California Water Service Company in a private placement transaction.
The note is unsecured, accrues interest at a rate of 5.55% per annum
and matures on December 1, 2013. Payment of principal is due at
maturity. Funds received were used to prepay first mortgage bonds
Series FF, which accrued interest at a rate of 6.95% and had a
principal balance of $19.1 million. In addition to the pre-payment of
the principal balance, funds were used to pay a call premium related to
Series FF, transaction costs and general corporate purposes.
On November 3, 2003, Senior Note Series M for $20 million was issued by
California Water Service Company in a private placement transaction.
The note is unsecured, accrues interest at a rate of 5.52% per annum
and matures on November 1, 2013. Payment of principal is due at
maturity. Funds received were used to prepay first mortgage bonds
Series GG, which accrued interest at a rate of 6.98% and had a
principal balance of $19.1 million. In addition
26
to the pre-payment of the principal balance, funds were used to pay a
call premium related to Series GG, transaction costs and general
corporate purposes.
These transactions listed above will conclude our refinancing program.
Based on terms currently available in the marketplace, we have
concluded that additional refinancing at this time would be cost
prohibitive. The refinancing program impacted approximately $100
million of long-term debt and we estimate it will save approximately
$2.0 million in interest expense on an annual basis through the year
2013.
Debt Credit Ratings
California Water Service Company is rated by Moody's Investors Service
("Moodys") and Standard & Poor's ("S&P"). The rating by Moodys is A1
and S&P is A+. The ratings were unchanged from the revised ratings
issued in the fourth quarter of 2002.
Shelf Registration Statement
On July 11, 2003, a shelf registration became effective which provides
for the issuance from time to time of up to $120,000,000 in common
stock, preferred stock and/or debt securities. We may issue any of
these types of securities until the amount registered is exhausted, and
will add the net proceeds from the sale of the securities to our
general funds to be used for general corporate purposes, which may
include investment in subsidiaries, working capital, capital
expenditures, repayment of short-term borrowings, refinancing of
existing long-term debt, acquisitions and other business opportunities.
On August 4, 2003, we announced the issuance of 1,750,000 additional
shares of common stock from the shelf registration statement. A
prospectus supplement and prospectus were filed with the SEC under rule
424 (b) (2) on August 5, 2003. The shares were sold at $26.25 per
share. The net proceeds to us were $43.8 million and the transaction
was closed on August 7, 2003. The funds were used to pay down
short-term borrowings and to invest in short-term money market
instruments pending their use for general corporate purposes. After
issuance of the 1,750,000 shares, there remains $74,062,500 in
securities under the shelf registration, which are available for future
issuance.
Dividends, Book Value and Stockholders
The quarterly common dividend was paid on August 14, 2003, at $0.28125
per common share compared to a quarterly dividend in 2002 of $0.28 per
common share. Annualized, the 2003 dividend rate is $1.125 per common
share compared to $1.12 per common share in 2002. Based on the 12-month
earnings per share at September 30, 2003, the dividend payout ratio is
115% of net income. For the full year 2002, the payout ratio was 90% of
net income. On a long-term basis, our goal is to achieve a dividend
payout ratio of about 60% of net income. The regular dividend on Series
C preferred stock was also paid.
At their October 22, 2003 meeting, the Board declared a quarterly
dividend of $0.28125 payable November 14, 2003 to stockholders of
record on October 31, 2003. The regular dividend on Series C preferred
stock was also declared. This will be our 236th consecutive quarterly
dividend.
27
About 4% of the outstanding shares participate in a reinvestment
program under the Company's Dividend Reinvestment and Stock Purchase
Plan ("Plan"). Shares under the Plan were purchased on the open market.
Shares are also purchased on the open market to fulfill the
requirements of our sponsored Employee Savings Plan (401K). Purchases
for this plan are made on a biweekly basis.
Book value per common share was $14.32 at September 30, 2003 compared
to $13.12 at December 31, 2002.
We have approximately 4,200 stockholders of record of our common stock.
Utility Plant Expenditures
During the nine months ended September 30, 2003, capital expenditures
totaled $53.3 million. $39.8 million was from company-funded projects
and $13.5 was from third party funded projects. The 2003 company-funded
capital expenditure budget is $51.7 million, but the actual amount may
vary from the budget number due to timing of actual payments related to
current year projects and prior year projects. We do not control
third-party funded capital expenditures, therefore we are unable to
estimate the amount of such projects for 2003.
At September 30, 2003, construction work in progress was $23.3 million
compared to $48.6 million at December 31, 2002. Work in progress
includes projects that are under construction, but not yet complete and
in service. The principal cause of the decrease in work in progress is
due to the capitalization of expenditures related to the Northeast
Bakersfield Treatment Plant, which became operational in the 2nd
quarter of 2003.
WATER SUPPLY
Based on information from water management agencies and internally
developed data, we believe that our various sources of water supply are
sufficient to meet customer demand for the remainder of the year.
Historically, about half of the water source is purchased from
wholesale suppliers with the other half pumped from underground wells.
A small portion is developed through three local surface treatment
plants.
To safeguard our water supply and facilities, we have heightened
security at our facilities and taken added safety precautions for our
employees and the water we deliver to our customers. 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 water delivery systems security. We have assigned a high
priority to completing work necessary to comply with new Environmental
Protection Agency (EPA) requirements concerning security of water
facilities. We have completed vulnerability assessments for our four
largest districts. Vulnerability assessments for medium size districts
are expected to be completed by December 31, 2003 and all districts are
expected to be completed by June 30, 2004, which complies with the EPA
requirements.
28
ACQUISITIONS
Rio Grande Utility Corporation
On July 1, 2002, after receiving state regulatory commission approval,
we acquired certain assets of Rio Grande Utility Corporation (Rio
Grande) through New Mexico Water. The purchase included the water and
wastewater assets of Rio Grande, which serves 2,400 water and 1,700
wastewater customers about 30 miles south of Albuquerque. The purchase
price was $2.3 million in cash, plus assumption of $3.1 million in
outstanding debt. Rate base for the system is approximately $5.4
million.
The Rio Grande purchase price was allocated to the fair value of net
assets acquired, including utility plant, water rights and assumed
liabilities. Our results of operations for the three-month and
nine-month periods ended September 30, 2003 and the three-month period
ended September 30, 2002 include the operating results of New Mexico
Water from the acquisition date. These were not material to the
Company.
Kaanapali Water Corporation
On April 30, 2003, we acquired the Kaanapali Water Corporation for an
initial payment of $7.5 million in cash. In July 2003, the purchase
price was adjusted due to adjustments in rate base for deferred taxes
and approximately $1.5 million was refunded to us, resulting in a net
purchase price of $6.0 million. The purchase price was initially
allocated to the fair value of net assets acquired, including utility
plant, water rights, receivables and assumed liabilities, and is
subject to adjustments as new information is available up to one year
after the acquisition date. After completing the acquisition, the
entity's name was changed to Hawaii Water Service Company, Inc.
("Hawaii Water"). Hawaii Water provides water utility services to 500
customers in Maui, Hawaii. Hawaii Water had 2002 revenues of $3.0
million, and had net plant excluding contributions in aid of
constructions of approximately $5.7 million and current assets of $0.3
million. The Hawaii Public Utilities Commission ("HPUC") approved the
acquisition in March 2003. The final purchase price will be determined
after certain events have occurred, principally the resolution of
determining rate base after filing for a general rate case with the
HPUC. At that time, the purchase price could be adjusted, which could
result in additional refunds estimated between 0% and 5% of the
purchase price. Our results of operations for the three-month and
nine-month periods ended September 30, 2003 include the operating
results of Hawaii Water from the acquisition date. They were not
material to the Company.
National Utilities Corporation
In June 2002, New Mexico Water signed an agreement to purchase National
Utilities Corporation and related parties for approximately $1.1
million. National Utilities serves 700 water customers located adjacent
to the Rio Grande water system and another 900 water customers located
150 miles south of Albuquerque, New Mexico. The purchase will entitle
NMWSC to purchase up to 2,000 acre-feet of water annually as required
for its operations. The purchase is subject to the approval of the New
Mexico Public Regulation Commission. Regulatory approval has not been
received. At this time, we are unable to predict when, or if,
regulatory approval will be received.
29
National Utilities had 2002 revenue of $0.6 million and total assets of
$1.4 million. Its net utility plant in service at December 31, 2001 was
$1.2 million.
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We do not hold, trade in or issue derivative financial instruments and
therefore are not exposed to risks these instruments present. Our
market risk to interest rate exposure is limited because the cost of
long-term financing and short-term bank borrowings, including interest
costs, is covered in consumer water rates as approved by the
commissions. We do not have foreign operations; therefore, we do not
have a foreign currency exchange risk. Our business is sensitive to
commodity prices and is most affected by changes in purchased water and
purchased power costs.
Historically, the commission's balancing account or offsetable expense
procedures allowed for increases in purchased water and purchased power
costs to be passed on to consumers. Traditionally, over 90% of our net
income and cash flows come from California regulated operations;
therefore the CPUC actions have a significant impact on our business.
See Item 2, Expense Balancing and Memorandum Accounts and Regulatory
Matters.
Item 4.
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
We carried out an evaluation, under the supervision of and with the
participation of our management, including our principal executive and
principal financial officer, of the effectiveness of the design and
operation of our disclosure controls and procedures as of the end of
the period covered by this report, pursuant to Rule 13a-15(e) under the
Securities Exchange Act of 1934. Based on their review of our
disclosure controls and procedures, the principal executive officer and
principal financial officer have concluded that our disclosure controls
and procedures are effective in timely alerting us to material
information that is required to be included in periodic SEC filings.
(b) Changes to Internal controls
There were no changes in our internal controls over financial reporting
that occurred during our last fiscal quarter that have materially
affected, or are reasonably likely to materially affect, such controls.
30
PART II OTHER INFORMATION
Item 1.
Legal Proceedings
(a) In March 2003, we were served with a lawsuit in state court, as one
of several defendants, for damages and injuries from alleged
contamination in our drinking water supply in the Marysville district.
The suit did not specify a dollar amount. In June 2003, all other
defendants, who were governmental entities, were dismissed, and the
plaintiff was granted leave to amend his complaint against us. In
September 2003, the judge ruled in our favor that the plaintiff's first
complaint failed to state facts sufficient to support an actionable
claim, but again granted plaintiff leave to amend the complaint. Based
on plaintiff's previously filed complaints, we doubt the amended
complaint will allege any facts under which we may be held liable. We
intend to vigorously defend the suit. In 2000 and 2002, the same
plaintiffs in this action brought suits against us in federal court
with similar allegations concerning drinking water supply
contamination. All federal claims were dismissed with prejudice;
however, the Federal Court refused to hear the state claims. Our
insurance carrier is paying for legal defense costs, and we believe
that our insurance policy will cover all costs including any damages
related to this matter.
(b) Cal Water is required to report each water system acquisition to
the CPUC and obtain CPUC authorization before charging rates. In
February 2003, the CPUC's Office of Ratepayer Advocates (ORA)
recommended that the Company be fined up to $9,600,000 and refund
$470,000 for failure to report and obtain CPUC authorizations on two
acquisitions. One acquisition was completed on March 12, 1997, prior to
adoption of the reporting requirement by the CPUC; the other was
inadvertently not reported. Cal Water purchased the two water systems
(Indian Springs and Country Meadows), which serve 283 customers, for
approximately $140,000. The staff's recommendation does not challenge
the level of service provided or amounts charged for water service to
the customers, but our failure to obtain authorization to charge rates
set forth in the purchase agreements and our failure to report the
acquisitions to the CPUC in accordance with a previously executed
memorandum of understanding. Cal Water and the ORA have filed their
briefs in the matter and are awaiting the Administrative Law Judge's
issuance of a proposed ruling. We believe that ORA's recommendation is
extraordinarily harsh given the nature of the infractions and that any
penalty will be substantially reduced when this matter is considered by
the full CPUC.
On May 7, 2002, Cal Water filed Advice Letters 1514 and 1515 notifying
the CPUC of its acquisition of the water systems and requesting
authorization to charge the rates filed and include the Indian Springs
and Country Meadows water systems in its Salinas District.
Additionally, on June 26, 2002, Cal Water filed Advice Letter 1517
notifying the CPUC of its acquisition of the Olcese Water District
water system and to include this system in its Salinas district. On
July 10, 2003, the CPUC issued Resolution W-4390. In this resolution,
the Commission staff raised the issue of the legality of the contracts
entered into by Cal Water to acquire the Indian Springs and Country
Meadows water systems and whether Cal
31
Water complied with legal requirements prior to charging rates to the
Olcese Water District customers. The resolution grants Cal Water's
request to consult with the CPUC Water Division to resolve these
issues. The CPUC will then consider if additional action is warranted.
We are working with Water Division to reconstruct the contracts. At
this time, we cannot estimate the amount of the penalty or the timing
of the resolution of these issues.
We are involved in other proceedings or litigation arising in the ordinary
course of operations. We believe the ultimate resolution of such matters will
not materially affect our financial position, results of operations or cash
flows.
Item 6.
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required to be filed by Item 601 of Regulation S-K.
The exhibit list required by this Item is incorporated by reference to
the Exhibit Index attached to this report.
(b) Reports on Form 8-K
On August 6, 2003, we filed a current report on Form 8-K pursuant to
item 5, "Other Events," attaching the Underwriting Agreement, the terms
Agreement and the legality opinion of counsel relating to the sale of
1,750,000 shares of common stock, par value $.01 per share.
On October 23, 2003, we furnished to the SEC a current report on Form
8-K pursuant to Item 12, "Disclosure of Results of Operations and
Financial Condition," attaching our press release dated October 22,
2003 announcing earnings results for the third quarter of 2003.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
CALIFORNIA WATER SERVICE GROUP
Registrant
November 13, 2003
By: /s/ Richard D. Nye
Richard D. Nye
Vice President, Chief Financial Officer
and Treasurer
33
Exhibit Index
Exhibit Description
4.24 Twelve Supplement to Note Agreement dated as of
October 24, 2003 pertaining to the issuance of
$20,000,000, 5.55%, Series N Senior Notes due
December 1, 2013
4.25 Eleventh Supplement to Note Agreement dated as of
November 3, 2003 pertaining to the issuance of
$20,000,000, 5.52%, Series M Senior Notes due
November 1, 2013
10.25 Water Supply Contract 99-73 between the City of
Bakersfield and California Water Service Company,
dated March 31, 1999
10.26 Amendment No. 1 to Water Supply Contract between the
City of Bakersfield and California Water Service
Company, dated October 3, 2001
31.1 Chief Executive Officer certification of financial
statements pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
31.2 Chief Financial Officer certification of financial
statements pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
32 Chief Executive Officer and Chief Financial Officer
Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
34