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, 2005
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
of incorporation or organization) identification No.)
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 ___
Indicate by checkmark whether the Registrant is an accelerated filer (as defined
in rule 12b-2 of the Act)
Yes _X_ No ___
Indicate by check mark whether the registrant is a shell company (as defined by
Rule 12b-2 of the Exchange Act).
Yes ___ 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
November 1, 2005 - 18,389,996.
TABLE OF CONTENTS
Page
PART I Financial Information.................................................... 3
Item 1 Financial Statements
Condensed Consolidated Balance Sheets (unaudited)
September 30, 2005 and December 31, 2004............................. 4
Condensed Consolidated Statements of Income (unaudited)
For the Three and Nine Months Ended September 30, 2005 and 2004...... 5
Condensed Consolidated Statements of Cash Flows (unaudited)
For the Nine Months Ended September 30, 2005 and 2004................ 6
Notes to Unaudited Condensed Consolidated Financial Statements......... 7
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ 16
Item 3 Quantitative and Qualitative Disclosure about Market Risk.............. 33
Item 4 Controls and Procedures................................................ 33
PART II Other Information
Item 1 Legal Proceedings...................................................... 34
Item 6 Exhibits............................................................... 34
Signatures............................................................. 35
Index to Exhibits...................................................... 36
2
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.
3
CALIFORNIA WATER SERVICE GROUP
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
Unaudited September 30, December 31,
2005 2004
----------- -----------
ASSETS
Utility plant:
Utility plant $ 1,199,681 $ 1,144,074
Less accumulated depreciation and amortization 366,019 343,769
----------- -----------
833,662 800,305
----------- -----------
Current assets:
Cash and cash equivalents 23,791 18,820
Receivables, net of allowances for uncollectible accounts
of $416 at September 30, 2005 and $287 at December 31, 2004
Customers 22,779 15,867
Income taxes -- 7,298
Other 3,865 3,147
Unbilled revenue 14,271 9,307
Materials and supplies, at average cost 4,017 3,161
Prepaid pension expense 2,599 3,671
Taxes and other prepaid expenses 4,055 9,122
----------- -----------
Total current assets 75,377 70,393
----------- -----------
Regulatory assets 55,449 53,477
Other assets 20,329 18,678
----------- -----------
$ 984,817 $ 942,853
=========== ===========
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, $.01 par value $ 184 $ 184
Additional paid-in capital 131,991 131,271
Retained earnings 162,410 156,851
Accumulated other comprehensive loss (701) (701)
----------- -----------
Total common stockholders' equity 293,884 287,605
Preferred stock 3,475 3,475
Long-term debt, less current maturities 274,361 274,821
----------- -----------
Total capitalization 571,720 565,901
----------- -----------
Current liabilities:
Current maturities of long-term debt 1,144 1,100
Accounts payable 29,541 19,745
Accrued expenses and other liabilities 51,440 36,367
----------- -----------
Total current liabilities 82,125 57,212
Unamortized investment tax credits 2,721 2,721
Deferred income taxes 56,741 54,826
Regulatory and other liabilities 36,328 35,986
Advances for construction 139,298 131,292
Contributions in aid of construction 95,884 94,915
Commitments and contingencies -- --
----------- -----------
$ 984,817 $ 942,853
=========== ===========
See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements
4
CALIFORNIA WATER SERVICE GROUP
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Unaudited
For the three months ended: For the nine months ended:
--------------------------- --------------------------
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
-------- -------- -------- --------
Operating revenue $101,128 $ 97,104 $242,888 $246,189
-------- -------- -------- --------
Operating expenses:
Water production costs 39,205 40,052 88,420 94,776
Other operations 22,307 22,404 66,054 64,628
Maintenance 3,877 3,640 11,295 9,853
Depreciation and amortization 7,287 6,518 21,289 19,557
Income taxes 8,968 7,050 14,571 14,852
Property and other taxes 3,381 2,942 9,438 8,551
-------- -------- -------- --------
Total operating expenses 85,025 82,606 211,067 212,217
-------- -------- -------- --------
Net operating income 16,103 14,498 31,821 33,972
-------- -------- -------- --------
Other income and expenses:
Non-regulated income, net 778 650 2,121 1,773
Gain on sale of non-utility property 669 6 728 7
-------- -------- -------- --------
Total other income and expenses 1,447 656 2,849 1,780
-------- -------- -------- --------
Interest expense:
Interest expense 4,660 4,615 13,959 14,013
Less capitalized interest 225 250 675 550
-------- -------- -------- --------
Total interest expense 4,435 4,365 13,284 13,463
-------- -------- -------- --------
Net income $ 13,115 $ 10,789 $ 21,386 $ 22,289
======== ======== ======== ========
Earnings per share
Basic $ 0.71 $ 0.59 $ 1.16 $ 1.27
======== ======== ======== ========
Diluted $ 0.71 $ 0.59 $ 1.16 $ 1.27
======== ======== ======== ========
Weighted average shares outstanding
Basic 18,384 18,345 18,376 17,418
======== ======== ======== ========
Diluted 18,422 18,362 18,412 17,433
======== ======== ======== ========
Dividends per share of common stock $ 0.2850 $ 0.2825 0.8550 $ 0.8475
======== ======== ======== ========
See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements
5
CALIFORNIA WATER SERVICE GROUP
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Unaudited
For the nine months ended: September 30, September 30,
2005 2004
-------- --------
Operating activities
Net income $ 21,386 $ 22,289
-------- --------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 21,289 19,557
Deferred income taxes, investment tax credits,
regulatory assets and liabilities, net 204 12,153
Gain on sale of non-utility assets (728) (7)
Changes in operating assets and liabilities:
Receivables (338) (5,233)
Unbilled revenue (4,964) (4,370)
Taxes and other prepaid expenses 6,140 168
Accounts payable 9,795 2,993
Other current assets (857) (319)
Other current liabilities 15,072 4,938
Other changes, net (347) (836)
-------- --------
Net adjustments 45,266 29,044
-------- --------
Net cash provided by operating activities 66,652 51,333
-------- --------
Investing activities:
Utility plant expenditures:
Company-funded (47,560) (35,969)
Developer-funded (9,726) (13,107)
Acquisitions (467) (900)
Proceeds from sale of non-utility assets 743 13
-------- --------
Net cash used in investing activities (57,010) (49,963)
-------- --------
Financing activities:
Net changes in short-term borrowings -- (6,454)
Retirement of long-term debt, net (734) (378)
Advances for construction 11,612 10,660
Refunds of advances for construction (3,606) (3,589)
Contributions in aid of construction 3,164 4,809
Issuance of common stock 720 36,913
Dividends paid (15,827) (14,865)
-------- --------
Net cash (used in) provided by financing
activities (4,671) 27,096
-------- --------
Change in cash and cash equivalents 4,971 28,466
Cash and cash equivalents at beginning of period 18,820 2,856
-------- --------
Cash and cash equivalents at end of period $ 23,791 $ 31,322
======== ========
See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements
6
CALIFORNIA WATER SERVICE GROUP
Notes to Unaudited Condensed Consolidated Financial Statements
September 30, 2005
Note 1. Organization and Operations
California Water Service Group (the Company) is a holding company with five
wholly owned subsidiaries that provide water utility and other related
services in California, Washington, New Mexico and Hawaii. 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 commission. 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 and related 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 covered. 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,
2004, included in its Form 10-K as filed with the Securities and Exchange
Commission on March 15, 2005.
Note 3. Stock-Based Compensation
The Company has an Equity Incentive Plan (the "Plan") approved by
stockholders on April 27, 2005, that allows granting of non-qualified stock
options and other equity instruments. No grants have been made under the
Plan, which replaces the former Long-Term Incentive Plan under which
options were granted, some of which are still outstanding. No further
grants will be made under the Long-Term Incentive Plan.
7
The Company has adopted the 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," to 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 either
of the three-month or nine-month periods ended September 30, 2005 or 2004
related to stock options. No options were granted during either period.
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.
(In thousands, except per share data)
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30,
2005 2004 2005 2004
------- ------- ------- -------
Net income, as reported $13,115 $10,789 $21,386 $22,289
Less preferred dividends 38 38 115 115
------- ------- ------- -------
Net income available to common stockholders 13,077 10,751 21,271 22,174
Deduct: Total stock-based employee compensation
expense determined under fair value
method for all awards, net of related tax effects 12 16 36 49
------- ------- ------- -------
Pro forma net income $13,065 $10,735 $21,235 $22,125
======= ======= ======= =======
Earnings per share
Basic - as reported $ 0.71 $ 0.59 $ 1.16 $ 1.27
Basic - pro forma $ 0.71 $ 0.59 $ 1.16 $ 1.27
Diluted - as reported $ 0.71 $ 0.59 $ 1.16 $ 1.27
Diluted - pro forma $ 0.71 $ 0.59 $ 1.16 $ 1.27
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 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 lower in the winter
months when cooler temperatures and rainfall curtail water usage and sales.
8
Note 5. Earnings Per Share Calculations
The computations of basic and diluted earnings per share are noted below.
Common stock options outstanding to purchase common shares were 98,750 and
143,250 at September 30, 2005 and September 30, 2004, respectively. All
options are dilutive and the dilutive effect is shown in the table below.
(In thousands, except per share data)
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30,
2005 2004 2005 2004
------- ------- ------- -------
Net income, as reported $13,115 $10,789 $21,386 $22,289
Less preferred dividends 38 38 115 115
------- ------- ------- -------
Net income available to common shareholders $13,077 $10,751 $21,271 $22,174
======= ======= ======= =======
Weighted average common shares, basic 18,384 18,345 18,376 17,418
Dilutive common stock options (treasury method) 38 15 36 15
------- ------- ------- -------
Shares used for dilutive calculation 18,422 18,360 18,412 17,433
======= ======= ======= =======
Earnings per share - basic $ 0.71 $ 0.59 $ 1.16 $ 1.27
------- ------- ------- -------
Earnings per share - dilutive $ 0.71 $ 0.59 $ 1.16 $ 1.27
------- ------- ------- -------
Note 6. Income Taxes
In October 2004, the American Jobs Creation Act of 2004 (the "Act") was
signed into law and provides a new federal income tax deduction from
qualified U.S. production activities, which is being phased in from 2005
through 2010. Under the Act, qualified production activities include
production of potable water, but excludes the transmission and distribution
of the potable water. In December 2004, the FASB issued FASB Staff Position
No. 109-1 and proposed that the deduction should be accounted for as a
"special deduction" in accordance with SFAS No. 109. As such, the special
deduction had no effect on deferred tax assets and liabilities existing at
the enactment date. Rather, the impact of the deduction is being reported
in the year in which the deduction is claimed on the Company's tax return.
During the third quarter of fiscal 2005, the Company completed its initial
evaluation of the provisions of the Act and included an estimate for 2005
of the deduction in the provision for income taxes. The impact was to lower
the tax provision for the three and nine months ending September 30, 2005
by $131,000.
Note 7. 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
and utility plant.
9
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.
Payments by the Company related to pension plan and other postretirement
benefits were $4,274,000 and $4,421,000 for the three and nine months ended
September 30, 2005, respectively. The estimated funding for 2005 is
$6,600,000.
10
The following table lists components of the pension plans and other
postretirement benefits. The data listed under "pension plan" includes the
qualified pension plan and the non-qualified executive supplemental
retirement plan. The data listed under "other benefits" is for all other
postretirement benefits.
(In thousands) Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------------- -------------------------------------------
Pension Benefit Other Benefits Pension Benefit Other Benefits
------------------- ------------------- ------------------- -------------------
2005 2004 2005 2004 2005 2004 2005 2004
------- ------- ------- ------- ------- ------- ------- -------
Service cost $ 863 $ 1,182 $ 234 $ 380 $ 3,251 $ 3,456 $ 1,120 $ 990
Interest cost 1,135 1,482 335 382 4,133 4,210 1,231 1,066
Expected return on plan assets (1,207) (1,208) (120) (83) (3,963) (3,646) (314) (255)
Recognized net initial APBO* N/A N/A 69 69 N/A N/A 207 207
Amortization of prior service cost 523 420 17 18 1,497 1,268 55 56
Recognized net actuarial loss 38 174 58 130 146 242 448 298
------- ------- ------- ------- ------- ------- ------- -------
Net periodic benefit cost $ 1,352 $ 2,050 $ 593 $ 896 $ 5,064 $ 5,530 $ 2,747 $ 2,362
======= ======= ======= ======= ======= ======= ======= =======
*APBO - Accumulated postretirement benefit obligation
The "other benefits" amount of $593,000 and $ 2,747,000 for the quarter and
year-to-date ended September 30, 2005 include a reduction of $581,000 and
$945,000, respectively, representing the estimated reduction for Medicare
subsidies to comply with FASB Staff Position (FSP) No. 106-2, "Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003," which was implemented by the
Company in the third quarter of 2004. For the quarter and year-to-date
ended September 30, 2004 the net periodic benefit cost reflected a
reduction of $604,000.
Postretirement benefit expenses for "other benefits" recorded in the
three-month periods ended September 30, 2005 and 2004 were $312,000 and
$251,000, respectively. Postretirement benefit expense for "other benefits"
recorded in the nine-month periods ended September 30, 2005 and 2004 was
$936,000 and $1,034,000, respectively. As of September 30, 2005, the
Company had a regulatory asset of $10,830,000 related to postretirement
benefits, which is expected to be recovered through future customer rates.
During the third quarter of 2005 and 2004, the Company received a revised
estimate of its annual expense for pension and postretirement benefits from
its actuaries. The Company has adjusted its monthly provision accordingly
to reflect this change in estimate. In 2005, an expense reduction of
$563,000 was recognized for the nine month period. In 2004, the adjustment
resulted in additional expense of $393,000 for the nine month period.
11
Note 8. Gains on Sale of Property
In 1995, the California Legislature enacted the Water Utility Infrastructure
Improvement Act of 1995 (Infrastructure Act) to encourage water utilities to
sell surplus properties and reinvest in needed water utility facilities. In
September 2003, the California Public Utilities Commission (CPUC) issued
decision D.03-09-021 in Cal Water's 2001 GRC filing. In this decision, the CPUC
ordered Cal Water to file an application setting up an Infrastructure Act
memorandum account with an up-to-date accounting of all real property that was
at any time in rate base and that Cal Water had sold since the effective date of
the Infrastructure Act. The decision also ordered Cal Water to file an
application for approval to replace the operations and customer centers in its
Chico District and treatment of the gain on sale proceeds.
Decision D.03-09-021 also directed the CPUC staff to file a detailed report on
its review of Cal Water's application. On January 11, 2005, the Office of
Ratepayer Advocates (ORA) issued a report expressing its opinion that Cal Water
had not proven that surplus properties sold since 1996 were no longer necessary
and useful to provide utility service. ORA also recommended that Cal Water be
fined $160,000 and that gains from property sales should generally benefit
ratepayers.
During the period under review, Cal Water's cumulative gains from surplus
property sales were $19.2 million, which included an inter-company gain related
to a transaction with CWS Utility Services and a like-kind exchange with a third
party. If the CPUC finds any surplus property sale or transfer was recorded
inappropriately, Cal Water's rate base could be reduced, which would lower
future revenues, net income, and cash flows.
In early April, the parties submitted testimony and briefs and the
Administrative Law Judge held an evidentiary hearing. Management believes it has
fully complied with the Infrastructure Act and that ORA's conclusions and
recommendations are without merit. Accordingly, Cal Water has not accrued a
liability in the financial statements for ORA's recommendations.
On October 27, 2005, the CPUC extended the statutory period for the proceeding
to January 3, 2006. On November 2, 2005, Administrative Law Judge issued his
Proposed Decision (PD). The PD finds that Cal Water appropriately reclassified
all properties as non-utility property prior to being sold. The criteria Cal
Water used to reclassify its properties were reasonable and consistent with the
requirements of the CPUC. Since the properties were properly reclassified, CPUC
approval was not required prior to the sale and no penalty is warranted.
Furthermore, the PD finds that Cal Water should be allowed to include in rate
base the full value of the new Chico customer center. This would result in an
increase revenue requirement of approximately $171,000.
However, the PD does not approve the amount of sales proceed (or gains) which
qualifies for reinvest under the Infrastructure Act. The PD defers the issues
regarding treatment of sale proceeds and allocation of gains on sale to its
R.04-09-003 proceeding, where the CPUC intents to set guidelines and a specific
rule on allocation of the gain on sale between shareholders and ratepayers. Cal
Water has no knowledge when this proceeding will be concluded.
12
Note 9. Commitments
On September 21, 2005, Cal Water entered into an agreement with Kern County
Water Agency to obtain treated water for the Company's operations. The term
of the agreement is to January 1, 2035, or until the repayment of the
Agency's bonds (described below) occurs. This agreement supersedes the
prior agreement with Kern County Water Agency, as amended, dated June 13,
1974.
Under the terms of the agreement, Cal Water is obligated to purchase 20,500
acre feet of treated water per year, which is an increase from the 11,500
acre feet in the prior agreement. The Company is obligated to pay the
Capital Facilities Charge and the Treated Water Charge regardless of
whether it can use the water in its operation and is obligated for these
charges even if the Agency cannot produce an adequate amount to supply the
20,500 acre feet in the year.
Three other parties are also obligated to purchase a total of 32,500 acre
feet per year under separate agreements with the Agency. These other
participating entities are North of the River Municipal Water District,
East Niles Community Services District, and the City of Bakersfield.
Further, the Agency has the right to proportionally reduce the water supply
provided to all of the participants if it cannot produce adequate supplies.
The participation of all parties in the transaction for expansion of the
Agency's facilities, including the Water Purification Plant, purchase of
the water and payment of interest and principal on the bonds being issued
by the Agency to finance the transaction is required as a condition to the
obligation of the Agency to proceed with expansion of the Agency's
facilities. If any of the other parties does not use its allocation, that
party is obligated to pay its contracted amount, but may make arrangements
for the other parties to purchase some or all of its allocation.
The Agency is planning to issue bonds to fund the project and will use the
payments of the Capital Facilities Charges by California Water Service
Company and the other contracted parties to meet the Agency's obligations
to pay interest and repay principal on the bonds. If any of the parties
were to default on making payments of the Capital Facilities Charge, then
the other parties are obligated to pay for the defaulting party's share on
a pro-rata basis. If there is a payment default by a party and the
remaining parties have to make payments, they also are entitled to a
pro-rata share of the defaulting party's water allocation.
The Company expects to use all its contracted amount of water in its
operations every year. In addition, if the Company were to pay for and
receive additional amounts of water due to a default of another
participating party, the Company believes it could use this additional
water in its operations without incurring substantial incremental cost
increases. If additional treated water is available, all parties have an
option to purchase this additional treated water, subject to the Agency's
right to allocate the water among the parties.
The total obligation of all participants, excluding Cal Water, is
approximately $108,000,000 to the agency. Based on the credit worthiness of
the other participants which are government entities, it is believed to be
highly unlikely that Cal Water would be required to assume any other
participants' obligations under the contract due to their default. In the
event of default by a Participant, Cal Water would receive entitlement to
the additional water for assuming any obligation.
13
Once the project is complete, the Company is obligated to pay a Capital
Facilities Charge and a Treated Water Charge that together total $4,739,000
annually, which equates to $231 per acre foot. Annual payments of
$1,951,000 for the Capital Facilities Charge will begin when the Agency
issues bonds to fund the project. Some of the Treated Water Charge of
$2,788,000 is expected to begin July 1, 2007, when a portion of the planned
capacity is expected to be available. The expanded water treatment plant is
expected to be at full capacity by July 1, 2008, and at that time, the full
annual payments of $4,739,000 would be made and continue through the term
of the agreement. Once treated water is being delivered, the Company will
also be obligated for its portion of the operating costs; that portion is
currently estimated to be $69 per acre foot. The actual amount will vary
due to variations from estimate, inflation and other changes in the cost
structure. The Company's overall estimated cost of $300 per acre foot is
less than the estimated cost of procuring untreated water (assuming water
rights could be obtained) and then providing treatment.
Note 10. Recent Accounting Standards
In November 2004, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards (SFAS) No. 151, "Inventory
Costs - an Amendment to ARB no. 43, Chapter 4." The statement clarifies the
accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material. The statement is effective for fiscal years
beginning after June 15, 2005. The adoption of this statement is not
expected to impact the Company's financial position, results of operations
or cash flows.
In December 2004, the FASB issued SFAS No. 153, "Exchange of Nonmonetary
Assets." The statement amends Opinion 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with the
general exception for exchanges of nonmonetary assets that do not have
commercial substance. The statement is effective for fiscal years beginning
after June 15, 2005. The adoption of this statement is not expected to
impact the Company's financial position, results of operations, or cash
flows.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment," which revised SFAS 123, "Accounting for Stock-Based
Compensation." The statement requires a public entity to measure the cost
of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award (with limited
exceptions). On April 14, 2005, the SEC revised the effective date to
fiscal years beginning after June 15, 2005. The adoption of this statement
is not expected to materially impact the Company's financial position,
results of operations, or cash flows for the equity instruments previously
granted.
In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-1,
"Application of FASB Statement No. 109, Accounting for Income Tax, to the
Tax Deduction on Qualified Production Activities Provided by the American
Jobs Creation Act of 2004." FSP No. 109-1 provides guidance on the
application of SFAS No. 109 to the provision within the American Jobs
14
Creation Act of 2004 (the Act) that allows a tax deduction on qualified
production activities. The guidance states that the deduction should be
accounted for as a special deduction in accordance with SFAS No. 109. The
adoption of this guidance is not expected to materially impact the
Company's financial position, results of operations or cash flows.
In March 2005, the FASB issued Interpretation No. 46R-5, "Implicit Variable
Interests under FASB Interpretation No. 46 (revised December 2003)", which
amends Interpretation No.46, "Consolidation of Variable Interest Entities."
The revision relates to issues commonly arising in leasing arrangements
among related parties and other types of arrangements involving related and
unrelated parties. The original guidance under Interpretation No. 46 in
January 2003 is still applicable. Interpretation Nos. 46 and 46R-5 provide
guidance for determining when a primary beneficiary should consolidate a
variable interest entity or equivalent structure that functions to support
the activities of a primary beneficiary. Interpretation No. 46R-5 is
effective for the first reporting period beginning after March 3, 2005. The
adoption of Interpretation No. 46R-5 did not impact the Company's financial
position, results of operations, or cash flows.
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations - an interpretation of FASB
Statement No. 143." Interpretation No. 47 provides guidelines as to when a
company is required to record a conditional asset retirement obligation. In
general, an entity is required to recognize a liability for the fair value
of a conditional asset retirement obligation if the fair value of the
liability can be reasonably estimated. The fair value of a liability for
the conditional asset retirement obligation should be recognized when
incurred - generally upon acquisition, construction, or development and
(or) through the normal operation of the asset. The Interpretation is
effective no later than the end of fiscal years ending after December 15,
2005 (December 31, 2005, for calendar-year enterprises). The implementation
of this Interpretation is not expected to have a material impact on the
Company's financial position, results of operations, or cash flows.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and
Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement
No. 3." Statement No. 154 replaces APB Opinion No. 20, "Accounting
Changes," and FASB Statement No. 3, "Reporting Accounting Changes in
Interim Financial Statements," and changes the requirements for and the
reporting of a change of an accounting principle. This Statement requires
retrospective application to prior periods' financial statements of changes
in accounting principle, unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. The
Statement is effective for all fiscal years beginning after December 15,
2005. The implementation of this Statement is not expected to have a
material impact on the Company's financial position, results of operations,
or cash flows.
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,
contains forward-looking statements within the meaning established by the
Private Securities Litigation Reform Act of 1995 (Act). The forward-looking
statements are intended to qualify under provisions of the federal
securities laws for "safe harbor" treatment established by the Act.
Forward-looking statements are based on currently available information,
expectations, estimates, assumptions and projections, and management's
judgment about the Company, the water utility industry, and general
economic conditions. Such words as expects, intends, plans, believes,
estimates, assumes, anticipates, projects, predicts, forecasts or
variations of such words or similar expressions are intended to identify
forward-looking statements. The forward-looking statements are not
guarantees of future performance. They are subject to uncertainty and
changes in circumstances. Actual results may vary materially from what is
contained in a forward-looking statement.
Factors that may cause a result different than expected or anticipated
include: governmental and regulatory commissions' decisions, including
decisions on proper disposition of property; changes in regulatory
commissions' policies and procedures; the timeliness of regulatory
commissions' actions concerning rate relief; new legislation; the ability
to satisfy requirements related to the Sarbanes-Oxley Act and other
regulations on internal controls; electric power interruptions; increases
in suppliers' prices and the availability of supplies including water and
power; fluctuations in interest rates; changes in environmental compliance
and water quality requirements; acquisitions and the ability to
successfully integrate acquired companies; the ability to successfully
implement business plans; 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 the 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
current or future debt that could increase financing costs or affect the
ability to borrow, make payments on debt, or pay dividends; and other risks
and unforeseen events. When considering forward-looking statements, the
reader should keep in mind the cautionary statements included in this
paragraph. For additional information relating to the risks of the
Company's business, see "Risk Factors" in the Company's Annual Report on
Form 10-K. The Company assumes no obligation to provide public updates on
forward-looking statements.
16
CRITICAL ACCOUNTING POLICIES
The Company maintains its accounting records in accordance with accounting
principles generally accepted in the United States of America and as
directed by the regulatory commissions to which the Company is 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 degree of complexity and
judgment, and can have a material impact on the results of operations and
financial condition.
Revenue Recognition
- -------------------
Revenue consists of monthly cycle customer billings for regulated water and
wastewater services at rates authorized by the governmental and regulatory
commissions (Commissions) and billings to certain non-regulated customers.
Revenue from metered customers includes billings to customers based on
monthly meter readings plus an estimate for water used between the
customer's last meter reading and the end of the accounting period. The
unbilled revenue amount is recorded as a current asset on the balance sheet
under the caption "Unbilled Revenue." At September 30, 2005, the unbilled
revenue amount was $14,271,000 and at December 31, 2004, the amount was
$9,307,000. 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 liability was $2,191,000
and $2,193,000 at December 31, 2004. This liability is included in "accrued
expenses and other liabilities" on the balance sheet.
17
Expense Balancing and Memorandum Accounts
- -----------------------------------------
Expense-balancing accounts and memorandum accounts are used to track
suppliers' rate changes for purchased water, purchased power, and pump
taxes that are not included in customer water rates. The cost changes are
referred to as "offsetable expenses," because under certain circumstances,
they are refundable from customers (or refunded to customers) in future
rates designed to offset cost changes from suppliers. The Company does not
record the balancing and memorandum accounts until the commission has
authorized a change in customer rates and the customer has been billed. The
cumulative net recoverable amount in the expense balancing accounts and
memorandum accounts as of September 30, 2005, was approximately $4,000,000.
This amount includes certain amounts that have been filed for recovery but
have not yet been authorized, or amounts that have not yet been filed for
recovery. See Regulatory Matters--Other Regulatory Matters below for
cumulative net balances of expense balancing and memorandum accounts that
have been authorized for recovery.
Regulated Utility Accounting
- ----------------------------
Because the Company operates extensively in a regulated business, it is
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 the Company's operations were no longer subject
to the provisions of SFAS No. 71, it would be required to write off related
regulatory assets that are not specifically recoverable and write off of
liabilities that are not realizable, and determine if other assets might be
impaired. If a regulatory commission determined that a portion of the
Company's assets were not recoverable in customer rates, the Company would
be required to determine if it had suffered an asset impairment that would
require a write-down in the assets' valuation. There have been no such
asset impairments as of September 30, 2005.
Income Taxes
- ------------
The Company accounts for income taxes using the asset and liability method.
Deferred taxes assets and liabilities are recognized for future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases. 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 the deferred tax assets and liabilities of a change in tax rate
is recognized in the period that includes the enactment date. The Company
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 at September 30,
2005.
18
The Company anticipates that future rate action by the Commissions will
reflect revenue requirements for the tax effects of temporary differences
recognized, which have previously been passed through to customers. The
Commissions have granted the Company rate increases to reflect the
normalization of the tax benefits of the federal accelerated methods and
available Investment Tax Credits (ITC) for all assets placed in service
after 1980. ITC are deferred and amortized over the lives of the related
properties for book purposes.
Advances for Construction and Contributions in Aid of Construction received
from developers subsequent to 1986 were taxable for federal income tax
purposes, and those received subsequent to 1991 were subject to California
income tax. In 1996, the federal law, and in 1997, the California law,
changed and only deposits for new services were taxable. In late 2000,
federal regulations were further modified to exclude fire services from
taxation.
Pension Benefits
- ----------------
The Company incurs costs associated with its pension and postretirement
health care benefits plans. To measure the expense of these benefits,
management must estimate compensation increases, mortality rates, future
health cost increases and discount rates used to value related liabilities
and to determine appropriate funding. Different estimates used by
management could result in significant variances in the cost recognized for
pension benefit plans. The estimates used are based on historical
experience, current facts, future expectations and recommendations from
independent advisors and actuaries. The Company uses an investment advisor
to provide advice in managing the plan's investments. Management
anticipates that any increase in funding for the pension and postretirement
health care benefits plans will be recovered in future customer rates.
19
RESULTS OF THIRD QUARTER 2005 OPERATIONS COMPARED TO THIRD QUARTER 2004
OPERATIONS
Summary
- -------
Third quarter net income was $13,115,000, equivalent to $0.71 per common
share on a diluted basis, compared to net income of $10,789,000 or $0.59
per share on a diluted basis in the third quarter of 2004. The primary
driver for the increase in net income was increased revenues from rate
increases and new customers which were partially offset by higher operating
expenses. Other income increased due to sale of non-utility properties this
year verses last year.
Operating Revenue
- -----------------
Operating revenue increased $4,024,000, or 4%, to $101,128,000. As
disclosed in the following table, the increase was due primarily to rate
increases and new customers, partially offset by decreases in usage.
Revenues from water usage decreased approximately 2% for the quarter as
cooler temperatures continued in some of our service areas.
The factors that affected the operating revenue decrease for the third
quarter of 2005 are presented in the following table:
Rate increases (net) $ 4,395,000
Decrease in usage by existing customers (1,559,000)
Usage by new customers 1,188,000
--------------
Net operating revenue increase $ 4,024,000
=============
The components of the net rate increase are
listed in the following table:
Purchased Water Offset $529,000
Balance Accounts 2003 (532,000)
Balance Accounts 2004 2,054,000
Balance Accounts 2005 76,000
General Rate Case (GRC)
2001 Catch-up (1,362,000)
GRC 2002 280,000
GRC 2003 115,000
GRC 2004 1,658,000
Step rate 2005 1,466,000
Hawthorne 76,000
New Mexico 56,000
Hawaii (21,000)
--------------
Total $ 4,395,000
=============
The number of customers from regulated and non-regulated, full system
operations increased 1.3% compared to September 2004.
20
Total Operating Expenses
- ------------------------
Total operating expenses were $85,025,000 for the three months ended
September 30, 2005, versus $82,606,000 for the same period in 2004, a 2.9%
increase.
Water production expense consists of purchased water, purchased power and
pump taxes. It represents the largest component of total operating
expenses, accounting for approximately 46.1% of total operating expenses.
Water production expenses decreased 2% compared to last year.
For California operations, sources of water production as a percent of
total water production are listed on the following table:
Three Months Ended September 30
--------------------------------
2005 2004
---- ----
Well production 50.8% 49.9%
Purchased 45.9% 46.5%
Surface 3.3% 3.6%
------------- -------------
Total 100% 100%
============= =============
Washington Water, New Mexico Water and Hawaii Water obtain all of their
water supply from wells.
The components of water production costs are shown in the table below:
Three Months Ended September 30
-------------------------------
2005 2004 Change
---- ---- ------
Purchased water $ 28,559,000 $ 28,838,000 $ (279,000)
Purchased power 7,649,000 8,460,000 (811,000)
Pump taxes 2,997,000 2,754,000 243,000
-------------- -------------- --------------
Total $ 39,205,000 $ 40,052,000 $ (847,000)
============== ============== ==============
Purchased water cost decreased due to lower usage of purchased water,
partially offset by higher prices from water wholesalers. Included in the
purchased water amounts are credits received from certain wholesale
suppliers and the sale of unused water rights. The amounts of the credits
were $324,000 and $366,000 for the quarter ended September 30, 2005 and
2004, respectively. Purchased power and pump taxes decreased primarily due
to lower usage and lower prices.
Other operations expenses were $22,307,000, increasing $97,000 or 0.5%.
Payroll and benefits charged to operations expense increased $607,000 or
4.3%. Wages for union employees increased 2.5%, effective January 1, 2005.
Overall payroll costs (expensed and capitalized) increased 4.4% due to
increases in the number of employees and higher wage rates. Employee and
retiree medical costs increased $72,000 or 23.8%. The above increases were
offset by lower administration and general expenses which were $12,201,000,
decreasing $171,000 or 1.4%. Pension costs decreased $561,000, or 33.5% due
to year-to-date true-up of the annual pension cost estimate based on an
actuarial calculation report received during the quarter. Workers'
compensation expense decreased $308,000, or 40.8% due to a decrease from
the prior year claims experience. Regulatory Commission expense decreased
$120,000 or 79.0%. At September 30, 2005, there were 846 employees and at
September 30, 2004, there were 830 employees.
21
Maintenance expense was up for the quarter ended September 30, 2005,
increasing $237,000, or 6.5% due to increases in main repairs of $160,000
and reservoirs and tank repairs of $46,000, which were partially offset by
lower well expense of $90,000.
Depreciation and amortization expense increased $769,000, or 12% because of
additional depreciation expense due to 2004 capital expenditures and due to
increased depreciation rates authorized by the Commission in eight
districts as part of the 2004 GRC decision.
Federal and state income taxes increased $1,918,000 due to the increase in
taxable income. The effective tax rate was 40.6% in the third quarter of
2005 and 39.5% for the prior year's third quarter.
Other Income and Expense
- ------------------------
Other income was $1,447,000 for the quarter ended September 30, 2005,
compared to $656,000 for the prior year's third quarter, an increase of
$791,000, primarily due to gain on sale of non-utility property of
$669,000. A gain of $6,000 was recognized in the quarter ended September
30, 2004. Non-regulatory income totaled $778,000 and increase of $128,000
or 19.7%
Interest Expense
- ----------------
Total interest expense increased $70,000, or 1.6%. This was due to an
increase in capitalized interest in the prior year on construction
projects.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 2005 COMPARED TO THE
NINE MONTHS ENDED SEPTEMBER 2004
Summary
- -------
Net income for the nine-month period ended September 30, 2005 was
$21,386,000, equivalent to $1.16 per common share on a diluted basis,
compared to net income of $22,289,000 or $1.27 per share on a diluted
basis, for the nine-months ended September 30, 2004. The primary driver for
the decrease in net income was the unfavorable weather conditions
experienced in each of the quarters of 2005 compared to the same prior year
periods.
Operating Revenue
- -----------------
Operating revenue decreased $3,301,000, or 1.3%, to $242,888,000. As
disclosed in the following table, the decrease was due to decreases in
usage, partially offset by increases in rates and revenue from new
22
customers. Weather impact was unfavorable as rainfall was much higher
compared to prior year. Temperatures were slightly cooler, which resulted
in a year-to-date decrease of approximately 6% in revenue from prior year
water usage, with the largest monthly decrease of 14.0% occurring in April.
The factors that affected the operating revenue decrease are presented in
the following table:
Rate increases (net) $ 8,984,000
Decrease in usage by existing customers (14,514,000)
Usage by new customers 2,229,000
-------------
Net operating revenue decrease $ (3,301,000)
=============
The components of the net rate increases are
listed in the following table:
Purchase Water Offset $ 930,000
Balance Accounts 2003 (936,000)
Balance Accounts 2004 4,503,000
Balance Accounts 2005 76,000
General Rate Case (GRC)
2001 Catch Up (3,470,000)
GRC 2002 1,782,000
GRC 2003 298,000
GRC 2004 1,658,000
Step Rate 2005 3,810,000
Hawthorne 280,000
Hawaii (41,000)
New Mexico 94,000
-------------
Total increase in rates $ 8,984,000
=============
Total Operating Expenses
- ------------------------
Total operating expenses were $211,067,000 for the nine-months ended
September 30, 2005, versus $212,217,000 for the same period in 2004, a 0.5%
decrease.
Water production expense consists of purchased water, purchased power and
pump taxes. It represents the largest component of total operating
expenses, accounting for approximately 41.9% of total operating expenses.
Water production expenses decreased 6.7% compared to last year.
23
For California operations, sources of water production as a percent of
total water production are listed on the following table:
Nine Months Ended September 30
-------------------------------
2005 2004
---- ----
Well production 47.5% 47.4%
Purchased 48.6% 48.5%
Surface 3.9% 4.1%
------------ ------------
Total 100% 100%
============ ============
Washington Water, New Mexico Water and Hawaii Water obtain all of their
water supply from wells.
The components of water production costs are shown in the table below:
Nine Months Ended September 30
------------------------------
2005 2004 Change
---- ---- ------
Purchased water $ 66,687,000 $ 70,580,000 $ (3,893,000)
Purchased power 15,770,000 18,012,000 (2,242,000)
Pump taxes 5,963,000 6,184,000 (221,000)
------------ ------------ ------------
Total $ 88,420,000 $ 94,776,000 $ (6,356,000)
============ ============ ============
Purchased water cost decreased due to lower usage, partially offset by
higher prices from water wholesalers and lower purchased water credits.
Included in purchased water are credits received from certain wholesale
suppliers and the sale of unused water rights. The amounts of the credits
were $1,091,000 and $2,942,000 for 2005 and 2004, respectively. Purchased
power and pump taxes also decreased due to lower production.
Other operations expenses were $66,054,000, increasing $1,426,000 or 2.2%
primarily due to administration and general expenses which were
$36,137,000, increasing $1,169,000 or 3.3%. Payroll and benefits charged to
operations expense increased $2,665,000, or 6.4%. Wages for union employees
increased 2.5%, effective January 1, 2005. Overall payroll costs (expensed
and capitalized) increased 4.5% due to increases in the number of employees
and higher wage rates. Employee and retiree medical costs increased
$675,000, or 10.5%. Outside services, which includes legal, auditor and
consultants fees, increased $831,000, or 47.2% primarily due to higher
consulting cost associated with information systems. Workers' compensation
expenses decreased $822,000, or 47.2%. At September 30, 2005, there were
846 employees and at September 30, 2004, there were 830 employees.
Maintenance expense was up for the nine-months ended September 30, 2005,
increasing $1,442,000, or 14.6%, due to increases in maintenance of meters
of $130,000, well maintenance expense of $68,000, and repairs of the
following: pumping equipment and plant of $327,000, water treatment
equipment of $115,000 and mains of $507,000.
24
Depreciation and amortization expense increased $1,732,000, or 8.8%,
because of 2004 capital expenditures and due to increased depreciation
rates authorized by the Commission in eight districts as part of the 2004
GRC decision.
Federal and state income taxes decreased $281,000 due to lower taxable
income. The effective tax rate was 40.5% in 2005 and 40.0% in 2004.
Other Income and Expense
- ------------------------
Other income was $2,849,000 for the nine-months ended September 30, 2005,
compared to $1,780,000 for the first nine months of 2004, an increase of
$1,069,000 that is primarily due to gains on sale of non-utility properties
and increase in net non-regulated income.
Interest Expense
- ----------------
Total interest expense decreased $179,000, or 1.3%, due to an increase in
capitalized interest of $125,000, on construction projects and lower
interest expense since short term borrowings were paid off.
REGULATORY MATTERS
Rate Case Proceedings
- ---------------------
In January 2005, Cal Water received approval from the California Public
Utilities Commission (CPUC) for step rate increases of $4.4 million on an
annual basis, which were effective in January 2005.
In February 2005, the Hawaii Public Utilities Commission issued a general
rate order that decreased rates for Hawaii Water Service Company's (HWSC)
Kaanapali water system by approximately $68,000 annually. Additionally,
HWSC was authorized to establish a tracking mechanism for recovering
certain water treatment plant costs, approximately $50,000 annually,
pending the outcome of litigation seeking recovery for treatment costs from
the potentially responsible parties. These claims are not expected to
materially affect the Company financial results.
In April 2005, the New Mexico Public Regulation Commission approved New
Mexico Water Service Company's GRC for its wastewater operations. The
approval was for a rate increase of $329,000 on an annual basis. Sixty-five
percent of the amount was effective in April 2005, and the full amount will
be effective on January 1, 2006.
In July 2005, the Company received a decision on its 2004 General Rate Case
(GRC) filings that authorizes rate increases of $7.6 million to annual
revenues. This GRC covers approximately 50% of the customers in the
Company's California operations. The rates became effective in July 2005.
25
Memorandum and Balancing Accounts
- ---------------------------------
In May 2005, the Company received authorization from the CPUC to recover in
rates $822,000 on an annual basis to offset higher purchased water and pump
tax costs in its Stockton district.
In July 2005, the Company received authorization from the CPUC to recover
in rates $614,000 on an annual basis to offset higher purchased water in
its Westlake district.
In September 2005, Cal Water received authorization from the CPUC to
collect in rates approximately $899,000 previously recorded in a memorandum
account for the Stockton district. Cal Water has pending memorandum account
filings for 2004 and previous years offsettable expenses to refund to
customers $1,258,000 over 12 months.
26
Below is a list of rate filings approved by the CPUC in 2004 that impacted
2005 revenues due to recording revenues based upon customer billings. (See
previous items on Operating Revenue).
February 2004 - increase of $700,000 annually for purchased water
costs
April 2004 - step rate increases of $500,000 annually
April 2004 - increase of $3,600,000 annually for the 2002 GRCs in four
districts
May 2004 - refund of $1,500,000 for balancing account over-collections
related to offsettable expenses incurred over multiple years in the
King City and Dominguez districts. Except for a minor amount refunded
over 36-months, surcredits will be effective for 12-months.
June 2004 - surcharge to recover $400,000 in offsettable expenses for
2001 in the Salinas district.
July 2004 - increase of $1,100,000, annually, for the 2001 GRC in the
Salinas district effective over 12 - months.
August 2004 - step rate increases of $500,000, annually, for four
districts
September 2004 - increase of $400,000, annually, for the 2003 GRC in
the South San Francisco and Bakersfield districts
September 2004 - increase of $500,000, annually, for higher purchased
water and pump taxes in the Los Altos district
October to December 2004 - surcharges to recover $9,200,000 in
offsettable expenses for 2002 and 2003 in multiple districts.
Surcharges vary by district and are effective from 12 to 36 months.
There were no rate filings approved during 2004 for Washington Water
Service Company, New Mexico Water Service Company, and Hawaii Water Service
Company.
Other Regulatory Matters
- ------------------------
Cal Water recovered certain amounts being tracked in off-balance sheet
expense balancing and memorandum accounts. Approvals to recover these
amounts were received in 2004. (See "Expense Balancing and Memorandum
Accounts" section in the Critical Accounting Policies.) The amounts
remaining to be recovered from these approved filings as of September 30,
2005, and December 31, 2004, were $4,000,000 and $8,588,000, respectively.
These amounts exclude pending amounts and amounts not yet filed for
recovery.
27
Surplus Property Sales
- ----------------------
In 1995, the California Legislature enacted the Water Utility
Infrastructure Improvement Act of 1995 (Infrastructure Act) to encourage
water utilities to sell surplus properties and reinvest in needed water
utility facilities. In September 2003, the California Public Utilities
Commission (CPUC) issued decision D.03-09-021 in Cal Water's 2001 GRC
filing. In this decision, the CPUC ordered Cal Water to file an application
setting up an Infrastructure Act memorandum account with an up-to-date
accounting of all real property that was at any time in rate base and that
Cal Water had sold since the effective date of the Infrastructure Act. The
decision also ordered Cal Water to file an application for approval to
replace the operations and customer centers in its Chico District and
treatment of the gain on sale proceeds.
Decision D.03-09-021 also directed the CPUC staff to file a detailed report
on its review of Cal Water's application. On January 11, 2005, the Office
of Ratepayer Advocates (ORA) issued a report expressing its opinion that
Cal Water had not proven that surplus properties sold since 1996 were no
longer necessary and useful to provide utility service. ORA also
recommended that Cal Water be fined $160,000 and that gains from property
sales should generally benefit ratepayers.
During the period under review, Cal Water's cumulative gains from surplus
property sales were $19.2 million, which included an inter-company gain
related to a transaction with CWS Utility Services and a like-kind exchange
with a third party. If the CPUC finds any surplus property sale or transfer
was recorded inappropriately, Cal Water's rate base could be reduced, which
would lower future revenues, net income, and cash flows.
In early April, the parties submitted testimony and briefs and the
Administrative Law Judge held an evidentiary hearing. Management believes
it has fully complied with the Infrastructure Act and that ORA's
conclusions and recommendations are without merit. Accordingly, Cal Water
has not accrued a liability in the financial statements for ORA's
recommendations.
On October 27, 2005, the CPUC extended the statutory period for the
proceeding to January 3, 2006. On November 2, 2005, Administrative Law
Judge issued his Proposed Decision (PD). The PD finds that Cal Water
appropriately reclassified all properties as non-utility property prior to
being sold. The criteria Cal Water used to reclassify its properties were
reasonable and consistent with the requirements of the CPUC. Since the
properties were properly reclassified, CPUC approval was not required prior
to the sale and no penalty is warranted. Furthermore, the PD finds that Cal
Water should be allowed to include in rate base the full value of the new
Chico customer center. This would result in an increase revenue requirement
of approximately $171,000.
However, the PD does not approve the amount of sales proceed (or gains)
which qualifies for reinvest under the Infrastructure Act. The PD defers
the issues regarding treatment of sale proceeds and allocation of gains on
sale to its R.04-09-003 proceeding, where the CPUC intents to set
guidelines and a specific rule on allocation of the gain on sale between
shareholders and ratepayers. Cal Water has no knowledge when this
proceeding will be concluded.
28
LIQUIDITY
Short-Term and Long-Term Debt
- -----------------------------
There were no outstanding short-term bank borrowings at September 30, 2005
or December 31, 2004, on either the Company's or Cal Water's credit
facility. The Company has a $10,000,000 credit facility, which includes
Washington Water, New Mexico Water, Hawaii Water, and CWS Utility Services.
Cal Water has a $45,000,000 credit facility. Both agreements have a
requirement for balances to be below certain thresholds for 30 consecutive
days each calendar year. The Company has met this requirement in 2005 for
both agreements. At September 30, 2005, the Company was in compliance with
the covenants of both facilities.
In September 2004, Cal Water received authorization from the CPUC on its
financing filing related to $250,000,000 of additional debt or equity
available for issuance through the year 2009. No amounts have been utilized
to date. This amount will be utilized on an as-needed basis. The balance
remaining from the previous authorization did not carry over.
Debt Credit Ratings
- -------------------
Cal Water's debt is rated A2 by Moody's Investors Service (Moody's) and A+
by Standard & Poor's (S&P), both unchanged from the previous quarter. The
rating from Moody's was last changed in February 2004, when the rating was
changed from A1 to A2. The rating from S&P was last changed in the fourth
quarter of 2002, when the rating was changed from AA- to A+.
Shelf Registration
- ------------------
The Company has $35,648,175 in securities under the shelf registration
filed with the SEC in 2003, which are available for future issuance.
Dividends
- ---------
The third quarter common stock dividend of $0.2850 per share was paid on
August 19, 2005, compared to a quarterly dividend in the third quarter of
2004 of $0.2825. This was the Company's 243rd consecutive quarterly
dividend. Annualized, the 2005 dividend rate is $1.14 per common share,
compared to $1.13 in 2004. Based on the 12-month earnings per share at
September 30, 2005, the dividend payout ratio is 83.6% of net income. For
the entire year 2004, the payout ratio was 77% of net income. On a
long-term basis, the Company's goal is to achieve a dividend payout ratio
of 60% of net income accomplished through future earnings growth.
At its October 26, 2005 meeting, the Board declared the Company's 244th
consecutive dividend in the amount of $0.2850 per share, payable on
November 18, 2005, to stockholders of record on November 7, 2005.
Dividend Reinvestment and Stock Purchase Plan
- ---------------------------------------------
The Company's transfer agent has a Dividend Reinvestment and Stock Purchase
Plan (Plan). Under the Plan, stockholders may reinvest dividends to
29
purchase additional Company common stock without commission fees. The Plan
also allows existing stockholders and other interested investors to
purchase Company common stock through the transfer agent up to certain
limits. The Company's transfer agent operates the Plan and purchases shares
on the open market to provide shares for the Plan.
30
2005 Financing Plan
- -------------------
The Company's 2005 financing plan includes raising approximately
$20,000,000 of new capital in 2005. The plan includes issuance of long-term
debt primarily to meet funding needs for capital expenditures. Depending
upon the level of capital expenditures, this planned issuance of long-term
debt may not occur in 2005 and would then be expected to occur in 2006.
Currently, the Company does not plan to issue additional equity in 2005,
although this may change depending on a variety of factors. Beyond 2005,
management intends to fund capital needs through a relatively balanced
approach between long-term debt and equity.
Book Value and Stockholders of Record
- -------------------------------------
Book value per common share was $15.98 at September 30, 2005, compared to
$15.66 at December 31, 2004.
There are approximately 3,089 stockholders of record for the Company's
common stock as of September 30, 2005.
Utility Plant Expenditures
- --------------------------
During the nine months ended September 30, 2005, capital expenditures
totaled $57,286,000; $47,560,000 was from Company-funded projects and
$9,726,000 was from third party-funded projects. The 2005 Company-funded
capital expenditure budget is $85,000,000, 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. The estimated cash payments for the
full-year of 2005 for Company-funded capital expenditures is $70 million.
The Company does not control third party-funded capital expenditures;
therefore, it is unable to estimate the amount of such projects for 2005.
At September 30, 2005, construction work-in-progress was $43,491,000
compared to $13,248,000 at December 31, 2004. Work-in-progress includes
projects that are under construction, but not yet complete and in service.
Sarbanes-Oxley Act, Section 404
- -------------------------------
To comply with the Sarbanes-Oxley Act, Section 404 on internal controls,
external costs of $900,000 were incurred related to 2004. For 2005, the
Company estimates incurring $500,000 to $600,000 in external costs.
31
WATER SUPPLY
Based on information from water management agencies and internally
developed data, the Company believes that its various sources of water
supply are sufficient to meet customer demand for the remainder of the
year. Historically, about half of the water is purchased from wholesale
suppliers with the other half pumped from underground wells. A small
portion is developed through three local surface treatment plants.
Earlier this year, the Company requested its customers in the Salinas
district to voluntarily cut down on peak hour water usage for a three-month
period due to six wells that were shut off temporarily because of
contamination. The Company also asked large commercial users to reduce
water usage during peak hours and to store water during non-peak hours for
later use. As of September 30, 2005, three wells have been put back on line
and the Company is no longer asking customers to take additional steps to
reduce water usage during peak hours. The Salinas district accounted for
4.4% of the Company's revenues for the third quarter and year-to-date ended
September 30, 2005. The Company does not believe that its request to
voluntary reduce water usage during peak hours materially impacted the
financial results or cash flows of the Company.
32
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not hold, trade in or issue derivative financial
instruments and therefore is not exposed to risks these instruments
present. Its market risk-to-interest rate exposure is limited because the
cost of long-term financing and short-term bank borrowings, including
interest costs, are covered in consumer water rates as approved by the
commissions. The Company does not have foreign operations; therefore, it
does not have a foreign currency exchange risk. The Company's business is
sensitive to commodity prices and is most affected by changes in purchased
water and purchased power costs.
Historically, the CPUC's balancing account or offsettable expense
procedures allowed for increases in purchased water and purchased power
costs to be passed on to consumers. Traditionally, a significant percentage
of our net income and cash flows comes from California regulated
operations; therefore the CPUC's actions have a significant impact on the
Company's business. See Item 2, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Critical Accounting
Policies --Expense Balancing and Memorandum Accounts" and "Regulatory
Matters."
Item 4.
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
The Company carried out an evaluation, under the supervision of and with
the participation of its management, including its principal executive
officer 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(b) under the
Securities Exchange Act of 1934. Based on their review of the Company's
disclosure controls and procedures, the principal executive officer and
principal financial officer have concluded that the Company's disclosure
controls and procedures are functioning effectively to provide reasonable
assurance that the information required to be disclosed in periodic SEC
filings is reported within the time periods specified by SEC rules and
regulations.
(b) Changes to Internal Control Over Financial Reporting
There was no change in the Company's internal control over financial
reporting that occurred during the last fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
33
PART II OTHER INFORMATION
Item 1.
LEGAL PROCEEDINGS
(a) From time to time, the Company has been involved in a variety of legal
proceedings. For a complete description, see the Company's annual report on
Form 10-K for the year ended December 31, 2004. During the quarter ended
September 30, 2005, there were no material developments with respect to
previously disclosed existing procedures and no material proceeding not
previously disclosed.
(b) The discussion under Part I, Financial Information, Item 2, "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Regulatory Matters: Surplus Property Sales" is incorporated by reference.
Item 6. EXHIBITS
The exhibit list required by this Item is incorporated by reference to the
Exhibit Index attached to this report.
34
SIGNATURES
Pursuant to the requirement 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 9, 2005
By: /s/ John S. Tootle
----------------------------------------------
JOHN S. TOOTLE
Acting Vice President, Chief Financial Officer
and Treasurer
35
Exhibit Index
Exhibit Description
------- -----------
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
36