Ten-Year Financial Review
Dollars in thousands, except common share data 2005 2004 2003
---- ---- ----
Summary of Operations
Operating Revenue
Residential $222,634 $221,323 $194,903
Business 56,962 55,803 49,666
Industrial 14,241 13,592 11,255
Public authorities 14,965 15,118 12,789
Other 11,926 9,731 8,515
-------- -------- --------
Total operating revenue 320,728 315,567 277,128
Operating expenses 280,918 274,084 246,894
Interest expense, other income and expenses, net 12,587 15,457 10,817
-------- -------- --------
Net income $ 27,223 $ 26,026 $ 19,417
======== ======== ========
Common Share Data
Earnings per share - diluted $ 1.47 $ 1.46 $ 1.21
Dividend declared 1.140 1.130 1.125
Dividend payout ratio 78% 77% 93%
Book value $ 15.98 $ 15.66 $ 14.44
Market price at year-end 38.23 37.65 27.40
Common shares outstanding at year-end (in thousands) 18,390 18,367 16,932
Return on average common stockholders' equity 9.3% 9.8% 9.1%
Long-term debt interest coverage 3.61 3.38 2.78
Balance Sheet Data
Net utility plant $862,731 $800,305 $759,498
Utility plant expenditures
(Company-funded and developer-funded) 94,517 68,573 74,253
Total assets 996,945 942,853 873,035
Long-term debt including current portion 275,275 275,921 273,130
Capitalization ratios:
Common stockholders' equity 51.4% 50.8% 47.0%
Preferred stock 0.6% 0.6% 0.7%
Long-term debt 48.0% 48.6% 52.3%
Other Data
Water production (million gallons)
Wells and surface supply 68,162 72,279 68,416
Purchased 64,028 66,760 63,264
-------- -------- --------
Total water production 132,190 139,039 131,680
======== ======== ========
Metered customers 402,191 395,286 387,579
Flat-rate customers 76,810 77,869 78,843
-------- -------- --------
Customers at year-end 479,001 473,155 466,422
======== ======== ========
New customers added 5,846 6,733 7,434
Revenue per customer $ 670 $ 667 $ 594
Utility plant per customer 2,578 2,418 2,313
Employees at year-end 840 837 813
Dollars in thousands, except common share data 2002 2001 2000 1999 1998 1997 1996
---- ---- ---- ---- ---- ---- ----
Summary of Operations
Operating Revenue
Residential $184,894 $173,823 $171,234 $163,681 $150,491 $158,210 $148,313
Business 46,404 44,944 44,211 41,246 38,854 40,520 37,605
Industrial 11,043 9,907 11,014 12,695 10,150 10,376 9,748
Public authorities 12,706 11,860 11,609 10,898 9,654 11,173 10,509
Other 8,104 6,286 6,738 6,417 5,777 4,886 4,083
-------- -------- -------- -------- -------- -------- --------
Total operating revenue 263,151 246,820 244,806 234,937 214,926 225,165 210,258
Operating expenses 232,404 221,116 211,610 201,890 183,245 188,020 177,356
Interest expense, other income
and expenses, net 11,674 10,739 13,233 11,076 11,821 11,388 11,502
-------- -------- -------- -------- -------- -------- --------
Net income $ 19,073 $ 14,965 $ 19,963 $ 21,971 $ 19,860 $ 25,757 $ 21,400
======== ======== ======== ======== ======== ======== ========
Common Share Data
Earnings per share - diluted $ 1.25 $ 0.97 $ 1.31 $ 1.44 $ 1.31 $ 1.71 $ 1.42
Dividend declared 1.120 1.115 1.100 1.085 1.070 1.055 1.040
Dividend payout ratio 90% 115% 84% 75% 82% 62% 73%
Book value $ 13.12 $ 12.95 $ 13.13 $ 12.89 $ 12.49 $ 12.15 $ 11.47
Market price at year-end 23.65 25.75 27.00 30.31 31.31 29.53 21.00
Common shares outstanding
at year-end (in thousands) 15,182 15,182 15,146 15,094 15,015 15,015 15,015
Return on average common stockholders' equity 9.7% 7.6% 10.1% 11.5% 10.8% 14.5% 12.8%
Long-term debt interest coverage 2.73 2.64 3.31 3.79 3.64 4.37 3.81
Balance Sheet Data
Net utility plant $696,988 $624,342 $582,782 $564,390 $538,741 $515,917 $495,985
Utility plant expenditures
(Company-funded and developer-funded) 88,361 62,049 37,161 48,599 41,061 37,511 40,310
Total assets 798,478 710,214 666,605 645,507 613,143 594,444 569,745
Long-term debt including current portion 251,365 207,981 189,979 171,613 152,674 153,271 151,725
Capitalization ratios:
Common stockholders' equity 44.0% 48.8% 51.1% 53.0% 54.6% 53.8% 52.7%
Preferred stock 0.7% 0.9% 0.9% 0.9% 1.0% 1.0% 1.1%
Long-term debt 55.3% 50.3% 48.0% 46.1% 44.4% 45.2% 46.2%
Other Data
Water production (million gallons)
Wells and surface supply 69,414 65,283 65,408 65,144 57,482 63,736 60,964
Purchased 62,811 61,343 62,237 58,618 54,661 59,646 56,769
-------- -------- -------- -------- -------- -------- --------
Total water production 132,225 126,626 127,645 123,762 112,143 123,382 117,733
======== ======== ======== ======== ======== ======== ========
Metered customers 380,087 371,281 366,242 361,235 354,832 350,139 345,307
Flat-rate customers 78,901 79,146 78,104 77,892 77,568 77,878 77,991
-------- -------- -------- -------- -------- -------- --------
Customers at year-end 458,988 450,427 444,346 439,127 432,400 428,017 423,298
======== ======== ======== ======== ======== ======== ========
New customers added 8,561 6,081 5,219 6,727 4,383 4,719 9,730
Revenue per customer $ 579 $ 552 $ 554 $ 539 $ 500 $ 529 $ 502
Utility plant per customer 2,182 2,020 1,916 1,851 1,768 1,694 1,632
Employees at year-end 802 783 797 790 759 752 740
Management's Discussion and Analysis of
Results of Operations and Financial Condition
Forward-Looking Statements
This annual report, including the Letter to Stockholders and Management's
Discussion and Analysis, (including, but not limited to, the section entitled
"Critical Accounting Policies and Estimates" found below, and the section
entitled "Risk Factors" in Item 1A on Form 10-K filed with the Securities and
Exchange Commission), 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, 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 and collection of regulatory assets; changes
in regulatory commissions' policies and procedures; the timeliness of regulatory
commissions' actions concerning rate relief; new legislation; changes in
accounting valuations and estimates; 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. The Company assumes no obligation to
provide public updates on forward-looking statements.
Overview
California Water Service Group (Company) provides water utility services to
customers in California, Washington, New Mexico, and Hawaii. The majority of the
business is regulated by the respective state's public utility commission. The
Company's California water utility service operations comprise the majority of
the business and contributed 96% of revenues and 95% of net income in 2005. The
Company also has a regulated wastewater business in New Mexico. Non-regulated
activities relate primarily to the water utility business and include operating,
maintenance, billing, meter reading, water testing services, and a new Extended
Service Protection (ESP) Program covering repairs to the customer water line
between the meter and the home. Further information on the Company's operations
may be found in the Company's Form 10-K filed with the Securities and Exchange
Commission (SEC). See page 68 of this Annual Report for information on how to
obtain a copy of Form 10-K.
The state regulatory entities governing the Company's regulated operations
are referred to as "Commission(s)" in this report. Revenues, income, and cash
flows are earned primarily through delivering potable water through pipes to
homes, businesses, industries, and public authorities. Rates charged to
customers for the regulated business are determined by the Commissions, which
also set operating and customer service standards. The rates are intended to
allow recovery of operating costs and a reasonable rate of return on invested
capital.
Major risk factors affecting the financial performance of the Company are:
extensive regulation, decisions by state regulatory commissions, and changes in
laws and regulations; increased costs, such as electricity, not recoverable from
ratepayers; operating costs affected by increased environmental regulations;
lack of control over water supply; inability to finance capital expenditures;
acquisitions, divestitures, or restructuring; failure and circumvention of
controls and procedures; and judgments and estimates regarding financial and
accounting matters. For additional information on "Risk Factors," see Item 1A of
the Form 10-K on file with the SEC. See page 68 of this Annual Report for
information on how to obtain Form 10-K.
The most significant risk and challenge to the business during the past
several years has been obtaining timely rate relief to cover increased costs and
investments. The Company addresses this risk by having an experienced team
dedicated solely to pursuing rate increases and managing Commission issues. The
business can also be impacted by weather. Weather risk is partially mitigated by
having operations in both northern and southern California, as well as in three
other states. Another risk in the water industry is obtaining adequate
financing, as the capital expenditures needed for infrastructure replacements
and improvements may significantly exceed the cash flow generated by operations.
Management believes that the Company has a strong balance sheet and is capable
of supporting the financing needs of the business through use of debt and
equity. Finally, the water industry is highly regulated and must comply with a
multitude of standards related to water quality and service. To address the
compliance issues, the Company has a highly trained, focused team that uses
state-of-the-art technology and works closely with government agencies to
monitor supplies and operations.
For 2005, net income was $27.2 million compared to $26.0 million in 2004,
an increase of 4.6%. Diluted earnings per share for 2005 were $1.47 compared to
$1.46 in 2004, an increase of 0.7%. The increase in earnings per share was
primarily due to higher rates approved by the Commissions, sales to new
customers, and increased gains from property sales. Partially offsetting
increased earnings were decreased sales to existing customers due to wetter than
normal weather conditions, higher maintenance costs, higher depreciation, higher
income taxes, and the dilutive effect of having more weighted average shares
outstanding than the prior year. The Company plans to continue to seek
additional rate increases to recover its operating cost increases and receive
reasonable returns on invested capital. For each of the five years subsequent to
2005, capital expenditures are expected to continue to increase generally at the
same rate as inflation and remain at much higher levels than depreciation
expense. Cash from operations is not expected to be sufficient to fund the cash
needs of the Company (capital expenditures, dividends, and other cash
requirements); therefore, the Company expects to fund anticipated cash
shortfalls through a combination of debt and common stock offerings in the next
five years.
In 2005 and 2004, the Company received many different types of rate
increases, some of which were temporary in nature. As such, the growth in
earnings due solely to rate relief in 2005 and 2004 is not expected to recur in
2006. A significant factor in 2006 affecting earnings will be the timing and the
amount of the General Rate Case (GRC) filings that are expected to be approved
in the second quarter of 2006. See the "Rates and Regulation" section of this
report for more information on regulatory activity occurring in 2004, 2005, and
through February 21, 2006.
Business
California Water Service Group is a holding company incorporated in
Delaware with five operating subsidiaries: California Water Service Company (Cal
Water), CWS Utility Services (Utility Services), New Mexico Water Service
Company (New Mexico Water), Washington Water Service Company (Washington Water),
and Hawaii Water Service Company, Inc. (Hawaii Water). Cal Water, New Mexico
Water, Washington Water, and Hawaii Water are regulated public utilities. The
regulated utility entities also provide some non-regulated services. Utility
Services provides non-regulated water operations and related services to private
companies and municipalities.
California water operations are conducted by Cal Water and Utility
Services, which serve 456,674 customers in 75 California communities through 26
separate districts. Of these 26 districts, 24 districts are regulated water
systems, subject to regulation by the California Public Utilities Commission
(CPUC). The other two districts, the City of Hawthorne and the City of Commerce,
are governed through their respective city councils and are considered
non-regulated because they are outside of the CPUC's jurisdiction. Their
activities are reflected in operating revenue and operating costs, as the risks
and rewards of these operations are similar to those of the regulated
activities. California water operations account for 95% of the total customers
and 96% of the total operating revenue.
Washington Water provides domestic water service to 15,311 customers in the
Tacoma and Olympia areas. Washington Water's utility operations are regulated by
the Washington Utilities and Transportation Commission. Washington Water
accounts for 3% of the total customers and 2% of the total operating revenue.
New Mexico Water provides service to 6,480 water and wastewater customers
in the Belen, Los Lunas, and Elephant Butte areas in New Mexico. Its regulated
operations are subject to the jurisdiction of the New Mexico Public Regulation
Commission. New Mexico Water accounts for 1% of the total customers and 1% of
the total operating revenue.
Hawaii Water provides water service to 537 customers on the island of Maui,
including several large resorts and condominium complexes. Its regulated
operations are subject to the jurisdiction of the Hawaii Public Utilities
Commission. Hawaii Water accounts for less than 1% of the total customers and 1%
of the total operating revenue.
Other non-regulated activities consist primarily of operating water systems
owned by other entities; providing meter reading and billing services; leasing
communication antenna sites on the Company's properties; operating recycled
water systems; providing brokerage services for water rights; providing lab
services; selling non-utility property; and ESP. These activities are reported
below
Management's Discussion and Analysis of Results of Operations and
Financial Condition
operating net income on the income statement, gross of income taxes; therefore,
the revenue is not included in operating revenue. Due to the variety of services
provided and the fact that the activities are outside of the Company's core
business, the number of customers is not tracked for these non-regulated
activities. Non-regulated activities, excluding gain on sale of non-utility
property, comprised 6% of the total net income in 2005.
Rates and operations for regulated customers are subject to the
jurisdiction of the respective state's regulatory commission. The Commissions
require that water and wastewater rates for each regulated district be
independently determined. The Commissions are expected to authorize rates
sufficient to recover normal operating expenses, and allow the utility the
opportunity to earn a fair and reasonable return on invested capital. Rates for
the City of Hawthorne and City of Commerce water systems are established in
accordance with operating agreements and are subject to ratification by the
respective city councils. Fees for other non-regulated activities are based on
contracts negotiated between the parties.
Results of Operations
Earnings and Dividends Net income in 2005 was $27.2 million compared to
$26.0 million in 2004 and $19.4 million in 2003. Diluted earnings per common
share were $1.47 in 2005, $1.46 in 2004, and $1.21 in 2003. The weighted average
number of common shares outstanding used in the diluted earnings per share
calculation was 18,402,000 in 2005, 17,674,000 in 2004, and 15,893,000 in 2003.
As explained below, the increase in 2005 earnings per share resulted from these
primary factors: receiving rate relief on GRC filings and balancing accounts;
customer growth; and gains on sale of non-utility properties. Partially
offsetting these positive factors were: higher maintenance costs; higher
depreciation costs; decreased water usage by existing customers due to wetter
than normal weather; higher income taxes; and increased common shares
outstanding.
At the January 2006 meeting, the Board of Directors declared the quarterly
dividend, increasing it for the 39th consecutive year. The quarterly dividend
was raised from $0.2850 to $0.2875 per common share, an annual rate of $1.15 per
common share. Dividends have been paid for 61 consecutive years. The annual
dividends paid per common share in 2005, 2004, and 2003 were $1.14, $1.13, and
$1.125, respectively. The dividend increases were based on projections that the
higher dividend could be sustained while still providing adequate financial
resources and flexibility. Earnings not paid as dividends are reinvested in the
business for the benefit of stockholders. In its long-term consideration, the
Board of Directors plan to achieve a payout ratio in the range of 60%. The
dividend payout ratio was 78% in 2005, 77% in 2004, and 93% in 2003, an average
of 83% over the three-year period.
Operating Revenue Operating revenue in 2005 was $320.7 million, an increase
of $5.1 million, or 1.6%, over 2004. Operating revenue in 2004 was $315.6
million, an increase of $38.5 million, or 14%, above 2003. The estimated sources
of changes in operating revenue were:
Dollars in millions 2005 2004
---- ----
Customer usage $(10.9) $ 3.3
Rate increases 12.2 29.8
Usage by new customers 3.8 5.4
------ ------
Net change $ 5.1 $ 38.5
====== ======
Average revenue per customer per year (in dollars) $ 670 $ 667
New customers added 5,846 6,733
Overall, temperatures in our service areas for 2005 were comparable to
2004; however, rainfall was significantly higher, particularly in the first half
of the year. Southern California had one of its wettest years on record. For
2004, rainfall was lower than 2003 in our California service areas, which
positively impacted the Company's revenues and earnings. For Washington Water
service areas, rainfall was significantly lower in 2005. As a result, state
officials mandated water conservation, resulting in decreased revenues compared
to 2004.
In 2005, rate relief increased revenues by $12.2 million. See the "Rates
and Regulation" section of this report for more information on regulatory
activity occurring in 2004, 2005, and through February 21, 2006.
The number of customers in 2005 increased by 5,846, or 1.2%, from 2004
levels. This increase includes 645 customers in New Mexico, 37 customers in
Hawaii, 296 customers in Washington, and 4,868 additional customers in
California. Approximately 350, 270, and 169 were added through acquisitions in
New Mexico, California, and Washington, respectively, with the remaining new
customers resulting from growth in existing service areas. In 2004, customer
growth was 6,733, which included approximately 1,700 new customers added through
an acquisition in New Mexico.
Water Production Expenses Water production expenses, which consist of
purchased water, purchased power, and pump taxes, comprise the largest segment
of total operating expenses. Water production costs accounted for 41.2%, 43.5%,
and 44.2% of total operating costs in 2005, 2004, and 2003, respectively. The
rates charged for wholesale water supplies, electricity, and pump taxes are
established by various public agencies. As such, these rates are beyond our
control. The table below provides the amount of increases (decreases), and
percentage changes in water production costs during the past two years:
2005 2004
--------------------------- ---------------------------
Dollars in millions Amount Change % Change Amount Change % Change
- ------------------- ------ ------ -------- ------ ------ --------
Purchased water $ 87.5 $ (2.2) (3%) $ 89.7 $ 8.9 11%
Purchased power 20.5 (1.3) (6%) 21.8 (0.1) (1%)
Pump taxes 7.6 -- -- 7.6 1.3 20%
------ ------ -------- ------ ------ --------
Total water production
expenses $115.6 $ (3.5) (3%) $119.1 $ 10.1 9%
====== ====== ======== ====== ====== ========
Two of the principal factors affecting water production expenses are the
amount of water produced and the source of the water. Generally, water from
wells costs less than water purchased from wholesale suppliers. The table below
provides the amounts, percentage change, and source mix for the respective
years:
2005 2004 2003
------------------------- ----------------------- ------------------------
Millions of gallons (MG) MG % of Total MG % of Total MG % of Total
- ------------------------ ------- ---------- ------- ---------- ------- ----------
Source:
Wells 63,101 47.7% 66,951 48.2% 66,009 50.0%
% change from prior year (6%) 1% (4%)
Purchased 64,028 48.5% 66,760 48.0% 63,264 48.2%
% change from prior year (4%) 6% 1%
Surface 5,061 3.8% 5,328 3.8% 2,407 1.8%
% change from prior year (5%) 121% 221%
------- ----- ------- ----- ------- -----
Total 132,190 100.0% 139,039 100.0% 131,680 100.0%
% change from prior year (5%) 6% (1%)
Purchased water expenses are affected by changes in quantities purchased,
supplier prices, and cost differences between wholesale suppliers. For 2005, the
$2.2 million decrease in purchased water costs is due to a 4% decrease in
quantities purchased, partially offset by overall higher wholesale water rates.
On an overall blended basis, wholesale water rates increased 1.4% on a
cost-per-million-gallon basis. In 2004, purchased water expenses included an
additional adjustment of $0.9 million, which related to the settlement of a
meter malfunction issue in the Stockton district. Purchased power expenses are
affected by the quantity of water pumped from wells and moved through the
distribution system, rates charged by electric utility companies, and rate
structures applied to usage during peak and non-peak times of the day or season.
The purchased power expense decrease of $1.3 million was primarily due to
decreased well production. Pump taxes were the same in 2005 as in 2004, as
higher rates offset the decreased pumping.
Administrative and General Expenses Administrative and general expenses
include payroll related to administrative and general functions, all Company
benefits charged to expense accounts, insurance expenses, legal fees, audit
fees, regulatory utility commissions' expenses, board of directors' fees, and
general corporate expenses.
Management's Discussion and Analysis of
Results of Operations and Financial Condition
During 2005, administrative and general expenses increased $1.6 million, or
3.4%, compared to 2004. Payroll expense charged to administrative and general
expense remained constant due to a decrease in the number of employees offset by
higher wages. Employee/retiree health care costs increased $1.6 million, or 19%,
due to increased medical claims. The Company is self-insured and experienced
several large-dollar medical claims (claims over $200,000), which primarily
caused the increase. Increases in other costs, including legal and outside
services, were substantially offset by a decrease in workers' compensation of
$1.1 million, which was due to fewer claims and a refund from the Company's
stop-loss insurance carrier.
During 2004, administrative and general expenses increased $6.1 million, or
15%, compared to 2003. Payroll expense charged to administrative and general
expense increased $1.0 million, or 13%, due to the addition of new employees and
wage increases. Employee benefits increased $1.4 million, due primarily to
increases in employee/retiree health care expenses. The Company also experienced
higher costs for workers' compensation, general liability claims, and insurance
premiums, which increased $1.3 million, or 40%. Higher expenses were incurred to
comply with Sarbanes-Oxley Section 404 on internal controls, which increased
expenses by $0.9 million for consultants and auditors. Fees to the CPUC
increased $0.5 million due to the increased revenue, as these fees are
calculated as a percentage of revenue. Other expense elements contributed to the
balance of the change, but none were individually significant.
Other Operations Expenses The components of other operations expenses
include payroll, material and supplies, and contract services costs of operating
the regulated water systems, including the costs associated with water
transmission and distribution, pumping, water quality, meter reading, billing,
and operations of district offices.
For 2005, other operating expenses increased $0.1 million, or 0.2%, from
2004. Payroll costs charged to other operating expenses increased $0.7 million,
or 2.2%, due to general wage increases. Expenses were offset by a decrease of
$0.5 million, or 64%, for changing the process for disposing of by-products for
the Bakersfield Treatment Plant. Other expense elements contributed to the
balance of the change, but none were individually significant.
For 2004, other operating expenses increased $2.5 million, or 7%, from
2003. Payroll costs charged to other operating expenses increased $1.3 million,
or 6%, due to general wage increases and increases in the number of employees.
Other major cost increases were operations of the Bakersfield Treatment Plant of
$0.6 million and additional lease cost of $0.4 million for the City of Commerce
operation. Other expense elements contributed to the balance of the change, but
none were individually significant.
Maintenance Maintenance expenses increased $2.0 million, or 15%, in 2005
compared to 2004. For 2004, maintenance expenses increased $0.5 million, or 4%,
compared to 2003. In 2005, maintenance expense increased due to repairs of water
treatment equipment, water main, and wells. In 2004, expenses increased
primarily for service line repairs, which are pipes from the main to the meter
box.
Depreciation and Amortization Depreciation and amortization increased due
to the level of Company-funded capital expenditures and a higher depreciation
rate authorized by the CPUC.
Income Taxes For 2005, income taxes increased $2.9 million. The significant
items include provision for taxes on gain on sale of non-utility properties of
$0.9 million, provision for taxes on increased income from operations of $0.5
million, and $0.7 million for the reversal of federal tax depreciation on
pre-1982 assets, which was previously flowed-through to ratepayers. The Company
anticipates the reversal of federal tax depreciation on pre-1982 assets to
continue in future years; however, its effect on the Company's tax provision is
uncertain due to the offsetting flow-through of state tax depreciation, which
continues to increase with capital additions.
Property and Other Taxes For 2005, expenses increased $1.1 million, or 10%,
compared to 2004. For 2004, expenses increased $1.0 million, or 9%. Increased
property taxes were the primary cause for the increase in both years.
Non-Regulated Income,
Net The major components of non-regulated income are revenue and operating
expenses related to the following activities: operating and maintenance services
(O&M), meter reading and billing services, antenna site leases, water rights
brokering, and design and construction services. For 2005, non-regulated income
increased $0.5 million, or 18%, compared to 2004, with increases primarily from
O&M contracts, antenna site leases, and reduced expenses related to business
development. For 2004, non-regulated income increased compared to 2003, with
increases primarily from O&M and antenna site leases offset by decreases in
water rights brokerage income. Water rights brokerage income is sporadic and is
affected by market opportunities and price volatility. See Note 3 of the Notes
to Consolidated Financial Statements for additional information.
Gain on Sale of Non-Utility Property For 2005, pretax gains from
non-utility property sales were $2.2 million compared to insignificant gains in
2004. The 2005 gains were primarily from three properties sold in the Los Altos
and Chico districts. Earnings and cash flow from these transactions are sporadic
and may or may not continue in future periods, depending upon market conditions.
The Company has other non-utility properties that may be marketed in the future
based on real estate market conditions.
In 2005, interest expenses decreased by $0.1 million, or 1%, as there were
no short-term borrowings in 2005. In 2004, interest expense increased $0.3
million, or 2%, due to a decrease in capitalized interest, which was a result of
lower value of capitalized projects. Capitalized interest in 2005 was comparable
to 2004. See the "Liquidity and Capital Resources" section for more information.
Rates and Regulation
The state regulatory commissions have plenary powers setting rates and
operating standards. As such, state commission decisions significantly impact
revenues, earnings, and cash flow of the Company. The amounts discussed are
generally annual amounts, unless specifically stated, and the financial impact
to recorded revenue is expected to occur over a 12-month period from the
effective date of the decision. In California, water utilities are required to
make several different types of filings. Most filings result in rate changes
that remain in place until the next GRC. As explained below, surcharges and
surcredits to recover balancing and memorandum accounts as well as the catch-up
are temporary rate changes, which have specific time frames for recovery.
General Rate Cases (GRCs)
GRCs, step rate increase filings, and offset filings change rates to
amounts that will remain in effect until the next GRC. The CPUC follows a rate
case plan, which requires Cal Water to file a GRC for each of its 24 regulated
operating districts every three years. In a GRC proceeding, the CPUC not only
considers the utility's rate-setting requests, but may consider other issues
that affect the utility's rates and operations. Effective in 2004, Cal Water's
GRC schedule was shifted from a calendar year to a fiscal year with test years
commencing July 1. The CPUC is generally required to issue its GRC decision
prior to the first day of the test year or authorize interim rates. As such, Cal
Water's GRC decisions, which prior to 2005 were generally issued in the fourth
quarter, are expected to be issued in the second quarter of each year. Cal Water
expects decisions on the eight GRCs filed in August of 2005 to be issued in June
of 2006.
Step Rate Increases
Between GRC filings, utilities may file step rate increases, which allow
the utility to recover cost increases, primarily from inflation and incremental
investment, during the second and third years of the rate case cycle. However,
step rate increases are subject to a weather-normalized earnings test. Under the
earnings test, the CPUC may reduce the step rate increase to prevent the utility
from earning in excess of the authorized rate of return for that district. Step
rate increases, which were previously approved in January, should be approved in
July under the new rate case schedule.
Offset Filings
In addition, utilities are entitled to file offset filings. Offset filings
may be filed to adjust revenues for construction projects authorized in GRCs
when the plant is placed in service or for rate changes charged to the Company
for purchased water, purchased power, and pump taxes (referred to as
"offsettable expenses"). Such rate changes approved in offset filings remain in
effect until a GRC is approved.
Surcharges and Surcredits
Surcharges and surcredits, which are usually effective for a 12-month
period, are authorized by the CPUC to recover the memorandum and balancing
accounts under- and over-collections usually due to changes in offsettable
expenses. However, significant under-collections may be authorized over multiple
years. Currently, filings to recover offsettable expenses are subject to a
non-weather-adjusted earnings test. Under the earnings test, the CPUC may reduce
recovery of an offsettable expense to prevent the utility from earning in excess
of its authorized rate of return. Typically, an expense difference occurs during
the time period from when an offsettable expense changes and the Company is
allowed to adjust its water rates. Expense changes for this regulatory lag
period, which is about two months, are booked into memorandum and balancing
accounts for later recovery. However, in 2001, the CPUC changed its procedures
and did not permit water companies to immediately adjust water rates for
offsettable expense changes. As a result, the amount accrued in memorandum and
balancing accounts, due primarily to the major increases in electric power costs
in 2001, grew to $9.2 million at the end of 2004. Beginning in November 2002,
the CPUC allowed water companies to file for recovery of memorandum and
balancing account under-collections subject to a non-weather-adjusted earnings
test. However, the Company did not receive authorization to collect a
significant portion of the under-collection from its ratepayers until the fourth
quarter of 2004.
Timing of Expense Balancing and Memorandum Accounts
The Company does not record an asset (or liability) for the recovery (or
refund) of expense balancing or memorandum accounts in its financial statements
as revenue (refunds), nor as a receivable (or payable), until the CPUC and other
regulators have authorized recovery and the customer is billed. Therefore, a
timing difference may occur between when costs are recorded as an expense and
the associated revenues are received (or refunds are made) and booked.
Management's Discussion and Analysis of Results of Operations and
Financial Condition
Summary of Rate Decisions and Resolutions
The following is a summary of rate filings and the anticipated annual
impact on revenues. California decisions and resolutions may be found on the
CPUC website at www.cpuc.ca.gov.
Type of Decision/ Approval Increase (Decrease) CA District/
Filing Resolution Date Annual Revenue Subsidiary
- ------ ---------- ---- -------------- ----------
GRC, Step Rate, and Offset Filings
Offset AL1748A February 2006 $0.2 million Selma
Step Rate Various1 January 2006 $1.9 million 13 districts
GRC 2004 D.05-07-022 July 2005 $7.6 million 8 districts
Offset AL 1732 July 2005 $0.6 million Westlake
Offset AL 1708 May 2005 $0.8 million Stockton
GRC 2004 04-00247-UT April 2005 $0.3 million New Mexico
GRC 2004 21644 August 2005 ($0.05 million) Hawaii
Step Rate Various2 January 2005 $4.8 million 19 districts
Offset Res. W-4495 October 2004 $0.5 million Los Altos
GRC 2003 D.04-09-038 September 2004 $0.4 million 2 districts
Step Rate D.04-04-041 August 2004 $0.5 million 4 districts
GRC 2001 D.04-07-033 July 2004 $1.1 million Salinas
GRC 2002 D.04-04-041 April 2004 $3.6 million 4 districts
Offset Res. W-4458 February 2004 $0.7 million Stockton
Step Rate Various3 January-April 2004 $4.4 million 14 districts
Surcharges and Surcredits
Memorandum AL1734A February 2006 $1.1 million Salinas
Balancing AL1711A February 2006 ($0.3 million) Visalia
Balancing AL1718A February 2006 ($0.4 million) Hermosa-Redondo
Balancing AL1710 September 2005 $0.9 million Stockton
Balancing Various4 4th Quarter 2004 $9.2 million 15 districts
Balancing AL 1622 September 2004 $0.4 million Salinas
Balancing Various4 May 2004 ($1.5 million) 2 districts
During 2005 and 2004, no rate filings were approved for Washington Water.
In 2004 and 2003, Cal Water collected a catch-up surcharge for its 2001 GRC. In
Cal Water's 2001 GRC, the CPUC-authorized effective date for rates was April
2003; however, a final decision was not approved until September 2003. As a
result, the Company was authorized to collect approximately $4.5 million of the
revenue not billed between April and September of 2003. In 2005, revenues
dropped compared to the prior year, due in part to the discontinuance of the
catch-up surcharge. In 2005 and 2004, the Company's revenues were favorably
impacted by approximately $3.9 million and $0.4 million, respectively, from the
net recovery of memorandum and balancing accounts.
1. Step rate increases were granted in compliance with D.03-09-021, D.03-10-005,
D.04-04-041, and D.04-09-038.
2. Step rate increases were granted in compliance with D.03-09-021, D.03-10-005,
D.04-04-041, D.04-07-033, and D.04-09-038.
3. Step rate increases were granted in compliance with D.01-08-039, D.03-09-021,
and D.03-10-005.
4. Various advice letters are approved in aggregate.
The Company expects that the net effect of surcharges and surcredits will
reduce revenue by approximately $2.3 million in 2006, assuming similar usage.
The estimated impact of rate changes compared to the prior years is listed in
the following table:
Dollars in millions 2005 2004 2003
- ------------------- ---- ---- ----
Step rate increases $ 4.8 $ 4.4 $ 2.2
Bakersfield Treatment Plant -- 4.2 2.3
General Rate Case (GRC) 5.8 13.3 3.7
Offset (purchased water/pump taxes) 1.2 4.7 0.9
Balancing accounts, net 3.9 0.4 1.9
Catch-up surcharge, net (3.5) 2.2 1.3
Other -- 0.6 0.3
------ ------ ------
Rate increases $ 12.2 $ 29.8 $ 12.6
====== ====== ======
Remaining Unrecorded Balances from Previously Authorized Balancing Account
Recoveries/Refunds
For the balancing accounts authorized in May 2004, the amount remaining to
be refunded as of December 2005 was $0.2 million and December 2004 was $0.6
million. The balance is expected to be refunded by May 2006.
For the balancing accounts authorized in September 2004, the amount
remaining to be collected in rates as of December 2005 was $0.2 million and
December 2004 was $0.3 million. The balance is expected to be recovered by June
2006.
For the balancing accounts authorized in the fourth quarter of 2004, the
net amount remaining to be collected in rates as of December 2005 was $3.1
million and December 2004 was $8.3 million. The net balance is expected to be
fully recovered by January 2008.
For the balancing accounts authorized in September 2005, the amount
remaining to be collected in rates as of December 2005 was $0.8 million. The
balance is expected to be recovered by the third quarter of 2006.
The total amount of unrecorded, under-collected memorandum and balancing
accounts was $2.6 million and $8.5 million, as of December 31, 2005 and 2004,
respectively. Included in this amount, Cal Water has pending memorandum account
filings for 2005 and previously authorized balancing accounts approved for
collection as stated above.
Pending Filings as of February 21, 2006
Cal Water has pending its 2005 GRC filings covering eight districts. Cal
Water expects decisions regarding its 2005 GRCs to be issued in the second
quarter of 2006. The amount requested in the 2005 GRCs is approximately $10.6
million in 2006/2007, $5.5 million in 2007/2008, and $5.5 million in 2008/2009.
The amounts granted may vary due to a variety of factors. Over the past few
years, the amount approved by the CPUC has been substantially less than the
requested amount. The GRCs also requested the CPUC to consider several
modifications to CPUC rate-setting procedures. The GRCs request a water revenue
adjustment mechanism that would allow the Company to recover (refund) water
revenues when actual water sales are below (above) adopted water sales in the
GRCs. This proposal would decouple the Company's revenues from conservation
efforts and inaccurate weather forecasts, putting in place a mechanism similar
to that employed by California's investor-owned electric utilities. The GRCs
also request a full-cost balancing account that would allow the Company to
recover changes in source of supply mix as well as price changes under current
procedures. The Company requested a rate base equalization account to minimize
the impact on rates of large capital projects in small water systems. Finally,
the Company requested that the Commission adjust its authorized rate of return
if modifications are not adopted to change certain rate-setting procedures. The
Company is unable to predict the timing and final outcome of the filings at this
time.
2006 Regulatory Activity
In accordance with the rate case plan, Cal Water will file a GRC for eight
districts in May of 2006. At this time, Cal Water does not know the amounts to
be requested. In January 2006, the Company was granted step rate increases for
13 districts and was authorized an increase of $1.9 million. In February 2006,
Cal Water received authorization to recover (refund) various balancing and
memorandum accounts. Memorandum account decision AL1734A will be collected over
a 36-month period. Cal Water also intends to file for step rate increases in
July for eight districts. Cal Water is authorized to request up to $5.5 million;
however, the request may be adjusted downward by the weather-adjusted earnings
test.
Management's Discussion and Analysis of
Results of Operations and Financial Condition
In the first quarter of 2006, Cal Water will file an advice letter to allow
it to track in a memorandum account additional funding associated with its
retiree health care plan. Currently, Cal Water funds and recognizes expenses
associated with the plan on a pay-as-you-go basis. The excess expense between
pay-as-you-go and accrual during the employees' expected service period has been
recognized as a regulatory asset. As of December 31, 2005, the regulatory asset
was approximately $9.8 million. Cal Water intends to increase its funding so the
plan is funded during the employee's service period. Cal Water has established
two Voluntary Employee Beneficiary Associations (VEBAs) to allow for increased
funding and a current-period income tax deduction. Cal Water will also file an
application to recover its regulatory asset. Cal Water believes that the CPUC
will recognize in rates the recovery of the regulatory asset and the additional
funding of the plan. If the CPUC does not permit the Company to recover the full
amount of its regulatory asset, the regulatory asset, to the extent not allowed
in recovery, will be written off. If the CPUC does not approve the memorandum
account, the Company will not be able to recover the higher expenses of
approximately $0.6 million per year until such expenses are recognized in its
GRC applications.
Washington Water is planning to submit a rate filing in the first quarter
of 2006, but has not filed as of the date of this report.
Review of Property Sales by CPUC
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 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 for treatment of
the gain on sale proceeds.
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.
On December 1, 2005, the CPUC issued its D.05-12-002. This decision found
that Cal Water appropriately reclassified all properties as non-utility property
prior to being sold and the criteria Cal Water followed to reclassify its
properties were reasonable and consistent with the requirements of the CPUC.
Since the properties were properly reclassified, the CPUC found that approval of
the property sales was not required and no penalty was warranted. Furthermore,
the decision found that Cal Water should be allowed to include in rate base the
full cost of the Chico customer center.
Although the decision concluded that all gains for the property sales
qualified for reinvestment in accordance with the Infrastructure Act, the
decision deferred the rate-making issue regarding treatment of sale proceeds to
its Order Instituting Rulemaking (R.) 04-09-003. On November 5, 2005, the
Commission issued its draft decision regarding the allocation of proceeds from
the sale of utility assets. The draft decision states that the CPUC has limited
discretion in how it allocates between ratepayers and utility shareholders the
gains on sale of real property that meet the criteria in the Infrastructure Act,
provided that water utilities reinvest the proceeds in new water infrastructure.
If the draft decision is adopted, the Company will be entitled to earn its full
authorized return on the proceeds reinvested in utility plant from the gains on
surplus property sales that were under review.
Based on D.05-12-002 and the draft decision, Cal Water has not recorded any
adjustments in its financial statements. Cal Water does not know when the CPUC
will issue its decision in the matter of R.04-09-003. If the CPUC rules that any
portion of the property sales should be allocated to the ratepayers, Cal Water's
rate base could be reduced, which would lower future revenues, net income, and
cash flows.
Elimination of the Earnings Test on Balancing Accounts
On January 23, 2006, the CPUC issued a draft decision to suspend, until
further notice, the non-weather-adjusted earnings test that applies to
memorandum and balancing account recovery for water utilities. The elimination
of the earnings test should significantly improve Cal Water's opportunity to
earn its authorized rate of return. Over the past three years, Cal Water has
been unable to recover $3.5 million in offsettable expenses. The draft decision
does not address the weather-adjusted earnings test, which is required for step
rate increases.
Water Supply
Our source of supply varies among our operating districts. Certain
districts obtain all of their supply from wells; some districts purchase all of
their supply from wholesale suppliers; and other districts obtain supply from a
combination of wells and wholesale suppliers. A small portion of supply comes
from surface sources and is processed through Company-owned water treatment
plants. The Company is meeting water quality, environmental, and other
regulatory standards.
California's normal weather pattern yields little precipitation between
mid-spring and mid-fall. The Washington Water service areas receive
precipitation in all seasons, with the heaviest amounts during the winter. New
Mexico Water's rainfall is heaviest in the summer monsoon season. Hawaii Water
receives precipitation throughout the year, with the largest amounts in the
winter months. Water usage in all service areas is highest during the warm and
dry summers and declines in the cool winter months. Rain and snow during the
winter months replenish underground water aquifers and fill reservoirs,
providing the water supply for subsequent delivery to customers. To date, snow
and rainfall accumulation during the 2005-2006 water year has been above
average. Precipitation in the prior year was also above average. Water storage
in California's reservoirs at the end of 2005 was at above-average levels.
Management believes that supply pumped from underground aquifers and purchased
from wholesale suppliers will be adequate to meet customer demand during 2006
and beyond. Long-term water supply plans are developed for each of the Company's
districts to help assure an adequate water supply under various operating and
supply conditions. Some districts have unique challenges in meeting water
quality standards, but management believes that supplies will meet current
standards using current treatment processes. The Company is in compliance with
the new Environmental Protection Agency (EPA) standard related to arsenic, which
became effective in January 2006.
Liquidity and Capital Resources
Short-Term Financing
Short-term liquidity is provided by bank lines of credit and internally
generated funds. Long-term financing is accomplished through use of both debt
and equity. Short-term bank borrowings were zero at December 31, 2005 and 2004.
Cash and cash equivalents were $9.5 million at December 31, 2005 and $18.8
million at December 31, 2004. In January 2005, the Company received a $7.2
million tax refund due to federal bonus depreciation allowed one time in 2004.
The Company does not expect to receive a similar refund in 2006. Given the
Company's ability to access its lines of credit on a daily basis, cash balances
are managed to levels required for daily cash needs, and excess cash is invested
in short-term or cash equivalent instruments. Minimal operating levels of cash
are maintained for Washington Water, New Mexico Water, and Hawaii Water.
The water business is seasonal. Revenue is lower in the cool, wet winter
months when less water is used compared to the warm, dry summer months when
water use is higher. During the winter period, the need for short-term
borrowings under the bank lines of credit increases. The increase in cash flow
during the summer allows short-term borrowings to be paid down. In years when
more than normal precipitation falls in the Company's service areas or
temperatures are lower than normal, especially in the summer months, customer
water usage can be lower than normal. The reduction in water usage reduces cash
flow from operations and increases the need for short-term bank borrowings. In
addition, short-term borrowings are used to finance capital expenditures until
long-term financing is arranged.
Cal Water has a $45 million credit facility. The term of the current
agreement expires in April 2007. The agreement requires a 30-day out-of-debt
consecutive period during any 24 consecutive months and that outstanding
balances be below $10 million for a 30-day consecutive period during any
12-consecutive-month period. In addition, the agreement requires debt as a
percentage of total capitalization to be less than 67%. The Company has met all
covenant requirements and is eligible to use the full amount of the commitment.
In addition to borrowings, the credit facility allows for letters of credit up
to $10 million. One letter of credit was outstanding at December 31, 2005, for
$0.5 million related to an insurance policy, which reduces the amount available
to borrow. Interest is charged on a variable basis and fees are charged for
unused amounts. As of December 31, 2005, there were no borrowings against the
credit facility.
A $10 million credit facility exists for the Company, Utility Services,
Washington Water, New Mexico Water, and Hawaii Water. The term of the current
agreement expires in April 2007. The agreement requires a 30-day out-of-debt
consecutive period during any 24 consecutive months and that outstanding
balances be below $5 million for a 30-day consecutive period during any
12-consecutive-month period. In addition, the agreement requires debt as a
percentage of total capitalization to be less than 67%. The Company has met all
covenant requirements and is eligible to use the full amount of the commitment.
In addition to borrowings, the credit facility allows for letters of credit up
to $5 million, which would reduce the amount available to borrow. No letters of
Management's Discussion and Analysis of Results of Operations
and Financial Condition
credit were outstanding at December 31, 2005. Interest is charged on a variable
basis and fees are charged for unused amounts. As of December 31, 2005, there
were no borrowings against the credit facility.
Credit Ratings
Cal Water's first mortgage bonds are rated by Moody's Investors Service
(Moody's) and Standard & Poor's (S&P). Previously, the two major credit facility
agreements contained covenants related to these debt ratings. The current
agreements do not contain such covenants. During 2005, management met separately
with the two credit rating agencies, and both agencies have maintained their
ratings of A2 for Moody's and A+ for S&P as of the filing date of this report.
The last time ratings were changed was in February 2004, when Moody's issued a
report lowering Cal Water's senior secured debt from A1 to A2 and characterizing
the rating as stable. In November 2003, S&P did not change its rating of A+, but
changed its outlook from stable to negative. Although the Company's financial
performance and capitalization structure improved in 2004 compared to 2003,
which was recognized by both agencies, both agencies noted concerns related to
the rate-setting process and decisions by the CPUC. Also, concerns were raised
about the Company's level of capital expenditures, which will need to be
partially financed through long-term borrowings or equity offerings. Management
believes the Company would be able to meet financing needs even if ratings were
downgraded, but a rating change could result in a higher interest rate on new
debt.
Long-Term Financing
Long-term financing, which includes senior notes, other debt securities,
and common stock, has been used to replace short-term borrowings and fund
capital expenditures. Internally generated funds, after making dividend
payments, provide positive cash flow, but have not been at a level to meet all
of the Company's capital expenditure needs. Management expects this trend to
continue given the Company's capital expenditures plan for the next five years.
In addition to Company-funded capital expenditures, some capital expenditures
are funded by developers' Contributions in Aid of Construction, which are not
refundable, and Advances for Construction, which are refundable. Management
believes long-term financing is available to meet the Company's cash flow needs
through issuances in both debt and equity markets. The Company did not issue any
significant long-term debt or additional stock in 2005.
In June 2004, the Company issued 1,409,700 shares of its common stock at
$27.25 per share. The net proceeds were $36.8 million and the transaction was
closed on June 29, 2004. The funds were used to pay down short-term borrowings
and invest in short-term money market instruments, pending their use for general
corporate purposes. After issuance of these shares, $35.6 million remains in
securities under the Company's shelf registration, which are available for
future issuance.
In September 2004, the CPUC issued a decision granting Cal Water authority
to complete up to $250 million of equity and debt financing through 2010,
subject to certain restrictions. No financing had been applied against this
authorization as of December 31, 2005.
In November 2004, New Mexico Water entered into a long-term debt
arrangement for $3.4 million. The interest rate is 5.65%, the loan terminates in
May 2014, and principal payments are required during the term of the loan. The
funds were used to retire debt of $2.3 million, fund an acquisition, fund
capital expenditures, and for general corporate purposes.
Washington Water has long-term debt primarily from two banks to meet its
operating and capital equipment purchase requirements at interest rates
negotiated with the banks. Both Washington Water and Hawaii Water have
inter-company debt with the holding company, which is eliminated at
consolidation. Hawaii Water does not have any debt with third parties.
The Company does not utilize off-balance-sheet financing or utilize special
purpose entity arrangements for financing. The Company does not have equity
ownership through joint ventures or partnership arrangements.
Additional information regarding the bank borrowings and long-term debt is
presented in Notes 8 and 9 of the Notes to Consolidated Financial Statements.
Dividend Reinvestment and Stock Purchase Plan
The Company's transfer agent offers stockholders a Dividend Reinvestment
and Stock Purchase Plan (Plan). Under the Plan, stockholders may reinvest
dividends to purchase additional Company common stock without brokerage fees.
The Plan also allows existing stockholders and other interested investors to
purchase Company common stock without brokerage fees through the transfer agent
up to certain limits. Our transfer agent operates the Plan and purchases shares
on the open market to provide shares for the Plan.
2006 Financing Plan
The Company's 2006 financing plan includes raising approximately $40-$50
million of new capital. The plan includes issuance of long-term debt and
additional equity, although this may change depending on a variety of factors.
Beyond 2006, management intends to fund capital needs through a relatively
balanced approach between long-term debt and equity.
Contractual Obligations
The Company's contractual obligations are summarized in the following
table. Long-term debt payments include annual sinking fund payments on first
mortgage bonds, maturities of long-term debt, and annual payments on other
long-term obligations. Advances for Construction represent annual contract
refunds to developers for the cost of water
systems paid for by the developers. The contracts are non-interest bearing, and
refunds are generally on a straight-line basis over a 40-year period. System and
Office leases include obligations associated with leasing water systems and
rents for office space.
Less Than After
Contractual Obligations (In thousands) Total 1 Year 1-3 Years 3-5 Years 5 Years
- --------------------------------------- ----- ------ --------- --------- --------
Long-term debt $275,275 $ 1,133 $ 2,210 $ 1,991 $269,941
Advances for Construction 141,842 5,077 9,777 9,588 117,400
Office leases 1,880 662 844 309 65
System leases 11,232 961 1,922 1,922 6,427
Water Supply Contracts 403,124 12,731 26,671 27,880 335,842
Cal Water has water supply contracts with wholesale suppliers in 16 of its
operating districts. For each contract, the cost of water is established by the
wholesale supplier and is generally beyond our control. The amount paid annually
to the wholesale suppliers is charged to purchased water expense on our
statement of income. Most contracts do not require minimum annual payments and
vary with the volume of water purchased.
The Company has a contract with the Santa Clara Water District that
contains minimal purchase provisions. The contract payment varies with the
volume of water purchased above the minimal level. Management plans to continue
to purchase and use at least the minimum water requirement under this contract
in the future. The total paid under this contract was $4,763 in 2005, $4,610 in
2004, and $4,452 in 2003.
The water supply contract with Stockton East Water District (SEWD) requires
a fixed, annual payment and does not vary during the year with the quantity of
water delivered by the district. Because of the fixed price arrangement, the
Company operates to receive as much water as possible from SEWD in order to
minimize the cost of operating Company-owned wells used to supplement SEWD
deliveries. The total paid under the contract was $4,300 in 2005, $4,392 in
2004, and $3,779 in 2003. Pricing under the contract varies annually. Estimated
annual contractual obligations in the table above are based on the same payment
levels as 2005. Future increased costs by SEWD are expected to be offset by a
decline in the allocation of costs to the Company, as other customers of SEWD
are expected to receive a larger allocation based upon growth of their service
areas.
On September 21, 2005, the Company entered into an agreement with Kern
County Water Agency (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. Under the terms of the
agreement, the Company is obligated to purchase 20,500 acre-feet of treated
water per year. The Company is obligated to pay a Capital Facilities Charge and
a Treated Water Charge, both of which will be expensed as invoiced, 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. (This agreement supersedes a prior agreement with
Kern County Water Agency for the supply of 11,500 acre-feet of water per year.
The total paid, under the prior agreement, was $3,288 in 2005, $3,308 in 2004,
and $2,691 in 2003.)
Three other parties, including the City of Bakersfield, are also obligated
to purchase a total of 32,500 acre-feet per year under separate agreements with
the Agency. Furthermore, 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.
The Agency is planning to issue bonds to fund the project and will use the
payments of the Capital Facilities Charges by the 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 are
also 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
Management's Discussion and Analysis of Results of Operations
and Financial Condition
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 parties, excluding the Company, is
approximately $108 million to the Agency. Based on the creditworthiness of the
other participants, which are government entities, it is believed to be highly
unlikely that the Company would be required to assume any other party's
obligations under the contract due to its default. In the event of default by a
party, the Company would receive entitlement to the additional water for
assuming the additional obligation.
Once the project is complete, the Company is obligated to pay a Capital
Facilities Charge and a Treated Water Charge that together total $4.7 million
annually, which equates to $231 per acre-foot. Annual payments of $2.0 million
for the Capital Facilities Charge will begin when the Agency issues bonds to
fund the project. Some of the Treated Water Charge of $2.8 million 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 $4.7 million
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 estimates, 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.
Capital Requirements Capital requirements consist primarily of new
construction expenditures for expanding and replacing utility plant facilities
and the acquisition of water systems. They also include refunds of Advances for
Construction.
Company-funded utility plant expenditures were $77.6 million, $50.4
million, and $53.9 million in 2005, 2004, and 2003, respectively. A majority of
capital expenditures was associated with mains and water treatment equipment.
For 2006, Company-funded capital expenditures are budgeted at approximately
$85 million. The 2006 capital budget is the same as the 2005 capital budget. For
the years 2006 through 2010, capital expenditures are estimated at $75-$85
million per year, and will be primarily for mains, related water distribution
equipment, water quality equipment, and pumping.
Other capital expenditures are funded through developer Advances and
Contributions in Aid of Construction (non-Company funded). The expenditure
amounts were $16.9 million, $18.2 million, and $20.4 million in 2005, 2004, and
2003, respectively. The changes from year to year reflect expansion projects by
developers in our service areas.
Management expects the Company to incur non-Company funded expenditures in
2006. These expenditures will be financed by developers through refundable
Advances for Construction and non-refundable Contributions in Aid of
Construction. Developers are required to deposit the cost of a water
construction project with the Company prior to our commencing construction work,
or the developers may construct the facilities themselves and deed the completed
facilities to the Company. Funds are generally received in advance of incurring
costs for these projects. Advances are normally refunded over a 40-year period
without interest. Future payments for Advances received are listed under
contractual obligations above. Because non-Company-funded construction activity
is solely at the discretion of developers, management cannot predict the level
of future activity. The cash flow impact is expected to be minor due to the
structure of the arrangements.
Capital Structure In 2005, common stockholders' equity increased by $6.3
million, due primarily to an increase in retained earnings. In 2004, common
stockholders' equity increased $43.1 million, or 18%, due primarily to earnings
and the issuance of new shares of common stock. The long-term debt decreased by
$0.7 million, due primarily to sinking fund payments. See the "Long-Term
Financing" section above for additional information.
Total capitalization at December 31, 2005 was $571.5 million and at
December 31, 2004 was $565.9 million. The Company intends to issue common stock
and long-term debt to maintain the Company's current capitalization structure,
taking into account reinvestment of earnings above dividends. At December 31,
capitalization ratios were:
2005 2004
---- ----
Common equity 51.4% 50.8%
Preferred stock 0.6% 0.6%
Long-term debt 48.0% 48.6%
The return (from both regulated and non-regulated operations) on average
common equity was 9.3% in 2005 compared to 9.8% in 2004.
Acquisitions
Although there were no significant acquisitions in the periods presented,
the following acquisitions were completed in 2005 and 2004:
In April 2005, the Company acquired the water system assets of the Los
Trancos Water District for $125,000 in cash. The Los Trancos water system and
its 270 customers were merged into Cal Water's Bear Gulch district. The purchase
price was approximately equal to rate base and no goodwill was recorded in the
transaction.
In June 2005, the Company acquired the water system assets of Gamble Bay
for $370,000. The Company assumed net liabilities of $336,000 and the balance
was paid in cash. The Company merged the water system and its 169 customers into
Washington Water. The Company recorded an acquisition adjustment of $18,000,
which it believes will be included in rate base. As such, the purchase price is
approximately equal to rate base and no goodwill was recorded.
In June 2005, the Company acquired the water system assets of the Cypress
Gardens Water Company for $312,000 in cash. The Company merged the water system
and its 350 customers into New Mexico Water. The purchase price is approximately
equal to rate base and no goodwill was recorded.
In April 2004, the Company acquired the stock of National Utility Company
(NUC) and land from owners of NUC for $0.9 million in cash. The Company retired
NUC's stock and merged it into New Mexico Water. Revenue for NUC for the
eight-month period in 2004 was $0.4 million and net income was zero. The
purchase price is approximately equal to rate base and an immaterial amount of
goodwill was recorded in the transaction.
Real Estate Program
The Company owns a certain amount of real estate. From time to time,
certain parcels are deemed unnecessary for and are not used in water utility
operations. Most surplus properties have a low cost basis. A program was
developed to realize the value of certain surplus properties through sale or
lease of those properties. The program will be ongoing for a period of several
years. Property sales produced pretax gains of $2.2 million in 2005, minimal
pretax gains were recorded in 2004, and $4.6 million was recorded in 2003. As
sales are dependent on real estate market conditions, future sales, if any, may
or may not be at prior year levels. As discussed in the "Rates and Regulation"
section, future sales may be impacted by the CPUC ruling in its proceeding
regarding sales of utility assets.
Critical Accounting Policies and Estimates
The Company maintains its accounting records in accordance with accounting
principles generally accepted in the United States of America and as directed by
the Commissions to which its operations are subject. The process of preparing
financial statements requires the use of estimates on the part of management.
The estimates used by management are based on historic experience and an
understanding of current facts and circumstances. A summary of our significant
accounting policies is listed in Note 2 of the Notes to Consolidated Financial
Statements and other Notes provide additional information. The following
sections describe the level of subjectivity, judgment, and variability of
estimates that could have a material impact on the financial condition,
operating performance, and cash flows of the business.
Regulated Utility Accounting
Because the Company operates extensively in a regulated business, it is
subject to the provisions of Statement of Financial Accounting Standards (SFAS)
No. 71, "Accounting for the Effects of Certain Types of Regulation." Application
of SFAS No. 71 requires accounting for certain transactions in accordance with
regulations defined by the respective Commission of that state. Under SFAS No.
71, a utility may defer certain costs of providing services if the rates
established by its regulators are designed to recover the utility's specific
costs and the economic environment gives reasonable assurance that those rates
can be charged and collected throughout the periods necessary to recover the
costs. In the event that a portion of the Company's operations were no longer
subject to the provisions of SFAS No. 71, the Company would be required to write
off related regulatory assets and liabilities that are not specifically
recoverable and determine if other assets might be impaired. If a 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
was no such asset impairment as of December 31, 2005. Additional information
relating to regulatory assets and liabilities are listed in Note 2 of the Notes
to Consolidated Financial Statements.
Unbilled Revenue
Unbilled revenue is estimated for metered customers for water used between
the last reading of the customer's meter and the end of the accounting period.
This estimate is based on the usage from the last bill to the customer, which
Management's Discussion and Analysis of Results of Operations
and Financial Condition
normally covers a 30-day period, and is prorated from the last meter-read date
to the end of the accounting period. The amount of variability is low at
December 31, as this is one of the lowest usage months of the year and usage for
the previous 30-day period is relatively consistent during this time of the
year. Actual usage may vary from this estimate.
Flat-rate customers are billed in advance at the beginning of the service
period. Since these are constant amounts, appropriate adjustments can be
calculated to determine the revenue related to the applicable period.
Estimated Expenses Some expenses are recorded using estimates, as actual
payments are not known or processed by the accounting deadline. Estimates are
made for unbilled purchased water, unbilled purchased power, unbilled pump
taxes, payroll, and other types of similar expenses. While management believes
its estimates are reasonable, actual results could vary. Differences between
actual results and estimates are recorded in the period when the information is
known.
Expense Balancing and Memorandum Accounts Expense balancing accounts and
memorandum accounts (offsettable expenses) represent recoverable costs incurred
but not billed to customers. The amounts included in these accounts relate to
rate changes charged to the Company for purchased water, purchased power, and
pump taxes that are different from amounts incorporated into the rates approved
by the CPUC. The Company does not record expense balancing or memorandum
accounts in its financial statements as revenue, nor as a receivable, until the
CPUC and other regulators have authorized recovery of the higher costs and
customers have been billed. Therefore, a timing difference may occur between
when costs and associated revenues are recognized. The balancing and memorandum
accounts are only used to track the specific costs outside of the financial
statements. The cost changes, which are beyond the Company's control, are
referred to as "offsettable expenses" because under certain circumstances, they
are recoverable from customers in future offset rate increases. During 2004 and
2005, the CPUC gave approval to charge customers for a portion of the
offsettable expenses. Additionally, the Company may file with the CPUC for its
offsettable expenses incurred in 2005. The amounts requested may not be
ultimately collected through rates, as amounts may be disallowed during the
review process or subject to a non-weather-adjusted earnings test. While the
adjustments would not impact previously recorded amounts, the adjustments may
change future earnings and cash flows. At this time, the Company cannot predict
the actual recovery (refund) associated with 2005 offsettable expenses to be
requested in 2006. (See "Rates and Regulation.")
Washington Water, New Mexico Water, and Hawaii Water did not have material
amounts in expense balancing or memorandum accounts.
Income Taxes Significant judgment is required in determining the provision
for income taxes. The process involves estimating current tax exposure and
assessing temporary differences resulting from 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. Management must also assess the likelihood that
deferred tax assets will be recovered in future taxable income. To the extent
recovery is unlikely, a valuation allowance would be required. If a valuation
allowance was required, it could significantly increase income tax expense. In
management's view, a valuation allowance was not required at December 31, 2005.
Detailed schedules relating to income taxes are provided in Note 11 of the Notes
to Consolidated Financial Statements.
Employee Benefit Plans The Company incurs costs associated with its pension
and postretirement health care benefit 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. Management works with
independent actuaries to measure these benefits. Different estimates and/or
actual amounts could result in significant variances in the costs and
liabilities recognized for these benefit plans. The estimates used are based on
historical experience, current facts, future expectations, and recommendations
from independent advisors and actuaries.
The Company uses an investment advisor to provide expert advice for
managing investments in these plans. To diversify investment risk, the plan's
goal is to invest 40%-60% of the assets in domestic equity mutual funds, 5%-15%
in foreign equity mutual funds, and 35%-45% in bond funds. At December 31, 2005,
51.9% of the assets were invested in domestic equity mutual funds, 11.7% in
foreign equity mutual funds, and 36.4% in bond funds. Based on the market values
of the investment funds for the year ended December 31, 2005, the total return
on the pension plan assets was 6.0%. For 2004 and 2003, returns were 13% and
19%, respectively. Future returns on investments could vary significantly from
estimates and could impact earnings and cash flows. Management expects any
changes to these costs to be recovered in future rate filings, mitigating the
financial impact.
For measurement in 2005, management estimated the discount rate at 5.60%,
which approximates the average return on long-term corporate bonds as of
year-end. Using the interest rate curve developed by Citigroup as of December
31, 2004 and 2005, the equivalent level discount rates were 5.74% and 5.58%,
respectively. Accordingly, the discount rate was lowered in 2005 from 6% to
5.60%. Management assumed the rate of compensation to increase 3% in its 2005
calculation. Any change in these assumptions would have an effect on the service
costs, interest costs, and accumulated benefit obligations. Additional
information related to employee benefit plans is listed in Note 12 of the Notes
to Consolidated Financial Statements.
Workers' Compensation, General Liability, and Other Claims The Company is
self-insured for a portion of workers' compensation and general liability
claims. Excess amounts are covered by insurance policies. For workers'
compensation, the Company utilizes an actuary firm to estimate the discounted
liability associated with claims submitted and claims not yet submitted based on
historical data. These estimates could vary significantly from actual claims
paid, which could impact earnings and cash flows. For general liability claims
and other claims, management estimates the cost incurred but not yet paid using
historical information. Actual costs could vary from these estimates. Management
believes actual costs incurred would be allowed in future rates, mitigating the
financial impact.
Contingencies The Company did not record any provisions relating to the
contingencies reported in Note 15 of the Notes to Consolidated Financial
Statements, as these did not qualify for recording under SFAS No. 5 or other
accounting standards. If management's assessment is incorrect, these items could
have a material impact on the financial condition, results of operations, and
cash flows of the Company.
Financial Risk Management
The Company does not participate in hedge arrangements, such as forward
contracts, swap agreements, options, or other contractual agreements relative to
the impact of market fluctuations on its assets, liabilities, production, or
contractual commitments. The Company operates only in the United States and,
therefore, is not subject to foreign currency exchange rate risks.
Terrorism Risk Due to terrorist risks, the Company has heightened security
at its facilities over the past few years and has taken added precautions to
protect its employees and the water delivered to customers. The Company has
complied with EPA regulations concerning vulnerability assessments and has made
filings to the EPA as required. In addition, communication plans have been
developed as a component of the Company's procedures related to this risk. While
the Company does not make public comments on its security programs, the Company
has been in contact with federal, state, and local law enforcement agencies to
coordinate and improve water delivery systems' security.
Interest Rate Risk The Company is subject to interest rate risk, although
this risk is lessened because the Company operates in a regulated industry. If
interest rates were to increase, management believes customer rates would
increase accordingly, subject to Commission approval in future GRC filings. The
majority of debt is long-term, fixed rate. Interest rate risk does exist on
short-term borrowings within the Company's credit facilities, as these interest
rates are variable. The Company also has interest rate risk on new financing, as
higher interest cost may occur on new debt if interest rates increase.
Stock Price Risk Because the Company operates primarily in a regulated
industry, its stock price risk is somewhat lessened; however, regulated
parameters also can be recognized as limitations to operations, earnings, and
the ability to respond to certain business condition changes. For example, prior
to 2004, the Company believes its stock price was adversely affected by analyst
reports, which stated the Company's earnings were negatively impacted by the
delays of certain CPUC decisions. An adverse change in the stock price could
make issuance of common stock less attractive in the future.
Stock Market Performance Risk The Company's stock price could be impacted
by changes in the general market. This could impact the costs of obtaining funds
through the equity markets. Stock market performance could also impact the
Company through the investments by the Company's defined benefit plan and
postretirement medical benefit plan. The Company is responsible for funding
these plans. Plan investments are made in stock market equities using mutual
funds and in corporate bonds. Poor performance of the equity and bond markets
could result in increased costs and additional funding requirements due to lower
investment returns. Management believes the Company would be able to recover
these higher costs in customer rates.
Equity Risk The Company does not have equity investments and, therefore,
does not have equity risks.
Recent Accounting Pronouncements and Law Changes
The description and impact of recent accounting pronouncements that are
effective for the period reported are described in Note 2 of the Notes to
Consolidated Financial Statements.
As of the filing date, there were no other accounting pronouncements
affecting future periods that are expected to have a material impact on the
Company's financial condition, results of operations, or cash flows.
Consolidated Balance Sheets
In thousands, except per share data
December 31, 2005 2004
- ------------ ---- ----
Assets
Utility plant:
Land $ 14,274 $ 13,070
Depreciable plant and equipment 1,171,218 1,102,932
Construction work in progress 35,372 13,248
Intangible assets 14,226 14,824
---------- ----------
Total utility plant 1,235,090 1,144,074
Less accumulated depreciation and amortization 372,359 343,769
---------- ----------
Net utility plant 862,731 800,305
---------- ----------
Current assets:
Cash and cash equivalents 9,533 18,820
Receivables, net of allowance for uncollectible accounts
Customers 16,061 15,867
Income taxes -- 7,298
Other 4,700 3,147
Unbilled revenue 11,445 9,307
Materials and supplies at weighted average cost 4,182 3,161
Prepaid pension expense 1,696 3,671
Taxes and other prepaid expenses 4,607 9,122
---------- ----------
Total current assets 52,224 70,393
---------- ----------
Other assets:
Regulatory assets 58,213 53,477
Unamortized debt premium and expense 7,746 8,411
Other 16,031 10,267
---------- ----------
Total other assets 81,990 72,155
---------- ----------
$ 996,945 $ 942,853
========== ==========
2005 2004
---- ----
Capitalization and Liabilities
Capitalization:
Common stock, $0.01 par value; 25,000 shares authorized,
18,390 and 18,367, outstanding in 2005 and 2004, respectively $ 184 $ 184
Additional paid-in capital 131,991 131,271
Retained earnings 162,968 156,851
Accumulated other comprehensive loss (1,202) (701)
--------- ---------
Total common stockholders' equity 293,941 287,605
Preferred stock without mandatory redemption provision, $25 par value;
380 shares authorized, 139 shares outstanding 3,475 3,475
Long-term debt, less current maturities 274,142 274,821
--------- ---------
Total capitalization 571,558 565,901
--------- ---------
Current liabilities:
Current maturities of long-term debt 1,133 1,100
Accounts payable 36,120 19,745
Accrued taxes 1,791 1,912
Accrued interest 2,715 2,676
Other accrued liabilities 35,057 31,779
--------- ---------
Total current liabilities 76,816 57,212
--------- ---------
Unamortized investment tax credits 2,615 2,721
Deferred income taxes 63,920 54,826
Regulatory liabilities 18,782 18,811
Advances for Construction 141,842 131,292
Contributions in Aid of Construction 99,958 94,915
Other long-term liabilities 21,454 17,175
Commitments and contingencies -- --
--------- ---------
$ 996,945 $ 942,853
========= =========
See accompanying Notes to Consolidated Financial Statements.
Consolidated Statements of Income
In thousands, except per share data
For the years ended December 31, 2005 2004 2003
---- ---- ----
Operating revenue $320,728 $315,567 $277,128
-------- -------- --------
Operating expenses:
Operations
Purchased water 87,504 89,787 80,831
Purchased power 20,541 21,801 21,921
Pump taxes 7,620 7,555 6,272
Administrative and general 48,655 47,078 40,969
Other 40,032 39,929 37,476
Maintenance 15,216 13,228 12,717
Depreciation and amortization 28,731 26,114 23,256
Income taxes 20,006 17,084 12,898
Property and other taxes 12,613 11,508 10,554
-------- -------- --------
Total operating expenses 280,918 274,084 246,894
-------- -------- --------
Net operating income 39,810 41,483 30,234
-------- -------- --------
Other income and expenses:
Non-regulated income, net 2,863 2,375 2,097
Gain on the sale of non-utility property 2,250 8 4,603
-------- -------- --------
Total other income and expenses 5,113 2,383 6,700
-------- -------- --------
Interest expense:
Interest expense 18,600 18,664 19,512
Less capitalized interest 900 824 1,995
-------- -------- --------
Net interest expense 17,700 17,840 17,517
-------- -------- --------
Net income $ 27,223 $ 26,026 $ 19,417
======== ======== ========
Earnings per share:
Basic $ 1.47 $ 1.46 $ 1.21
Diluted $ 1.47 $ 1.46 $ 1.21
Weighted average number of common shares outstanding:
Basic 18,379 17,652 15,882
Diluted 18,402 17,674 15,893
See accompanying Notes to Consolidated Financial Statements.
Consolidated Statements of Common Stockholders' Equity
and Comprehensive Income
In thousands
For the years ended December 31, 2005, 2004, and 2003
Accumulated
Additional Other Total
Common Paid-in Retained Comprehensive Stockholders'
Stock Capital Earnings Loss Equity
----- ------- -------- ---- ------
Balance at December 31, 2002 $ 152 $ 49,984 $149,215 $ (134) $199,217
------ -------- -------- ------- --------
Net income -- -- 19,417 -- 19,417
Net other comprehensive loss -- -- -- (167) (167)
------ -------- -------- ------- --------
Comprehensive income -- -- -- -- 19,250
Issuance of common stock 17 43,764 -- -- 43,781
Dividends paid:
Preferred stock -- -- (153) -- (153)
Common stock -- -- (17,571) -- (17,571)
------ -------- -------- ------- --------
Total dividends paid -- -- (17,724) -- (17,724)
------ -------- -------- ------- --------
Balance at December 31, 2003 169 93,748 150,908 (301) 244,524
------ -------- -------- ------- --------
Net income -- -- 26,026 -- 26,026
Net other comprehensive loss -- -- -- (400) (400)
------ -------- -------- ------- --------
Comprehensive income -- -- -- -- 25,626
Issuance of common stock 15 37,523 -- -- 37,538
Dividends paid:
Preferred stock -- -- (153) -- (153)
Common stock -- -- (19,930) -- (19,930)
------ -------- -------- ------- --------
Total dividends paid -- -- (20,083) -- (20,083)
------ -------- -------- ------- --------
Balance at December 31, 2004 184 131,271 156,851 (701) 287,605
------ -------- -------- ------- --------
Net income -- -- 27,223 -- 27,223
Net other comprehensive loss -- -- -- (501) (501)
------ -------- -------- ------- --------
Comprehensive income -- -- -- -- 26,722
Issuance of common stock -- 720 -- -- 720
Dividends paid:
Preferred stock -- -- (153) -- (153)
Common stock -- -- (20,953) -- (20,953)
------ -------- -------- ------- --------
Total dividends paid -- -- (21,106) -- (21,106)
------ -------- -------- ------- --------
Balance at December 31, 2005 $ 184 $131,991 $162,968 $(1,202) $293,941
====== ======== ======== ======= ========
See accompanying Notes to Consolidated Financial Statements.
Consolidated Statements of Cash Flows
In thousands For the years ended December 31, 2005 2004 2003
- --------------------------------------------- ---- ---- ----
Operating activities:
Net income $ 27,223 $ 26,026 $ 19,417
-------- -------- --------
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 28,731 26,114 23,256
Net change in deferred income taxes, investment tax credits,
regulatory assets and liabilities 3,908 17,637 2,834
Gain on sale of non-utility property (2,250) (8) (4,603)
Changes in operating assets and liabilities:
Receivables 5,545 (2,720) 1,292
Unbilled revenue (2,138) (771) (554)
Taxes and other prepaid expenses 6,491 (7,168) (2,876)
Accounts payable 16,374 (4,042) (301)
Other current assets (1,021) (203) (197)
Other current liabilities 3,841 2,713 7,537
Other changes, net (445) (2,167) (1,374)
-------- -------- --------
Net adjustments 59,036 29,385 25,014
-------- -------- --------
Net cash provided by operating activities 86,259 55,411 44,431
-------- -------- --------
Investing activities:
Utility plant expenditures:
Company-funded (77,569) (50,388) (53,884)
Developer advances and contributions in aid of construction (16,948) (18,185) (20,369)
Proceeds from sale of non-utility assets 2,316 14 4,803
Acquisitions (471) (900) (6,094)
-------- -------- --------
Net cash used in investing activities (92,672) (69,459) (75,544)
-------- -------- --------
Financing activities:
Net changes in short-term borrowings -- (6,454) (29,925)
Issuance of common stock, net of expenses 720 37,538 43,781
Issuance of long-term debt, net of expenses 227 3,501 80,114
Advances for construction 15,389 14,388 13,248
Refunds of advances for construction (4,840) (5,049) (4,838)
Contributions in aid of construction 7,924 6,882 9,311
Retirement of long-term debt (1,188) (711) (61,061)
Dividends paid (21,106) (20,083) (17,724)
-------- -------- --------
Net cash (used in) provided by financing activities (2,874) 30,012 32,906
-------- -------- --------
Change in cash and cash equivalents (9,287) 15,964 1,793
Cash and cash equivalents at beginning of year 18,820 2,856 1,063
-------- -------- --------
Cash and cash equivalents at end of year $ 9,533 $ 18,820 $ 2,856
======== ======== ========
Supplemental disclosures of cash flow information:
Cash paid during the year for
Interest (net of amounts capitalized) $ 16,811 $ 17,202 $16,873
Income taxes 12,411 8,026 6,188
See accompanying Notes to Consolidated Financial Statements.
Notes to Consolidated Financial Statements
December 31, 2005, 2004, and 2003
Amounts in thousands, except per share data and share data
Note 1. Organization and Operations
California Water Service Group (Company) is a holding company that provides
water utility and other related services in California, Washington, New Mexico,
and Hawaii through its wholly owned subsidiaries. California Water Service
Company (Cal Water), Washington Water Service Company (Washington Water), New
Mexico Water Service Company (New Mexico Water), and Hawaii Water Service
Company, Inc. (Hawaii Water) provide regulated utility services under the rules
and regulations of their respective state's regulatory commissions (jointly
referred to as the Commissions). CWS Utility Services (Utility Services)
provides non-regulated water utility and utility-related services. At Cal Water,
as of December 31, 2005, there were 566 union employees covered by two-year
agreements with the Utility Workers Union of America, AFL-CIO, and the
International Federation of Professional and Technical Engineers, AFL-CIO. The
agreements include a 3.5% wage increase for 2006, with wage increases for 2007
to be negotiated in the fall of 2006. The Company believes that it maintains
good relationships with the unions. Employees at Washington Water, Hawaii Water
and New Mexico Water do not belong to Unions.
The Company operates primarily in one business segment, providing water and
related utility services.
Note 2. Summary of Significant Accounting Policies
Principles of Consolidation and Accounting Records
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. Inter-company transactions and balances have
been eliminated. The accounting records of the Company are maintained in
accordance with the uniform system of accounts prescribed by the Commissions.
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Revenue
Revenue consists of monthly cycle customer billings for regulated water and
wastewater services at rates authorized by the Commissions and billings to
certain non-regulated customers. Revenue from metered accounts includes unbilled
amounts based on the estimated usage from the latest meter reading to the end of
the accounting period. Flat-rate accounts, which are billed at the beginning of
the service period, are included in revenue on a pro-rata basis for the portion
applicable to the current accounting period.
The Company provides an allowance for doubtful accounts. The balance of
customer receivables, net of the allowance for doubtful accounts was $272 and
$287 at December 31, 2005 and 2004, respectively. The activity in the reserve
account is as follows:
2005 2004
---- ----
Beginning Balance $ 287 $ 289
Provision for uncollectible accounts 756 1,073
Net write-off of uncollectible accounts (771) (1,075)
---- ------
Ending Balance $ 272 $ 287
==== ======
Non-Regulated Revenue
Revenues from non-regulated operations and maintenance agreements are
recognized when services have been rendered to companies or municipalities under
such agreements. Expenses are netted against the revenue billed and are reported
in Other Income and Expenses on the Consolidated Statements of Income. Other
non-regulated revenue is recognized when title has transferred to the buyer, or
ratably over the term of the lease. For construction and design services,
revenue is generally recognized on the completed contract method, as most
projects are completed in less than three months.
Expense Balancing and Memorandum Accounts
Expense balancing 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
"Offsettable Expenses" because under certain circumstances they are recoverable
from customers (or refunded to customers) in future rates designed to offset the
cost changes from the 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.
Notes to Consolidated Financial Statements
Utility Plant
Utility plant is carried at original cost when first constructed or
purchased, except for certain minor units of property recorded at estimated fair
values at the date of acquisition. When depreciable plant is retired, the cost
is eliminated from utility plant accounts and such costs are charged against
accumulated depreciation. Maintenance of utility plant is charged to operating
expenses as incurred. Maintenance projects are not accrued for in advance.
Interest is capitalized on plant expenditures during the construction period and
amounted to $900 in 2005, $824 in 2004, and $1,995 in 2003.
Intangible assets acquired as part of water systems purchased are stated at
amounts as prescribed by the Commissions. All other intangibles have been
recorded at cost and are amortized over their useful life. Included in
intangible assets is $6,515 paid to the City of Hawthorne in 1996 to lease the
city's water system and associated water rights. The asset is being amortized on
a straight-line basis over the 15-year life of the lease.
The following table represents depreciable plant and equipment as of
December 31:
2005 2004
---- ----
Equipment $ 234,073 $ 214,202
Transmission and distribution plant 864,450 819,793
Office buildings and other
structures 72,695 68,937
---------- ----------
Total $1,171,218 $1,102,932
========== ==========
Depreciation of utility plant for financial statement purposes is computed
on a straight-line basis over the assets' estimated useful lives and provides
for asset retirement costs as follows:
Useful
Lives
-----
Equipment 5 to 50 years
Transmission and distribution plant 40 to 65 years
Office buildings and other structures 50 years
The provision for depreciation expressed as a percentage of the aggregate
depreciable asset balances was 2.7% in 2005, 2.6% in 2004, and 2.5% in 2003. For
income tax purposes, as applicable, the Company computes depreciation using the
accelerated methods allowed by the respective taxing authorities. Plant
additions since June 1996 are depreciated on a straight-line basis for tax
purposes in accordance with tax regulations.
Cash Equivalents
Cash equivalents include highly liquid investments with original maturities
of three months or less. As of December 31, 2005 and 2004, cash equivalents
included investments in money market funds in the amount of $4,003 and $6,133,
respectively, and investment in high-quality commercial paper in the amount of
zero and $4,997, respectively.
Restricted Cash
Restricted cash primarily represents proceeds collected through a surcharge
on certain customers' bills, plus interest earned on the proceeds, and is used
to service California Safe Drinking Water Bond obligations. All restricted cash
is classified in other prepaid expenses. At December 31, 2005 and 2004,
restricted cash was $1,200 and $1,337, respectively.
Regulatory Assets and Liabilities
The Company records regulatory assets for future revenues expected to be
realized in customers' rates when certain items are recognized as expenses for
rate-making purposes. The income tax temporary differences relate primarily to
the difference between book and federal income tax depreciation on utility plant
that was placed in service before the regulatory Commissions adopted
normalization for rate-making purposes. Previously, the tax benefit of tax
depreciation was passed onto customers (flow-through). For state income tax
purposes, the Commission continues to use the flow-through method. As such
timing differences reverse, the Company will be able to include the impact of
such differences in customer rates. These federal tax differences will continue
to reverse over the remaining book lives of the related assets.
In addition, regulatory assets include items that are recognized as
liabilities for financial statement purposes, which will be recovered in future
customer rates. Asset retirement obligations are recorded net of depreciation,
which has been recorded and recognized through the regulatory process. The
liabilities relate to asset retirement obligations, postretirement benefits
other than pensions, and accrued benefits for vacation, self-insured workers'
compensation, and directors' retirement benefits.
Regulatory liabilities represent future benefits to ratepayers for tax
deductions that will be allowed in the future. Regulatory liabilities also
reflect timing differences provided at higher than the current tax rate, which
will flow through to future ratepayers.
Regulatory assets and liabilities are comprised of the following as of
December 31:
2005 2004
---- ----
Regulatory Assets
Income tax temporary differences $ 32,856 $ 29,196
Asset retirement obligations, net 1,538 2,540
Postretirement benefits other than pensions 9,791 9,019
Other accrued benefits 14,028 12,722
-------- --------
Total regulatory assets $ 58,213 $ 53,477
======== ========
Regulatory Liabilities
Future tax benefits due ratepayers $ 18,782 $ 18,811
======== ========
Long-Lived Assets
The Company regularly reviews its long-lived assets for impairment,
annually or when events or changes in business circumstances have occurred that
indicate the carrying amount of such assets may not be fully realizable.
Potential impairment of assets held for use is determined by comparing the
carrying amount of an asset to the future undiscounted cash flows expected to be
generated by the asset. If assets are considered to be impaired, the impairment
to be recognized is measured as the amount by which the carrying value of the
asset exceeds its fair value. There have been no asset impairments as of
December 31, 2005 and 2004.
Long-Term Debt Premium, Discount, and Expense
The discount and issuance expense on long-term debt is amortized over the
original lives of the related debt issues. Premiums paid on the early redemption
of certain debt issues and the unamortized original issue discount and expense
are amortized over the life of new debt issued in conjunction with the early
redemption. These amounts were zero in 2005 and 2004 and $3,154 in 2003.
Amortization expense included in interest expense was $661, $660, and $415 for
2005, 2004, and 2003, respectively.
Accumulated Other Comprehensive Loss
The Company has an unfunded Supplemental Executive Retirement Plan. The
unfunded accumulated benefit obligation of the plan, less the accrued benefit,
exceeds the unrecognized prior service cost, resulting in an accumulated other
comprehensive loss that has been recorded net of tax as a separate component of
Stockholders' Equity.
Advances for Construction
Advances for Construction consist of payments received from developers for
installation of water production and distribution facilities to serve new
developments. Advances are excluded from rate base for rate-setting purposes.
Annual refunds are made to developers without interest. Advances of $141,168 and
$130,558 at December 31, 2005 and 2004, respectively, are refunded primarily
over a 40-year period in equal annual amounts. In addition, other Advances for
Construction totaling $674 and $734 at December 31, 2005 and 2004, respectively,
are refundable based upon customer connections. Estimated refunds of advances
for each succeeding year (2006 through 2010) are $5,077, $4,921, $4,856, $4,795,
$4,793, and $117,400 thereafter.
Contributions in Aid of Construction
Contributions in Aid of Construction represent payments received from
developers, primarily for fire protection purposes, which are not subject to
refunds. Facilities funded by contributions are included in utility plant, but
excluded from rate base. Depreciation related to assets acquired from
contributions is charged to Contributions in Aid of Construction account.
Income Taxes
The Company accounts for income taxes using the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Measurement of the deferred tax assets and liabilities is at enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in the period that
includes the enactment date.
It is anticipated that future rate action by the Commissions will reflect
revenue requirements for the tax effects of temporary differences recognized,
which have previously been flowed through to customers. The Commissions have
granted the Company rate increases to reflect the normalization of the tax
benefits of the federal accelerated methods and available Investment Tax Credits
(ITC) for all assets placed in service after 1980. ITCs are deferred and
amortized over the lives of the related properties for book purposes.
Advances for Construction and Contributions in Aid of Construction received
from developers subsequent to 1986 were taxable for federal income tax purposes
and subsequent to 1991 were subject to California income tax. In 1996, the
federal tax
Notes to Consolidated Financial Statements
law, and in 1997, the California tax law, changed, and only deposits for new
services were taxable. In late 2000, federal regulations were further modified
to exclude contributions of fire services from taxable income.
Workers' Compensation, General Liability and Other Claims
For workers' compensation, the Company utilized an actuary firm to estimate
the discounted liability associated with claims submitted and claims not yet
submitted based on historical data. For general liability claims and other
claims, the Company estimates the cost incurred but not yet paid using
historical information.
Earnings Per Share
The computations of basic and diluted earnings per share are noted below.
Common stock options outstanding to purchase common shares were 98,000, 121,500,
and 149,250 at December 31, 2005, 2004, and 2003, respectively.
All options are dilutive and the dilutive effect is shown in the table below.
2005 2004 2003
---- ---- ----
Net income, as reported $ 27,223 $ 26,026 $ 19,417
Less preferred dividends 153 153 153
-------- -------- --------
Net income available to common stockholders $ 27,070 $ 25,873 $ 19,264
======== ======== ========
Weighted average common shares, basic 18,379 17,652 15,882
Dilutive common stock options (treasury method) 23 22 11
-------- -------- --------
Shares used for dilutive calculation 18,402 17,674 15,893
======== ======== ========
Earnings per share - basic $ 1.47 $ 1.46 $ 1.21
Earnings per share - dilutive $ 1.47 $ 1.46 $ 1.21
Stock-Based Compensation
The Company has a stockholder-approved Long-Term Incentive Plan under which
non-qualified stock options are outstanding. 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
to SFAS No. 123," and as permitted by the statement, applies Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," for
its plan. All of the Company's outstanding options have an exercise price equal
to the market price on the date they were granted. No compensation expense was
recorded for the years ended December 31, 2005, 2004, or 2003.
In 2005, the Company adopted a stockholder-approved Equity Incentive Plan
that allows certain stock-based compensation awards. There were no awards during
2005. The Company adopted SFAS No. 123 (revised 2004) "Share-Based Payment,"
effective January 1, 2006, and will be recording compensation expense in
accordance with that standard for any awards granted in the future.
The table below illustrates the effect on net income and earnings per share
as if the Company had applied the fair value recognition provisions of SFAS No.
123 to stock-based employee compensation under the Long-Term Incentive Plan.
2005 2004 2003
---- ---- ----
Net income available to common stockholders $ 27,070 $ 25,873 $ 19,264
Deduct: Total stock-based employee compensation
expense determined under fair-value-based method
for all awards, net of related tax effects 46 67 68
-------- -------- --------
Pro forma net income available to common stockholders $ 27,024 $ 25,806 $ 19,196
======== ======== ========
Earnings per share:
Basic - as reported $ 1.47 $ 1.46 $ 1.21
Basic - pro forma $ 1.47 $ 1.46 $ 1.21
Diluted - as reported $ 1.47 $ 1.46 $ 1.21
Diluted - pro forma $ 1.47 $ 1.46 $ 1.21
Recent Accounting Pronouncements
In May 2004, the FASB issued FASB Staff Position (FSP) No. 106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003." FSP No. 106-2 was effective
for the first quarter after June 15, 2004, and replaces FSP No. 106-1. FSP No.
106-1 was effective for the Company's consolidated financial statements for the
year ended December 31, 2003. The Company has determined its retiree health plan
is actuarially equivalent and would qualify for the subsidy that would begin in
2006. Because the Company is regulated, FSP No. 106-2 did not have an impact on
the income statement or cash flows in 2004. The adjustment for FSP No. 106-2
impacted the balance sheet only, decreasing liabilities and regulatory assets by
$663 in 2004. In 2005, the Company elected to apply the entire subsidy to reduce
the cost of the retiree health care expense. The impact on the net periodic
postretirement benefit costs for 2005 was to reduce the expense by $1,574.
In November 2004, the FASB issued 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 a
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 revises SFAS No. 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). The statement is effective
for the Company in the first quarter of 2006. The adoption of this statement is
not expected to materially impact the Company's financial position, results of
operations, or cash flows for equity instruments based upon the level of options
previously granted and the level of awards granted in January 2006. In January
2006, Restrict Stock Awards were granted for 9,142 shares of common stock and
Stock Appreciation Rights Awards were granted for 37,500 shares of common stock.
In December 2004, the FASB issued 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 Creations Act of 2004." FSP
No. 109-1 provides guidance on the application of SFAS No. 109 to the provision
within the American Jobs Creation Act of 2004 (Act) that provides a
Notes to Consolidated Financial Statements
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 did not have a material impact on 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
adoption of this Interpretation did not have a material impact on the Company's
financial position, results of operations, or cash flows. The Company has been
allowed to collect retirement obligation costs from ratepayers through
depreciation expense. As of December 31, 2005, the Company estimates its
retirement obligation costs to be $4,480, of which $2,942 has been collected
from ratepayers. The balance is recorded as a regulatory asset.
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 adoption of this Statement did not have a
material impact on the Company's financial position, results of operations, or
cash flows.
Note 3. Other Income and Expenses
The Company conducts various non-regulated activities as reflected in the
table below. Income reflects revenue less direct and allocated costs. Income
taxes are not included.
2005 2004 2003
------------------- -------------------- ---------------------
Revenue Income Revenue Income Revenue Income
------- ------ ------- ------ ------- ------
Operating and maintenance $ 4,931 $ 1,142 $ 4,536 $ 997 $ 4,137 $ 939
Meter reading and billing 1,112 473 1,261 622 1,337 473
Leases 1,457 958 1,285 818 1,190 781
Water rights brokering -- -- -- (96) 196 112
Design and construction 929 232 606 209 1,305 204
Other and non-regulated expenses 831 58 385 (175) 320 (412)
------- ------- ------- ------- ------- -------
Total $ 9,260 $ 2,863 $ 8,073 $ 2,375 $ 8,485 $ 2,097
======= ======= ======= ======= ======= =======
Operating and maintenance services and meter reading and billing services
are provided for water and wastewater systems owned by private companies and
municipalities. The agreements call for a fee-per-service or a flat-rate amount
per month. Leases have been entered into with telecommunications companies for
cellular phone antennas placed on the Company's property. Water rights brokering
activity involves purchasing water rights from third parties and reselling those
rights to other third parties. Design
and construction services are for the design and installation of water mains and
other water infrastructure for others outside the Company's regulated service
areas.
Note 4. Acquisitions
In 2005, after receiving regulatory approval, the Company's subsidiaries
acquired three water systems for a combined purchase price of $807, including
liabilities assumed of $336, which was the approximate value of the rate base in
aggregate of the assets acquired.
In 2004, after receiving regulatory approval, the Company's wholly owned
subsidiary, New Mexico Water, acquired the stock of National Utilities
Corporation. The purchase was for $900, which was the approximate amount of rate
base of the assets acquired and for certain real estate used by the water
system.
In 2003, after receiving regulatory approval, the Company acquired the
Kaanapali Water Corporation and renamed the corporation Hawaii Water Service
Company, Inc. The purchase was for $6,094, which was the approximate amount of
the rate base of assets acquired.
Condensed balance sheets and pro forma results of operations for these
acquisitions have not been presented since the impact of the purchases was not
material. Minimal or no goodwill was recorded in connection with the
acquisitions.
Note 5. Intangible Assets
As of December 31, 2005 and 2004, intangible assets that will continue to
be amortized and those not amortized were:
2005 2004
----------------------------------- --------------------------------
Weighted
Average Gross Net Gross Net
Amortization Carrying Accumulated Carrying Carrying Accumulated Carrying
Period Value Amortization Value Value Amortization Value
------ ----- ------------ ----- ----- ------------ -----
Amortized intangible assets:
Hawthorne lease 15 $ 6,515 $ 4,271 $ 2,244 $ 6,515 $ 3,837 $ 2,678
Water pumping rights usage 1,084 11 1,073 1,046 8 1,038
Water planning studies 14 2,873 605 2,268 3,164 763 2,401
Leasehold improvements & other 24 876 515 361 1,130 624 506
---- -------- ------- ------- ------- ------- -------
Total 16 $ 11,348 $ 5,402 $ 5,946 $11,855 $ 5,232 $ 6,623
==== ======== ======= ======= ======= ======= =======
Unamortized intangible assets:
Perpetual water rights and other $ 2,878 -- $ 2,878 $ 2,969 -- $ 2,969
For the years ending December 31, 2005, 2004, and 2003, amortization of
intangible assets was $876, $799, and $713, respectively. Estimated future
amortization expense related to intangible assets for the succeeding five years
is $749, $706, $677, $652, and $624, and $2,537 thereafter.
Note 6. Preferred Stock
As of December 31, 2005 and 2004, 380,000 shares of preferred stock were
authorized. Dividends on outstanding shares are payable quarterly at a fixed
rate before any dividends can be paid on common stock.
The outstanding 139,000 shares of $25 par value cumulative, 4.4% Series C
preferred shares are not convertible to common stock. A premium of $243 would be
due to preferred stock shareholders upon voluntary liquidation of Series C.
There is no premium in the event of an involuntary liquidation. Each Series C
preferred share is entitled to 16 votes, with the right to cumulative votes at
any election of directors.
Notes to Consolidated Financial Statements
Note 7. Common Stockholders' Equity
The Company is authorized to issue 25 million shares of $0.01 par value
common stock. As of December 31, 2005 and 2004, 18,389,996 shares and 18,367,246
shares, respectively, of common stock were issued and outstanding.
Dividend Reinvestment and Stock Repurchase Plan
The Company has a Dividend Reinvestment and Stock Purchase Plan (Plan).
Under the Plan, stockholders may reinvest dividends to purchase additional
Company common stock without commission fees. The Plan also allows existing
stockholders and other interested investors to purchase Company common stock
through the transfer agent up to certain limits. The Company's transfer agent
operates the Plan and purchases shares on the open market to provide shares for
the Plan.
Stockholder Rights Plan
The Company's Stockholder Rights Plan (Plan) is designed to protect
stockholders and to maximize stockholder value by encouraging a prospective
acquirer to negotiate with the Board. The Plan was adopted in 1998 and
authorized a dividend distribution of one right (Right) to purchase 1/100th
share of Series D Preferred Stock for each outstanding share of common stock in
certain circumstances. The Rights are for a 10-year period that expires in
February 2008.
Each Right represents a right to purchase 1/100th share of Series D
Preferred Stock at the price of $120, subject to adjustment (Purchase Price).
Each share of Series D Preferred Stock is entitled to receive a dividend equal
to 100 times any dividend paid on common stock and 100 votes per share in any
stockholder election. The Rights become exercisable upon occurrence of a
Distribution Date. A Distribution Date event occurs if (a) any person
accumulates 15% of the then outstanding common stock, (b) any person presents a
tender offer which would cause the person's ownership level to exceed 15% and
the Board determines the tender offer not to be fair to the Company's
stockholders, or (c) the Board determines that a stockholder maintaining a 10%
interest in the common stock could have an adverse impact on the Company or
could attempt to pressure the Company to repurchase the holder's shares at a
premium.
Until the occurrence of a Distribution Date, each Right trades with the
common stock and is not separately transferable. When a Distribution Date
occurs: (a) the Company would distribute separate Rights Certificates to Common
Stockholders and the Rights would subsequently trade separate from the common
stock; and (b) each holder of a Right, other than the acquiring person (whose
Rights would thereafter be void), would have the right to receive upon exercise
at its then current Purchase Price that number of shares of common stock having
a market value of two times the Purchase Price of the Right. If the Company
merges into the acquiring person or enters into any transaction that unfairly
favors the acquiring person or disfavors the Company's other stockholders, the
Right becomes a right to purchase common stock of the acquiring person having a
market value of two times the purchase price.
The Board may determine that in certain circumstances a proposal that would
cause a Distribution Date is in the Company stockholders' best interest.
Therefore, the Board may, at its option, redeem the Rights at a redemption price
of $0.001 per Right.
Note 8. Short-Term Borrowings
At December 31, 2005, the Company maintained a bank line of credit
providing unsecured borrowings of up to $10 million at the prime lending rate or
lower rates as quoted by the bank. Cal Water maintained a separate bank line of
credit for an additional $45 million on the same terms as the Company's line of
credit. Both agreements required a 30-day out-of-debt period during any 24
consecutive months. The $10 million and $45 million lines have a requirement
where the outstanding balance must be below $10 million and $5 million,
respectively, for a 30-day consecutive period during any 12-month period. Both
agreements have a covenant requiring debt as a percentage of total
capitalization to be less than 67%. At December 31, 2005, there were no
borrowings on the Company or Cal Water line, and one letter of credit for $0.5
million is outstanding under the Cal Water line.
The following table represents borrowings under the bank lines of credit:
Dollars in thousands 2005 2004 2003
- -------------------- ---- ---- ----
Maximum short-term borrowings $ -- $ 18,800 $58,633
Average amount outstanding $ -- $ 4,330 $30,388
Weighted average interest rate n/a 2.94% 2.96%
Interest rate at December 31 n/a n/a 4.08%
Note 9. Long-Term Debt
As of December 31, 2005 and 2004, long-term debt outstanding was:
Interest Maturity
Series Rate Date 2005 2004
------ ---- ---- ---- ----
First Mortgage Bonds: J 8.86% 2023 $ 3,600 $ 3,800
K 6.94% 2012 5,000 5,000
CC 9.86% 2020 18,100 18,200
--------- --------
Total First Mortgage Bonds 26,700 27,000
--------- --------
Senior Notes:
A 7.28% 2025 20,000 20,000
B 6.77% 2028 20,000 20,000
C 8.15% 2030 20,000 20,000
D 7.13% 2031 20,000 20,000
E 7.11% 2032 20,000 20,000
F 5.90% 2017 20,000 20,000
G 5.29% 2022 20,000 20,000
H 5.29% 2022 20,000 20,000
I 5.54% 2023 10,000 10,000
J 5.44% 2018 10,000 10,000
K 4.58% 2010 10,000 10,000
L 5.48% 2018 10,000 10,000
M 5.52% 2013 20,000 20,000
N 5.55% 2013 20,000 20,000
--------- --------
Total Senior Notes 240,000 240,000
--------- --------
California Department of Water Resources loans 3.0% to 7.4% 2008-32 2,546 2,673
Other long-term debt 6,029 6,248
--------- --------
Total long-term debt 275,275 275,921
Less current maturities 1,133 1,100
--------- --------
Long-term debt excluding current maturities $ 274,142 $274,821
========= ========
The first mortgage bonds and unsecured senior notes are obligations of Cal
Water. All bonds are held by institutional investors and secured by
substantially all of Cal Water's utility plant. The senior notes are held by
institutional investors and require interest-only payments until maturity,
except series G and H, which have an annual sinking fund requirement of $1.8
million starting in 2012. The Department of Water Resources (DWR) loans were
financed under the California Safe Drinking Water Bond Act. Repayment of
principal and interest on the DWR loans is through a surcharge on customer
bills. Other long-term debt includes a term loan of $3.4 million for New Mexico
Water and other equipment and system acquisition financing arrangements with
financial institutions. Aggregate maturities and sinking fund requirements for
each of the succeeding five years (2006 through 2010) are $1,133, $1,115,
$1,095, $1,026, and $965, and $269,941 thereafter.
Notes to Consolidated Financial Statements
Note 10. Other Accrued Liabilities
As of December 31, 2005 and 2004, other accrued liabilities were:
2005 2004
---- ----
Accrued pension and postretirement benefits $ 14,272 $ 13,032
Accrued and deferred compensation 9,370 7,953
Accrued benefit and workers' compensation claims 4,533 4,142
Other 6,882 6,652
-------- --------
Total other accrued liabilities $ 35,057 $ 31,779
======== ========
Note 11. Income Taxes
Income tax expense consists of the following:
Federal State Total
------- ----- -----
2005 Current $ 12,275 $ 3,433 $ 15,708
Deferred 4,274 24 4,298
-------- -------- --------
Total $ 16,549 $ 3,457 $ 20,006
======== ======== ========
2004 Current $ 4,211 $ 3,623 $ 7,834
Deferred 9,146 104 9,250
-------- -------- --------
Total $ 13,357 $ 3,727 $ 17,084
======== ======== ========
2003 Current $ 8,506 $ 2,604 $ 11,110
Deferred 1,697 91 1,788
-------- -------- --------
Total $ 10,203 $ 2,695 $ 12,898
======== ======== ========
Income tax expense computed by applying the current federal 35% tax rate to
pretax book income differs from the amount shown in the Consolidated Statements
of Income. The difference is reconciled in the table below:
2005 2004 2003
---- ---- ----
Computed "expected" tax expense $ 16,530 $ 15,089 $ 11,310
Increase (reduction) in taxes due to:
State income taxes net of federal tax benefit 2,714 2,477 1,846
Investment tax credits (31) (139) (91)
Other 793 (343) (167)
-------- -------- --------
Total income tax $ 20,006 $ 17,084 $ 12,898
======== ======== ========
Included in Other in the above table is the recognition of the flow-through
accounting for federal depreciation expense on assets acquired prior to 1982.
For assets acquired prior to 1982, the benefit of excess tax depreciation was
previously passed through to the ratepayers. The tax benefit is now reversing
and a higher tax expense is being recognized and is included in customer rates.
In October 2004, the American Jobs Creation Act of 2004 (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 exclude 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 2005, the Company completed its evaluation of the
provisions of the Act and included a deduction in the provision for income
taxes. The impact was to lower the income tax provision by $175 in 2005.
The components of deferred income tax expense were:
In thousands 2005 2004 2003
- ------------ ---- ---- ----
Depreciation $ 3,593 $ 11,603 $ 3,110
Developer Advances and Contributions (561) (1,409) (1,136)
Prepaid expenses 2,004 -- --
Bond redemption premiums -- (231) 911
Investment tax credits (106) (107) (110)
Other (632) (606) (987)
------- -------- -------
Total deferred income tax expense $ 4,298 $ 9,250 $ 1,788
======= ======== =======
The tax effects of differences that give rise to significant portions of
the deferred tax assets and deferred tax liabilities at December 31, 2005 and
2004 are presented in the following table:
2005 2004
---- ----
Deferred tax assets:
Developer deposits for extension agreements
and Contributions in Aid of Construction $ 48,020 $ 47,688
Federal benefit of state tax deductions 7,464 7,120
Book plant cost reduction for future deferred ITC amortization 1,545 1,607
Insurance loss provisions 1,846 1,158
Pension plan 1,663 1,524
Other 812 190
-------- --------
Total deferred tax assets 61,350 59,287
-------- --------
Deferred tax liabilities:
Utility plant, principally due to depreciation differences 120,875 111,506
Prepaid expense 2,004 --
Premium on early retirement of bonds 2,391 2,607
-------- --------
Total deferred tax liabilities 125,270 114,113
-------- --------
Net deferred tax liabilities $ 63,920 $ 54,826
======== ========
A valuation allowance was not required at December 31, 2005 and 2004. Based
on historical taxable income and future taxable income projections over the
period in which the deferred assets are deductible, management believes it is
more likely than not that the Company will realize the benefits of the
deductible differences.
Notes to Consolidated Financial Statements
Note 12. Employee Benefit Plans
Pension Plans
The Company provides a qualified, defined-benefit, non-contributory pension
plan for substantially all employees. The Company also maintains an unfunded,
non-qualified, supplemental executive retirement plan. The costs of plans are
charged to expense and utility plant. The Company makes annual contributions to
fund the amounts accrued for pension cost. The Company estimates that the annual
contribution to the pension plans will be $7.4 million in 2006. Plan assets in
the defined benefit pension plan as of December 31, 2005 and 2004 (the
measurement dates for the plan) were as follows:
Asset Category Target 2005 2004
- -------------- ------ ---- ----
Bond funds 35% to 45% 36.4% 39.4%
Equity accounts 55% to 65% 63.6% 60.6%
The investment objective of the fund is to maximize the return on assets,
commensurate with the risk the Company Trustees deem appropriate to meet the
obligations of the Plan, minimize the volatility of the pension expense, and
account for contingencies. The Trustees utilize the services of an outside
investment advisor and periodically measure fund performance against specific
indexes in an effort to generate a rate of return for the total portfolio that
equals or exceeds the actuarial investment rate assumptions.
Pension payment obligations are generally funded by the purchase of an
annuity from a life insurance company. In 2005, the Plan annuitized pension
benefits that would otherwise be paid to certain retirees in the future. Benefit
payments under the supplemental executive retirement plan are paid currently.
Excluding costs to annuitize future retirement benefits, benefits expected to be
paid in each year from 2006 through 2010 are $2,610, $3,266, $4,412, $5,617, and
$5,683, respectively. The aggregate benefit expected to be paid in the five
years 2011 through 2015 is $39,142. The expected benefit payments are based upon
the same assumptions used to measure the Company's benefit obligation at
December 31, 2005, and include estimated future employee service.
The accumulated benefit obligations of the pension plan are $71,463 and
$65,938 as of December 31, 2005 and 2004, respectively. The fair value of
pension plan assets was $70,225 and $75,064 as of December 31, 2005 and 2004,
respectively. The unfunded supplemental executive retirement plan accumulated
benefit obligations were $8,608 and $7,234 as of December 31, 2005 and 2004,
respectively.
The data in the following tables includes the unfunded, non-qualified,
supplemental executive retirement plan.
Savings Plan
The Company sponsors a 401(k) qualified, defined-contribution savings plan
that allows participants to contribute up to 20% of pre-tax compensation. The
Company matches 50 cents for each dollar contributed by the employee up to a
maximum Company match of 4.0%. Company contributions were $1,498, $1,443, and
$1,433, for the years 2005, 2004, and 2003, respectively.
Other Postretirement
Plan The Company provides substantially all active, permanent employees
with medical, dental, and vision benefits through a self-insured plan. Employees
retiring at or after age 58, along with their spouses and dependents, continue
participation in the plan by payment of a premium. Plan assets are invested in
mutual funds, short-term money market instruments and commercial paper. Retired
employees are also provided with a $5,000 life insurance benefit.
The Company records the costs of postretirement benefits other than pension
during the employees' years of active service. The Company has recorded a
regulatory asset in prior years for the difference between the Company-funded
amount and the net periodic benefit cost. The Company intends to file with the
Commission an Advice Letter to recover the regulatory asset in future customer
rates, as customer rates have only included the lower Company-funded amount.
The following table reconciles the funded status of the plans with the
accrued pension liability and the net postretirement benefit liability as of
December 31, 2005 and 2004:
Pension Benefits Other Benefits
--------------------- ---------------------
2005 2004 2005 2004
---- ---- ---- ----
Change in benefit obligation:
Beginning of year $ 87,616 $ 88,356 $ 30,870 $ 22,219
Service cost 4,335 4,608 1,019 1,461
Interest cost 5,511 5,613 1,088 1,560
Assumption change 11,783 (5,992) (8,364) 3,266
Benefit adjustment 4,086 -- -- --
Medicare Modernization Act -- -- -- (4,360)
Experience (gain) loss 3,426 2,938 (2,106) 8,130
Benefits paid, net of retiree premiums (13,559) (7,907) (1,030) (1,406)
-------- -------- -------- --------
End of year $103,198 $ 87,616 $ 21,477 $ 30,870
-------- -------- -------- --------
Change in plan assets:
Fair value of plan assets at beginning of year $ 75,064 $ 63,216 $ 4,543 $ 3,697
Actual return on plan assets 4,000 8,298 184 294
Employer contributions 4,720 11,457 1,356 1,958
Retiree contributions -- -- 651 649
Benefits paid (13,559) (7,907) (1,681) (2,055)
-------- -------- -------- --------
Fair value of plan assets at end of year $ 70,225 $ 75,064 $ 5,053 $ 4,543
-------- -------- -------- --------
Funded status $(32,973) $(12,552) $(16,424) $(26,327)
Unrecognized actuarial (gain) or loss 13,516 (2,783) 4,053 14,293
Unrecognized prior service cost 17,473 15,383 564 638
Unrecognized transition obligation -- -- 2,217 2,493
Unrecognized net initial asset -- -- (276) (276)
-------- -------- -------- --------
Net amount recognized $ (1,984) $ 48 $ (9,866) $ (9,179)
======== ======== ======== ========
Amounts recognized on the balance sheet consist of:
Pension Benefits Other Benefits
-------------------- ----------------------
2005 2004 2005 2004
---- ---- ---- ----
Accrued benefit costs $ (1,984) $ 48 $ (9,866) $ (9,179)
Additional minimum liability (6,921) (3,081) -- --
Intangible asset 5,719 2,380 -- --
Accumulated other comprehensive loss 1,202 701 -- --
-------- -------- -------- --------
Net amount recognized $ (1,984) $ 48 $ (9,866) $ (9,179)
======== ======== ======== ========
Notes to Consolidated Financial Statements
Below are the actuarial assumptions used in determining the benefit
obligation for the benefit plans:
Pension Benefits Other Benefits
---------------- --------------
Weighted average assumptions as of December 31: 2005 2004 2005 2004
---- ---- ---- ----
Discount rate 5.60% 6.00% 5.60% 6.00%
Long-term rate of return on plan assets 8.00% 8.00% 8.00% 8.00%
Rate of compensation increases 3.75% 3.00% -- --
The long-term rate of return assumption is the expected rate of return on a
balanced portfolio invested roughly 60% in equities and 40% in fixed income
securities. The average return for the plan for the last five and 10 years was
7% and 8.7%, respectively.
Net periodic benefit costs for the pension and other postretirement plans
for the years ending December 31, 2005, 2004, and 2003 included the following
components:
Pension Plan Other Benefits
------------------------------ -------------------------------
2005 2004 2003 2005 2004 2003
---- ---- ---- ---- ---- ----
Service cost $ 4,335 $ 4,608 $ 3,879 $ 1,019 $ 1,461 $ 1,033
Interest cost 5,511 5,613 5,374 1,088 1,560 1,224
Expected return on plan assets (5,285) (4,861) (4,757) (419) (340) (233)
Net amortization and deferral 2,191 2,014 1,861 355 894 637
------- ------- ------- ------- ------- -------
Net periodic benefit cost $ 6,752 $ 7,374 $ 6,357 $ 2,043 $ 3,575 $ 2,661
======= ======= ======= ======= ======= =======
Below are the actuarial assumptions used in determining the net periodic
benefit costs for the benefit plans:
Pension Benefits Other Benefits
---------------- --------------
Weighted average assumptions as of December 31: 2005 2004 2005 2004
---- ---- ---- ----
Discount rate 6.00% 6.00% 6.00% 6.00%
Long-term rate of return on plan assets 8.00% 8.00% 8.00% 8.00%
Rate of compensation increases 3.00% 3.00% -- --
Postretirement benefit expense recorded in 2005, 2004, and 2003, was
$1,572, $1,420, and $1,160, respectively. The remaining net periodic benefit
cost as of December 31, 2005, of $9,791 is expected to be recovered through
future customer rates and is recorded as a regulatory asset. The Company intends
to make annual contributions to the plan up to the amount deductible for tax
purposes.
For 2005 measurement purposes, the Company assumed an 8.5% annual rate of
increase in the per capita cost of covered benefits, with the rate decreasing 1%
per year for the next four years to a long-term annual rate of 4.5% per year
after four years. The health care cost trend rate assumption has a significant
effect on the amounts reported. A one-percentage point change in assumed health
care cost trends is estimated to have the following effect:
1-percentage 1-percentage
Point Increase Point Decrease
-------------- --------------
Effect on total service and interest costs $ 422 $ (331)
Effect on accumulated postretirement benefit obligation $ 3,693 $ (2,949)
Note 13. Stock-Based Compensation Plans
The Company has two stockholder-approved stock-based compensation plans.
Under the Long-Term Incentive Plan that allowed granting of non-qualified stock
options, some of which are currently outstanding, there will be no future grants
made. Options were granted under the Long-Term Incentive Plan at an exercise
price that was not less than the per share common stock market price on the date
of grant. At December 31, 2005, 86,500 options were exercisable at a weighted
average price of $24.93. The options vest at a 25% rate on their anniversary
date over their first four years and are exercisable over a 10-year period. No
options were granted in 2005, 2004, or 2003.
The following table summarizes the activity of the Long-Term Incentive
Plan:
Weighted Weighted Weighted
Average Average Average
Exercise Remaining Options Fair
Shares Price Contractual Life Exercisable Value
------ ----- ---------------- ----------- -----
Outstanding at December 31, 2002 154,500 24.77 8.2 36,750 --
Cancelled (5,250) 24.78 -- -- --
------- ----- ----- ------ -----
Outstanding at December 31, 2003 149,250 24.77 7.2 74,625 --
Exercised (25,500) 23.67 -- -- --
Cancelled (2,250) 25.41 -- -- --
------- ----- ----- ------ -----
Outstanding at December 31, 2004 121,500 24.99 6.3 85,500 --
Exercised` (22,750) 25.15 -- -- --
Cancelled (750) 25.15 -- -- --
------- ----- ----- ------ -----
Outstanding at December 31, 2005 98,000 24.95 5.4 86,500 --
======= ===== ===== ====== =====
In 2005, the Long-Term Incentive Plan was replaced by a
stockholder-approved Equity Incentive Plan, which allows granting of incentive
and non-qualified stock options, stock appreciation rights, restricted stock
awards, and other stock awards. Under the Equity Incentive Plan, a total of
1,000,000 common shares have been authorized for future grants. As of December
31, 2005, there were no grants under the Plan. The Company will be reporting
compensation expense related to any grants under this plan in accordance with
SFAS No. 123 (revised 2004), as discussed in Note 2.
Note 14. Fair Value of Financial Instruments
For those financial instruments for which it is practicable to estimate a
fair value, the following methods and assumptions were used. For cash
equivalents, accounts receivables, and accounts payables, the carrying amount
approximates the fair value because of the short-term maturity of the
instruments. The fair value of the Company's long-term debt is estimated at $289
million and $301 million as of December 31, 2005, and 2004, respectively, using
a discounted cash flow analysis, based on the current rates available to the
Company for debt of similar maturities. The book value of the long-term debt is
$274 million and $276 million as of December 31, 2005 and 2004, respectively.
The fair value of Advances for Construction contracts is estimated at $57
million as of December 31, 2005 and $51 million as of December 31, 2004, based
on data provided by brokers who purchase and sell these contracts.
Notes to Consolidated Financial Statements
Note 15. Commitments and Contingencies
Commitments
The Company leases office facilities and two water systems from cities, and
has long-term commitments to purchase water from water wholesalers. The
commitments are noted in the table below.
Office Leases System Leases Water Contracts
------------- ------------- ---------------
2006 $ 662 $ 961 $ 12,731
2007 486 961 12,731
2008 358 961 13,940
2009 184 961 13,940
2010 125 961 13,940
Thereafter 65 6,427 335,842
The Company leases office facilities in many of its operating districts.
The total paid and charged to operations for such leases was $682 in 2005, $632
in 2004, and $577 in 2003.
The Company leases the City of Hawthorne water system, which in addition to
the upfront lease payment, includes an annual payment. The 15-year lease expires
in 2011. The annual payments in 2005, 2004, and 2003 were $116, $116, and $111,
respectively. In July 2003, the Company negotiated a 15-year lease of the City
of Commerce water system. At this time, the lease has not been formally executed
by the parties. The lease includes an annual lease payment of $845 per year plus
a cost-savings sharing arrangement.
The Company has a long-term contract with Santa Clara Water District that
requires the Company to purchase minimum annual water quantities. Purchases are
priced at the District's then-current wholesale water rate. The Company operates
to purchase sufficient water to equal or exceed the minimum quantities under the
contract. The total paid under the contract was $4,763 in 2005, $4,610 in 2004,
and $4,452 in 2003.
The Company also has a water supply contract with Stockton East Water
District (SEWD) that requires a fixed, annual payment and does not vary during
the year with the quantity of water delivered by the district. Because of the
fixed price arrangement, the Company operates to receive as much water as
possible from SEWD in order to minimize the cost of operating Company-owned
wells used to supplement SEWD deliveries. The total paid under the contract was
$4,300 in 2005, $4,392 in 2004, and $3,779 in 2003. Pricing under the contract
varies annually. Estimated annual contractual obligations in the table above are
based on the same payment levels as 2005. Future increased costs by SEWD are
expected to be offset by a decline in the allocation of costs to the Company, as
other customers of SEWD are expected to receive a larger allocation based upon
growth of their service areas.
On September 21, 2005, the Company entered into an agreement with Kern
County Water Agency (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 hereafter) occurs. Under the terms of
the agreement, the Company is obligated to purchase 20,500 acre-feet of treated
water per year. 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. (This agreement
supersedes a prior agreement with Kern County Water Agency for the supply of
11,500 acre-feet of water per year. The total paid under the prior agreement was
$3,288 in 2005, $3,308 in 2004, and $2,691 in 2003.)
Three other parties, including the City of Bakersfield, are also obligated
to purchase a total of 32,500 acre-feet per year under separate agreements with
the Agency. Furthermore, 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.
The Agency is planning to issue bonds to fund the project and will use the
payments of the Capital Facilities Charges by the 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 are
also 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 parties, excluding the Company, is
approximately $108 million to the Agency. Based on the creditworthiness of the
other participants, which are government entities, it is believed to be highly
unlikely that the Company would be required to assume any other parties'
obligations under the contract due to their default. In the event of default by
a party, the Company would receive entitlement to the additional water for
assuming any obligation.
Once the project is complete, the Company is obligated to pay a Capital
Facilities Charge and a Treated Water Charge that together total $4.7 million
annually, which equates to $231 per acre-foot. Annual payments of $2.0 million
for the Capital Facilities Charge will begin when the Agency issues bonds to
fund the project. Some of the Treated Water Charge of $2.8 million 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 reimbursable operating cost
estimates, 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.
Contingencies
In 1995, the State of California's Department of Toxic Substances Control
(DTSC) named Cal Water as a potential responsible party for cleanup of a toxic
contamination plume in the Chico groundwater. The toxic spill occurred when
cleaning solvents, which were discharged into the city's sewer system by local
dry cleaners, leaked into the underground water supply. The DTSC contends that
Cal Water's responsibility stems from its operation of wells in the surrounding
vicinity that caused the contamination plume to spread. While Cal Water is
cooperating with the cleanup effort, Cal Water denies any responsibility for the
contamination or the resulting cleanup and intends to vigorously resist any
action that may be brought against Cal Water. In December 2002, Cal Water was
named along with other defendants in two lawsuits filed by DTSC for the cleanup
of the plume. The suits assert that the defendants are jointly and severally
liable for the estimated cleanup of $8.7 million. The parties have undertaken
settlement negotiations. In response to Cal Water's request for its insurance
carrier to participate in settlement negotiations, the insurance carrier
threatened to exercise its reservation of rights letter to seek reimbursement of
past defense costs. Past defense costs approximate $0.6 million. Cal Water
believes that the carrier clearly has a duty to defend and is not entitled to
any defense cost reimbursement. Furthermore, Cal Water believes that insurance
coverage exists for this claim. If Cal Water's claim is ultimately found to be
excludable under its policies, Cal Water believes any damages will be covered by
the ratepayer as pump-and-treat is the most economical approach to the cleanup
effort. Cal Water believes that there will not be a material adverse effect to
its financial position or results of operations.
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 General Rate Case 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. Additionally, the decision 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 used and useful. ORA recommended that
Cal Water be fined $160,000 and that gains from property sales be used to
benefit ratepayers.
Notes to Consolidated Financial Statements
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 Utility Services and a like-kind exchange with a third
party.
On December 1, 2005, the CPUC issued its decision D.05-12-002 (Decision).
The Decision found that Cal Water appropriately reclassified all properties as
non-utility property prior to being sold. The criteria Cal Water followed to
reclassify its properties was 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
Decision found that Cal Water should be allowed to include in rate base the
remaining $1,182,462 of the Chico customer center costs not yet in rate base and
to earn a return on the additional rate base, an increased revenue requirement
of approximately $171,000.
However, the Decision did not approve the amount of sale proceeds (or
gains) that qualify for reinvestment under the Infrastructure Act, although it
concluded that all property sales should qualify and should be accounted for in
accordance with the Act. The Decision defers the issues regarding treatment of
sale proceeds and allocation of gains on sale to its R.04-09-003 proceeding,
where the CPUC intends to set guidelines and a specific rule on allocation of
the gain on utility asset sales between shareholders and ratepayers. On November
5, 2005, the Commission mailed its proposed decision (Proposed Decision)
regarding the allocation of proceeds from the sale of utility assets. The
Proposed Decision states that the Commission has limited discretion in how it
allocates gains on sale of real property, provided that water companies reinvest
the proceeds in new water infrastructure. As such, the Company is entitled to
earn a full authorized return on the proceeds reinvested in utility plant.
Based on the Decision and the Proposed Decision, Cal Water has not accrued
a liability in its financial statements. Cal Water has no knowledge when the
CPUC will issue its decision in the matter of R.04-09-003. If the CPUC finds any
portion of the property sales should be allocated to the ratepayers, Cal Water's
rate base could be reduced, which would lower future revenues, net income, and
cash flows.
The Company is involved in other proceedings or litigation arising in the
ordinary course of operations. The Company believes the ultimate resolution of
such matters will not materially affect its financial position, results of
operations, or cash flows.
Note 16. Quarterly Financial Data (unaudited)
The Company's common stock is traded on the New York Stock Exchange under
the symbol "CWT."
2005 (in thousands, except per share amounts First Second Third Fourth
----- ------ ----- ------
Operating revenue $ 60,303 $ 81,457 $101,128 $ 77,840
Net operating income 4,465 11,253 16,103 7,989
Net income 680 7,591 13,115 5,837
Diluted earnings per share 0.03 0.41 0.71 0.32
Common stock market price range:
High 36.76 38.12 41.90 41.09
Low 32.12 32.85 37.53 32.64
Dividends paid .2850 .2850 .2850 .2850
2004 (in thousands, except per share amounts) First Second Third Fourth
----- ------ ----- ------
Operating revenue $ 60,240 $ 88,845 $ 97,104 $ 69,378
Net operating income 5,391 14,083 14,498 7,511
Net income 1,446 10,054 10,789 3,737
Diluted earnings per share 0.08 0.59 0.59 0.20
Common stock market price range:
High 29.99 29.75 29.42 37.70
Low 27.25 26.60 26.19 28.20
Dividends paid .2825 .2825 .2825 .2825
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
California Water Service Group:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that
California Water Service Group and subsidiaries maintained effective internal
control over financial reporting as of December 31, 2005, based on the criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Management of
California Water Service Group is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
internal control over financial reporting of California Water Service Group and
subsidiaries based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that California Water Service Group
and subsidiaries maintained effective internal control over financial reporting
as of December 31, 2005, is fairly stated, in all material respects, based on
criteria established in Internal Control - Integrated Framework issued by the
COSO. Also, in our opinion, California Water Service Group and subsidiaries
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2005, based on the criteria established in Internal
Control - Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets of California Water Service Group and subsidiaries as of December 31,
2005 and 2004, and the related consolidated statements of income, common
stockholders' equity and comprehensive income, and cash flows for each of the
years in the three-year period ended December 31, 2005, and our report dated
March 9, 2006, expressed an unqualified opinion on those consolidated financial
statements.
/s/ KPMG LLP
Mountain View, California
March 9, 2006
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
California Water Service Group:
We have audited the accompanying consolidated balance sheets of California
Water Service Group and subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of income, common stockholders' equity and
comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 2005. These consolidated financial statements are the
responsibility of the management of California Water Service Group. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of California
Water Service Group and subsidiaries as of December 31, 2005 and 2004, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2005, in conformity with U.S. generally
accepted accounting principles.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of the
internal control over financial reporting of California Water Service Group and
subsidiaries as of December 31, 2005, based on the criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report dated March 9,
2006, expressed an unqualified opinion on management's assessment of, and the
effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Mountain View, California
March 9, 2006
Controls and Procedures
Management's Evaluation of Disclosure Controls and Procedures
The Company carried out an evaluation, under the supervision of and with
the participation of management, including the principal executive officer and
principal financial officer, of the effectiveness of the design and operation of
the Company's disclosure controls and procedures as of December 31, 2005,
pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934. Based on
their review of the disclosure controls and procedures, the Chief Executive
Officer and Acting Chief Financial Officer have concluded that the Company's
disclosure controls and procedures are effective in timely alerting management
to material information that is required to be included in periodic SEC filings.
Management, including the Chief Executive Officer and Acting Chief
Financial Officer, does not expect that the Company's disclosure controls and
procedures or its internal control over financial reporting will prevent or
detect all errors and all fraud. A control system, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of each control must be considered relative to its costs. Because of
the inherent limitations in all control systems, no evaluation of a control
system can provide absolute assurance that all control issues and instances of
fraud, if any, within the Company have been prevented or detected.
There was no change in the Company's internal control over financial
reporting during the quarter ended December 31, 2005, that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
Management's Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate
internal control over financial reporting (as defined in Rule 13a-15(f) and
15d-15(f) under the Securities Exchange Act of 1934, as amended). Management
assessed the effectiveness of the Company's internal control over financial
reporting as of December 31, 2005. In making this assessment, management used
the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in Internal Control-Integrated Framework. Management
has concluded that, as of December 31, 2005, the Company's internal control over
financial reporting is effective based on these criteria. The Company's
independent registered public accounting firm, KPMG LLP, which has audited the
financial statements included in this Annual Report, has issued an audit report
on management's assessment of the Company's internal control over financial
reporting, which is included herein.
Certification
As provided in the rules of the New York Stock Exchange, the Company's Chief
Executive Officer has certified to the Exchange in writing that, as of February
22, 2006, he was not aware of any violation by the Company of the NYSE's
Corporate Governance listing standards. The Company has included as Exhibits
31.1 and 31.2 to its Annual Report on Form 10-K for the year ended December 31,
2005, certifications from its Chief Executive Officer and Acting Chief Financial
Officer regarding the quality of the Company's public disclosure.