California Water Service Group
Annual Report 2000

Plain-text annual report

California Water Service Group 2000 Annual Report SEVENTY- FIVE YEARS OF SERVICE California Water Service Group 2000 Annual Report California Water Service Group 3 2 Letter to Stockholders 5 About the Company 18 Ten-Year Financial Review 20 Management’s Discussion and Analysis of Results of Operations and Financial Condition 28 Consolidated Balance Sheet 30 Consolidated Statement of Income 31 Consolidated Statement of Common Stockholders’ Equity and Comprehensive Income 32 Consolidated Statement of Cash Flows 33 Notes to Consolidated Financial Statements 43 Independent Auditors’ Report 44 Corporate Information and Officers Inside Back Cover Board of Directors California Water Service Group provides high-quality water utility services to 2 million people through four subsidiaries: California Water Service Company, Washington Water Service Company, New Mexico Water Service Company, and CWS Utility Services. The three water service companies are regulated by state public utilities commissions; CWS Utility Services provides non-regulated contract services, including meter reading, billing, and full-system operations. Financial Highlights In thousands, except per share amounts Year ended December 31 2000 1999 1998 1997 1996 Book value* Market price at year-end Earnings per share* Dividends Revenue* Net income* $ 13.13 $ 12.89 $ 12.49 $ 12.15 $ 11.47 27.00 1.31 1.10 30.31 1.44 1.085 31.31 1.31 1.07 29.53 1.71 1.055 21.00 1.42 1.04 244,806 234,937 214,926 225,165 210,258 19,963 21,971 19,860 25,757 21,400 * Restated to reflect Dominguez and Washington acquisitions, which were accounted for as poolings of interest. To Our Stockholders In 2001, California Water Service earnings were $1.31 per share, compared Company, our largest subsidiary, cele- to $1.44 per share in 1999. The decline brates its 75th year. That means we were in net income and earnings was due pri- in business a year before Charles marily to one-time costs associated with Lindbergh’s historic flight across the the completion of the Dominguez Services Atlantic Ocean! As those who have cele- Corporation merger, and to higher costs of brated milestone birthdays know, such an purchased water, purchased power, and occasion causes one to reflect on accom- labor. Revenues were positively impacted plishments and to evaluate plans for meet- by a 3 percent increase in water sales, the ing ambitious new goals. Our introspection addition of 5,200 regulated customers, has brought to light some amazing facts, and rate increases in California. The dif- which we share with you throughout this ference between 1999 and 2000 results report. The bottom line is that working is attributable in part to the one-time together, we have built a Company that is merger costs recorded in 2000 and $1.3 known for its financial stability, customer million in pre-tax real estate sales in 1999. focus, dedicated employees, and commit- Annual dividends increased to $1.10 in ment to quality. And we keep on building, 2000, and were paid for the 56th consec- having grown our customer base by 16 utive year. percent in the last two years alone. What our financial results do not yet Our financial results for 2000 reflect reflect is the great progress we made in this growth. Operating revenues rose to 2000 toward growing the Company. In $244.8 million, compared to $234.9 mil- May, we received long-awaited approval lion in 1999. from the California Public Utilities Net income dipped to $19.9 million, Commission on our merger with compared to $21.9 million last year, and Dominguez and set about integrating 40,000 new service connections into our Robischon Engineers, Inc., gives us a operations. As anticipated, we already are Washington-based, in-house engineering capturing synergies by combining opera- capability that lowers costs and positions tions and expect the transaction to be us better to capitalize on the state’s Dominguez systems. We continued to integrate our new accretive to our stockholders during 2001. expertise of 75 new employees and evalu- The intangible benefits of the merger have ate growth opportunities surrounding also become evident, as we enjoy the OUR DIVIDEND HAS INCREASED EVERY YEAR SINCE THE BEATLES’ HIT “HEY JUDE” TOPPED THE CHARTS. due in part to our new service contract 2000, and watched that subsidiary grow business in Washington also prospered, metered connections through our acquisi- County and Lacamas Farmsteads Water Company in Pierce County. Non-regulated companies in the state of Washington in by 5 percent with the addition of 800 tion of Mirrormount Water Services in King with the Miller Brewery in Tumwater. growth opportunities. The year 2000 also saw us establish a foothold for regulated operations in another western state, as we signed an agreement to acquire the water and waste- water assets of the Rio Grande Utility Corporation, which serves 2,300 water and 1,600 wastewater customers in unin- corporated areas of Valencia County, New Mexico, 30 miles south of Albuquerque. The Rio Grande transaction is contingent upon approval of the New Mexico Public Regulation Commission, expected in the third quarter of 2001. Prior to securing this agreement, we expanded our existing non-regulated New Mexico business by entering into a five-year meter-reading Opportunities abound in the Evergreen contract with Los Alamos County. State, which has a favorable regulatory cli- Throughout the Company, we have mate and many small water systems. Our continued to implement customer-driven second-quarter purchase of the assets of initiatives developed by our employees 2 California Water Service Group California Water Service Group 3 To Our Stockholders In 2001, California Water Service earnings were $1.31 per share, compared Company, our largest subsidiary, cele- to $1.44 per share in 1999. The decline brates its 75th year. That means we were in net income and earnings was due pri- in business a year before Charles marily to one-time costs associated with Lindbergh’s historic flight across the the completion of the Dominguez Services Atlantic Ocean! As those who have cele- Corporation merger, and to higher costs of brated milestone birthdays know, such an purchased water, purchased power, and occasion causes one to reflect on accom- labor. Revenues were positively impacted plishments and to evaluate plans for meet- by a 3 percent increase in water sales, the ing ambitious new goals. Our introspection addition of 5,200 regulated customers, has brought to light some amazing facts, and rate increases in California. The dif- which we share with you throughout this ference between 1999 and 2000 results report. The bottom line is that working is attributable in part to the one-time together, we have built a Company that is merger costs recorded in 2000 and $1.3 known for its financial stability, customer million in pre-tax real estate sales in 1999. focus, dedicated employees, and commit- Annual dividends increased to $1.10 in ment to quality. And we keep on building, 2000, and were paid for the 56th consec- having grown our customer base by 16 utive year. percent in the last two years alone. What our financial results do not yet Our financial results for 2000 reflect reflect is the great progress we made in this growth. Operating revenues rose to 2000 toward growing the Company. In $244.8 million, compared to $234.9 mil- May, we received long-awaited approval lion in 1999. from the California Public Utilities Net income dipped to $19.9 million, compared to $21.9 million last year, and Commission on Peter C. Nelson President and CEO Dominguez and set about integrating our merger with Robert W. Foy Chairman 40,000 new service connections into our Robischon Engineers, Inc., gives us a operations. As anticipated, we already are Washington-based, in-house engineering capturing synergies by combining opera- capability that lowers costs and positions tions and expect the transaction to be us better to capitalize on the state’s accretive to our stockholders during 2001. growth opportunities. The intangible benefits of the merger have The year 2000 also saw us establish a also become evident, as we enjoy the foothold for regulated operations in expertise of 75 new employees and evalu- another western state, as we signed an ate growth opportunities surrounding agreement to acquire the water and waste- Dominguez systems. water assets of the Rio Grande Utility We continued to integrate our new Corporation, which serves 2,300 water companies in the state of Washington in and 1,600 wastewater customers in unin- 2000, and watched that subsidiary grow corporated areas of Valencia County, New by 5 percent with the addition of 800 Mexico, 30 miles south of Albuquerque. metered connections through our acquisi- The Rio Grande transaction is contingent tion of Mirrormount Water Services in King upon approval of the New Mexico Public County and Lacamas Farmsteads Water Regulation Commission, expected in the Company in Pierce County. Non-regulated third quarter of 2001. Prior to securing business in Washington also prospered, this agreement, we expanded our existing due in part to our new service contract non-regulated New Mexico business by with the Miller Brewery in Tumwater. entering into a five-year meter-reading Opportunities abound in the Evergreen contract with Los Alamos County. State, which has a favorable regulatory cli- Throughout the Company, we have mate and many small water systems. Our continued to implement customer-driven second-quarter purchase of the assets of initiatives developed by our employees 2 California Water Service Group California Water Service Group 3 through our Continuous Improvement have on our business, and we are. From a Process (CIP). Every one of our employees financial standpoint, we track higher elec- in our 25 districts, working in teams, con- tric and gas prices through regulatory bal- tributes to improving the business ancing accounts for recovery in future processes that we use to serve customers. rates. From an operational standpoint, we Providing excellent customer service are equipped with strategically-located remains our top priority. This principle backup power generators to allow contin- drives everything we do, from improving ued water production during interruptions our water system infrastructure to upgrad- in our power supply. ing our computer software. As we move forward, we will continue Our capital investment in 2000 to pursue growth opportunities in the totaled $37 million, a number we expect western United States while we work to to increase to $54 million in 2001—our enhance existing operations by improving largest capital expenditure budget ever. customer service and increasing our effi- The increase is largely attributable to the ciency. As the water industry experiences surface water treatment plant that we plan continued consolidation and change, we to construct in Bakersfield, California believe we have what it takes to be the beginning in 2001. The plant will enable leader in providing our communities and our Bakersfield District to serve a rapidly customers with traditional and innovative growing population and meet anticipated utility services. This optimism is cause for new Environmental Protection Agency celebration as we commemorate 75 years water quality standards. Additionally, we of outstanding water service with a look at are building operations centers in our some amazing facts about California Water Chico and Stockton districts that will Service Group. replace inadequate existing facilities and one in our Rancho Dominguez district Sincerely, that will house our newly combined South Bay operations. Because our return is based upon invested equity capital, we view this upward trend as a positive one for our stockholders. ROBERT W. FOY As the last regulated utility, the water CHAIRMAN OF THE BOARD industry has not faced the deregulation challenges confronting electric and natu- ral gas utilities. However, we do need to be prepared for the impacts that power PETER C. NELSON supply shortages and higher costs could PRESIDENT AND CHIEF EXECUTIVE OFFICER 4 California Water Service Group IN 75 YEARS, WE HAVE BUILT A COMPANY THAT IS KNOWN FOR ITS FINANCIAL STABILITY, CUSTOMER FOCUS, DEDICATED EMPLOYEES, AND COMMITMENT TO QUALITY. OUR CUSTOMER SATISFACTION RATING IS HIGHER THAN MICHAEL JORDAN’S 84% CAREER FREE THROW PERCENTAGE. (Left) Desalination Plant - Torrance, CA There is a reason we have “service” in our name —it is because we are committed to providing excellent cus- tomer service. Our efforts to improve service are guided by the “Voice of the Customer,” a tool that lets our employees know what customers want and need in the customers’ own words. This information determines the types of projects we undertake in our Continuous Improvement Process. Our approach to the business, inspired by those of industrial giants Hewlett-Packard and General Electric, enables every employee in the Company to play an integral role in enhancing customer service and improving operating efficiency. Does it work? Yes. At last count, 89 percent of our customers ranked our service as “very good” or “excellent.” WE CONDUCT MORE WATER QUALITY TESTS IN A DAY THAN THERE ARE DAYS IN THE YEAR. (Left) Water Quality Lab - San Jose, CA Our customers rely on us to provide high-quality water, and we take that responsibility very seriously. Working in our certified, state-of-the-art laboratory under the direction of the American Water Works Association 2000 George Warren Fuller Award winner, Chet Auckly, our chemists and technicians work tirelessly to ensure that the water we provide meets or surpasses state and federal water quality standards. As technology advances, enabling us to detect progressively more minute quantities of constituents in the water, we expect water quality standards to become increasingly stringent. As they do, we stand ready to invest the time and resources necessary to meet them. Our team of 11 experts, who have completed a combined total of 66 years of advanced water quality education, will do what it takes to keep us on the leading edge of a field that presents new challenges every year. LAID END TO END, OUR PIPELINES WOULD REACH FROM CALIFORNIA TO NEW YORK AND BACK AGAIN. (Left) Water Main Repair - Gig Harbor, WA Providing water utility services to 2 million people in 96 communities in California, Washington, and New Mexico, we supply enough water every day to fill a glass of water for every person in the world. Serving a range of communities—from large to small, urban to rural, wet to dry—has given us an invaluable breadth of oper- ational experience. When we face a challenge in one district, chances are that we have overcome similar challenges in another. And having proven experience in operating a variety of systems and treatment facilities makes us an attractive business partner to neighboring water providers who need assistance meeting the needs of their customers. To ensure that our extensive network of water systems is well maintained, our San Jose- based engineering team plans and oversees capital projects throughout the Company. A FAMILY WHO SWITCHES FROM BOTTLED WATER TO OUR WATER COULD SAVE ENOUGH MONEY IN ONE YEAR TO BUY 800 LOAVES OF BREAD AND 615 GALLONS OF MILK. (Left) Water Tower - Chico, CA As an investor-owned water utility, we must balance our customers’ need for reasonable water rates with our stockholders’ desire to earn a fair rate of return on their investment. One way we do that is by operating effi- ciently and holding down expenses, responsibility for which is borne by every employee in our Company. Another way we do it is by growing our Company prof- itably to achieve economies of scale and spread fixed costs over a larger number of customers. Considering the range of services we provide for just a fraction of a penny per gallon—from maintaining and upgrading water system infrastructure to testing and treating water supplies—our life-sustaining, irreplaceable product just might be the bargain of the century. THE NUMBER OF NEW PEOPLE THAT WE’VE BEGUN TO SERVE IN THE PAST 2 YEARS COULD FILL THE ROSE BOWL TWICE. (Left) Engineering Department - Olympia, WA Consolidation continues in the water industry, as smaller providers opt out of a business that is becom- ing more complex and capital intensive every year. Our Company has taken its place as a leading consolidator in the western United States, having completed the largest merger in California’s history and established a presence in two new states. We also have grown our non-regulated business by entering into a number of innovative partnerships that provide utility services to neighboring cities and agencies. Having districts strate- gically located in California, Washington, and New Mexico positions us well for future growth, as we con- tinue to execute our strategy of pursuing opportunities that add to stockholder value and enhance service to the customer. Harbor South Sound Washington California Chico Willows Oroville Marysville Redwood Valley Dixon Stockton Salinas King City Selma Visalia Westlake Hermosa-Redondo Palos Verdes Dominguez South San Francisco Mid-Peninsula Bear Gulch Los Altos Livermore Headquarters (General Office) Kern River Valley Bakersfield Antelope Valley Hawthorne East Los Angeles Customers District Name California Antelope Valley Bakersfield Bear Gulch Chico † Dixon Dominguez King City † Livermore Los Altos Marysville † Including Regulated Non-regulated Fremont Valley, Lake Hughes, Lancaster and Leona Valley; numerous operating agreements O&M contracts for the City of Bakersfield and Spicer City Atherton, Woodside, Portola Valley, portions of Menlo Park and City of Menlo Park service contract Hamilton City Carson and portions of Compton, Harbor City, Long Beach, Los Angeles and Torrance East Los Angeles O&M contracts for cities of Commerce and Montebello Hawthorne 15-year lease — full-service water operations Hermosa-Redondo † A portion of Torrance; meter reading for Manhattan Beach Kern River Valley Bodfish, Kernville, Lakeland, Mountain Shadows, Onyx, Squirrel Valley, South Lake and Wofford Heights; numerous operating contracts O&M contracts for Castlewood Country Club and Crane Ridge MWC 16,800 400 Portions of Cupertino, Los Altos Hills, Mountain View and Sunnyvale 18,300 Subtotal 425,800 55,000 Stockton Visalia † Westlake Willows † New Mexico Los Alamos Santa Fe Washington Harbor Four O&M contracts A portion of Thousand Oaks Meter-reading contract Meter-reading contract Subtotal Numerous O&M contracts South Sound Numerous O&M contracts Subtotal Total 1,300 400 57,500 17,500 23,300 2,800 32,800 26,400 25,800 4,000 2,700 6,100 25,600 13,400 4,100 500 2,200 3,800 35,800 3,500 23,800 1,900 26,700 5,200 16,300 41,700 29,300 6,900 2,300 300 300 1,100 22,200 26,300 48,500 1,400 1,000 2,400 9,700 2,800 12,500 438,300 105,900 New Mexico Los Alamos Sante Fe Mid-Peninsula San Mateo and San Carlos Oroville Palos Verdes Redwood Valley Salinas Selma Palos Verdes Estates, Rancho Palos Verdes, Rolling Hills Estates and Rolling Hills Lucerne, Duncans Mills, Guerneville, Dillion Beach and a portion of Santa Rosa O&M contracts for Foothill Estates and Spreckels Water Co. South San Francisco Colma and Broadmoor California Water Service Company Washington Water Service Company New Mexico Water Service Company MWC = Mutual Water Company | O&M = Operations and Maintenance | † = Indicates Billing Contract California Water Service Group 17 Ten-Year Financial Review Dollars in thousands, except common share data 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 Summary of Operations Operating revenue Residential Business Industrial Public authorities Other Total operating revenue Operating expenses Interest expense, other income and expenses, net $171,234 44,211 11,014 11,609 6,738 244,806 211,610 13,233 $163,681 41,246 12,695 10,898 6,417 234,937 201,890 11,076 $150,491 38,854 10,150 9,654 5,777 214,926 183,245 11,821 $158,210 40,520 10,376 11,173 4,886 225,165 188,020 11,388 $148,313 37,605 9,748 10,509 4,083 210,258 177,356 11,502 $132,859 35,873 9,952 9,585 4,833 193,102 164,958 11,176 $127,228 33,712 9,080 9,397 3,767 183,184 155,012 11,537 $122,585 31,360 8,415 8,535 4,985 175,880 145,517 12,785 $111,353 29,208 7,905 7,899 7,104 163,469 137,401 11,794 $ 95,393 25,490 7,037 6,754 12,799 147,473 121,179 10,769 Net income $ 19,963 $ 21,971 $ 19,860 $ 25,757 $ 21,400 $ 16,968 $ 16,635 $ 17,578 $ 14,274 $ 15,525 Common Share Data Earnings per share — diluted Dividend declared Dividend payout ratio Book value Market price at year-end Common shares outstanding at year-end (in thousands) Return on average common stockholders’ equity Long-term debt interest coverage Balance Sheet Data Net utility plant Utility plant expenditures Total assets Long-term debt including current portion Capitalization ratios: Common stockholders’ equity Preferred stock Long-term debt Other Data Water production (million gallons) Wells Purchased Total water production Metered customers Flat-rate customers Customers at year-end, including Hawthorne New customers added Revenue per customer Utility plant per customer Employees at year-end $ 1.31 1.100 84% $ 13.13 27.00 15,146 10.1% 3.58 $ $ 1.44 1.085 75% 12.89 30.31 15,094 11.5% 3.73 $ $ 1.31 1.070 82% 12.49 31.31 15,015 10.8% 3.64 $582,008 37,161 666,605 189,979 $564,390 48,599 645,507 171,613 $538,741 41,061 613,143 152,674 51.1% 0.9% 48.0% 53.0% 0.9% 46.1% 54.6% 1.0% 44.4% 65,408 62,237 127,645 366,242 78,104 $ 444,346 5,219 551 1,916 797 65,144 58,618 123,762 361,235 77,892 $ 439,127 6,727 535 1,851 790 57,482 54,661 112,143 354,832 77,568 $ 432,400 4,383 497 1,768 759 $ $ 1.71 1.055 62% 12.15 29.53 15,015 14.5% 4.37 $ 1.42 1.040 73% $ 11.47 21.00 15,015 12.8% 3.81 $ $ 1.13 1.020 90% 10.97 16.38 14,934 10.6% 3.41 $ 1.17 0.990 $ 1.26 0.960 $ 1.02 0.930 $ 1.12 0.900 85% 76% 91% 80% $ 10.72 16.00 14,890 11.1% 3.49 $ 10.03 20.00 13,773 12.6% 3.34 $ 9.65 16.50 13,773 10.7% 3.21 $ 9.48 14.00 13,773 11.8% 3.33 $515,917 37,511 594,444 153,271 $495,985 40,310 569,745 151,725 $471,994 31,031 553,027 154,416 $455,769 32,435 516,507 138,628 $437,065 31,097 497,717 138,863 $419,194 37,698 451,754 130,971 $389,965 37,935 440,294 108,572 53.8% 1.0% 45.2% 52.7% 1.1% 46.2% 50.9% 1.1% 48.0% 52.9% 1.2% 45.9% 49.3% 1.2% 49.5% 49.7% 1.3% 49.0% 53.9% 1.4% 44.7% 63,736 59,646 123,382 350,139 77,878 $ 428,017 4,719 526 1,694 752 60,964 56,769 117,733 345,307 77,991 $ 423,298 9,730 497 1,632 740 54,818 57,560 112,378 335,238 78,330 $ 413,568 2,263 467 1,580 738 53,274 59,850 113,124 332,146 79,159 $ 411,305 3,325 445 1,520 729 48,598 59,103 107,701 326,564 81,416 $ 407,980 2,906 431 1,459 717 55,641 49,303 104,944 322,457 82,617 $ 405,074 3,769 404 1,400 706 52,944 44,457 97,401 318,275 83,030 401,305 6,301 367 1,327 689 $ 18 California Water Service Group California Water Service Group 19 Management’s Discussion and Analysis of Results of Operations and Financial Condition California Water Service Group (Company) is a holding company with four operating subsidiaries: California Water Service Company (Cal Water), CWS Utility Services (Utility Services), New Mexico Water Service Company (New Mexico Water) and Washington Water Service Company (Washington Water). Cal Water and Washington Water are regulated public utilities. Their assets and operating revenues currently comprise the majority of the Company’s assets and revenues. New Mexico Water is a new subsidiary formed in 2000 to provide regulated water services. Utility Services pro- vides non-regulated water operations and related services to other private companies and munic- ipalities. The following discussion and analysis provides information regarding the Company, its assets, operations and financial condition. Forward-Looking Statements This annual report, including the Letter to Stockholders and Management’s Discussion and Analysis, contains for- ward-looking statements within the meaning of the federal securities laws. Such statements are based on cur- rently available information, expectations, estimates, assumptions and projections, and management’s judgment about the Company, the water utility industry and general economic conditions. Such words as expects, intends, plans, believes, estimates, anticipates 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. Actual results may vary materially from what is contained in a forward-looking statement. Factors which may cause a result different than expected or anticipated include governmental and regulatory commissions’ decisions, new legislation, increases in suppliers’ prices and the availability of supplies, changes in environmental compliance requirements, acquisitions, the ability to successfully implement business plans, changes in customer water use patterns and the impact of weather on operating results. The Company assumes no obligation to provide public updates of forward-looking statements. Business Cal Water is a public utility supplying water service to 431,900 customers in 75 California communities through 25 separate water systems or districts. Cal Water’s 24 regulated systems, which are subject to regu- lation by the California Public Utilities Commission (CPUC) serve 425,800 customers. An additional 6,100 customers receive service through a long-term lease of the City of Hawthorne’s water system, which is not sub- ject to CPUC regulation. Washington Water’s utility operations are regulated by the Washington Utilities and Transportation Commission (WUTC). Washington Water provides domestic water service to 12,500 customers in the Tacoma and Olympia areas. An additional 2,400 customers are served under operating agreements with private owners. New Mexico Water was organized in 2000. It currently provides meter reading services for 48,500 accounts in Santa Fe and Los Alamos. In November, the Company entered an agreement to acquire the water and waste- water assets of Rio Grande Utility Corporation. Rio Grande has annual revenue of $1.2 million and serves 2,300 water and 1,600 wastewater customers south of Albuquerque. The acquisition is contingent on approval of the state’s Public Regulation Commission, which is expected in the third quarter of 2001. Utility Services derives non-regulated income from contracts with other private companies and municipalities to operate water systems and provide meter reading and billing services for 105,900 customers. It also leases communication antenna sites, operates recycled water systems, provides meter reading and customer services, and conducts real estate sales. Rates and operations for regulated customers are subject to the jurisdiction of the respective state’s regula- tory commission. The commissions require that water rates for each regulated district be independently determined. Rates for the City of Hawthorne system are established in accordance with an operating agreement and are subject to ratification by the City Council. Fees for other operating agreements are based on contracts negotiated among the parties. Results of Operations RESTATEMENT. During 2000, the Company issued 2,210,000 shares of common stock in exchange for all of the outstanding shares of Dominguez Services Corporation. The acquisition, which was accounted for as a pooling of interests, was completed on May 25, 2000. The accompanying financial statements have been restated to include the Dominguez accounts in the current and prior periods. EARNINGS AND DIVIDENDS. Net income in 2000 was $19,963,000 compared to $21,971,000 in 1999 and $19,860,000 in 1998. Diluted earnings per common share were $1.31 in 2000, $1.44 in 1999 and $1.31 in 1998. The weighted average number of common shares outstanding was 15,173,000 in 2000, 15,142,000 in 1999 and 15,061,000 in 1998. At its January 2000 meeting, the Board of Directors increased the common stock dividend for the 33rd con- secutive year. 2000 also marked the 56th consecutive year that a dividend had been paid on the Company’s com- mon stock. The annual dividend paid in 2000 was $1.10, a 1.4% increase over the $1.085 paid in 1999, which was an increase of 1.4% over the $1.07 paid in 1998. The dividend increases were based on projections that the higher dividend could be sustained while still providing the Company with adequate financial flexibility. Earnings not paid as dividends are reinvested in the business for the benefit of stockholders. The dividend pay- out ratio was 84% in 2000, 75% in 1999 and 82% in 1998, an average of 80% during the three-year period. OPERATING REVENUE. Operating revenue, including revenue from the City of Hawthorne lease, was $244.8 million, $9.9 million or 4% more than the $234.9 million recorded last year. Revenue in 1998 was $214.9 million. The source of changes in operating revenue were: Dollars in millions Customer water usage Rate increases Usage by new customers Net change Average revenue per customer (in dollars) Average metered customer usage (Ccf) New customers added 2000 1999 1998 $ 4.8 3.0 2.1 $ 9.9 $ 551 317 5,200 $ 14.0 3.2 2.8 $ 20.0 $ 535 305 6,700 $ (14.4) 2.1 2.1 $ (10.2) $ 497 284 4,400 Weather always has an important influence on water revenues. The first quarter of 2000 was wetter than in the previous year, causing a reduction in customer usage. Second and third quarter weather was normal; however, rains in the early part of the fourth quarter negatively affected usage. The year-end customer count was 444,000, an increase of 1.0%. Weather in the first half of 1999 was normal, while in the prior year it was cooler and wetter; as a result, cus- tomer usage and revenue were higher in 1999. Third quarter weather in both years was normal. Fourth quarter 1999 weather was mild and drier than 1998, causing an increase in customer usage and an increase in revenue. The year-end customer count was 439,000, an increase of 1.6%. 20 California Water Service Group California Water Service Group 21 Management’s Discussion and Analysis (continued) During the first half of 1998, weather in our service areas was wet and cool, very much the reverse of 1997’s favorable weather pattern. Weather in the second half of the year returned to a more normal pattern. However, the wet, cool weather in the early part of the year resulted in an overall 9% decrease in 1998 water usage, negatively impacting revenue. The year-end customer count was 432,000, a 1.0% increase. OPERATING AND INTEREST EXPENSES. Total operating expenses, including those for the Hawthorne operation, were $211.6 million in 2000, $201.9 million in 1999 and $183.2 million in 1998. Wells provided 50.7% of water requirements in 2000 and purchased water provided 48.7%, with 0.6% obtained from surface supplies. In 1999 the corresponding percentages were 52.4%, 47.2% and 0.4%, and in 1998, 50.8%, 48.7% and 0.5%. The table below provides information regarding water production costs con- sisting of purchased water, purchased power and pump taxes: Dollars in millions Purchased water Purchased power Pump taxes Total water production costs Change from prior year 2000 $73.8 15.1 6.3 $95.2 1999 $69.4 14.4 6.9 $90.7 1998 $61.0 12.5 5.2 $78.7 5% 15% (5)% Water production (billion gallons) 128 124 112 Change from prior year 3% 10% (9)% The year-to-year water production cost changes are influenced by weather patterns and sources of supply. In each of the three years, purchased water expense, the largest component of annual operating expense, was affected by wholesale suppliers’ rate increases. During 2000, seven districts experienced wholesale price increases ranging from 2% to 7%. Water production costs in 1999 reflect an increase in customer usage and sig- nificant purchased water price increases for the San Francisco Peninsula districts where the wholesale supplier’s rates increased 37%. Despite some wholesale price increases in 1998, overall water production expenses declined. Well production decreased due to the decline in water sales and because several wells were out of ser- vice for maintenance. With reduced well production, purchased power and pump tax expenses declined. During the last three years, the Company has not been subject to significant energy rate increases. However, as has been widely publicized, California energy costs are expected to rise significantly. In January 2001, the CPUC approved temporary energy surcharges that the Company estimates may increase its power costs by 10%. The Company believes that energy cost increases are recoverable from consumers through established CPUC procedures, although on a short-term basis the regulatory lag in recovering higher energy costs will negatively impact earnings. Employee payroll and benefits charged to operations and maintenance expense was $43.9 million for 2000, $43.0 million in 1999 and $38.8 million in 1998. The increases in payroll and related benefits are attributable to general wage increases effective at the start of each year and additional hours worked. At year-end 2000, 1999 and 1998, there were 797, 790 and 759 employees, respectively. During 2000, a curtailment of the Dominguez pension plan was recorded resulting in a gain of $1.2 million which was offset against operating expenses. The curtailment occurred because the Dominguez plan was frozen at the merger date and its participants became participants in the Company pension plan. Previous amounts expensed by Dominguez but not funded to the plan comprise the curtailment amount. This amount is not included in the $43.9 million reported for payroll and benefits charged to operations and maintenance expense. Income tax expense was $11.6 million in 2000, $13.5 million in 1999 and $11.4 million in 1998. The changes in taxes are generally due to variations in taxable income. There is no state income tax in Washington. In 2000, interest on long-term debt was unchanged from 1999. In October, $20 million, Series C, 8.15% senior notes were issued. The added interest expense was offset by sinking fund reductions of outstanding bonds and interest capitalized on constructed assets. Long-term debt interest expense increased $1 million in 1999 because of the issue of Series B, 6.77% senior notes in March. Short-term bank borrowing interest expense increased in 2000 by $0.7 million because of higher borrowings to meet operating and interim construction funding needs. Bank borrowings were reduced when Series C senior notes were issued. In 1999, other interest expense decreased $0.4 million. Short-term borrowings were reduced after the issue of Series B senior notes and by strong cash flow from operations. Interest coverage of long-term debt before income taxes was 3.6 times in 2000, 3.7 times in 1999 and 3.6 times in 1998. There was $14.6 million in short-term borrowings at the end of 2000, $14.0 million at the end of 1999 and $22.9 million at the end of 1998. OTHER INCOME AND EXPENSES. Other income is derived from management contracts whereby the Company operates private and municipally owned water systems, agreements for operation of two recycled water systems, contracts for meter reading and billing services to various cities, leases of communication antenna sites, surplus property sales, other non-utility sources and interest on short-term investments. Total other income was $1.8 million in 2000, $3.6 million in 1999 and $2.1 million in 1998. During 1999, $1.3 million in pre-tax profits were recorded from properties sold as part of the Real Estate Program that is described in more detail in the “Liquidity and Capital Resources” section of this report. There were no property sales in 2000 or 1998. Rates and Regulation The Company’s regulatory staff reviewed 15 Cal Water districts that were eligible for general rate filings in 2000. Based on current earnings levels, projected expense increases and expected capital expenditures, applications were filed in July 2000 for three districts representing about 25% of Cal Water customers. The applications request a 10.75% return on equity and would provide $3.4 million in new revenue in 2001 and $7.2 million in 2002. A CPUC decision is expected during the second quarter of 2001. There can be no assurance that the increases will be granted as requested. Step rate increases of $0.8 million for 2001 from prior general rate decisions were effective in January. New water rates for the City of Hawthorne water system, which the Company operates under a long-term lease, became effective in early August 2000. The rates are designed to add $0.3 million in annual revenue in their first full year. Step rate increases of $0.2 million will be effective on July 1, 2001 and 2002. Additionally, there will be a surcharge added to customer bills for a two-year period starting in August 2001 designed to produce $0.5 million in annual revenue. Effective in August 2000, offset rate increases to recover increases in water production expenses became effective in four Cal Water districts. The rates generated $1.6 million in additional 2000 revenue and are expected to add $1.8 million in 2001. Prior to and unrelated to the merger with the Company, Dominguez Services Corporation filed a general rate increase application with the CPUC. A CPUC decision was issued in October 2000 authorizing an increase in cus- tomer rates and granting a return on equity of 9.95%. For 2000, $0.2 million in new revenue was received from the rate increase and for the full year 2001, $1.7 million is expected. During 1999, the Company’s regulatory staff completed a review of 14 Cal Water districts that were eligible for general rate application filings. Based on existing earnings levels, projected expense increases and expected capital expenditures, a determination was made that no general rate increase applications were necessary. In May 1999, the CPUC authorized general rate increases for the rate applications filed in July 1998 affect- ing four districts representing about 25% of Cal Water’s customers. The decision generated $4.1 million in new revenue during the twelve months following the mid-June effective date. The decision’s 9.55% authorized return on equity provided $1.9 million in new annual revenue. In addition, the decision provided another $2.2 million in annual revenue for environmental compliance, specific capital budget expenditures and recovery of General Office expenses. The $2.2 million is not reflected in the 9.55% return on equity calculation. 22 California Water Service Group California Water Service Group 23 Management’s Discussion and Analysis (continued) CPUC decisions were received in July 1998 for the general rate applications filed in July 1997. Additional annual revenue from these decisions was $0.3 million in 1998, $0.3 million in 1999 and $0.1 million in 2000, with $0.1 million expected in 2001. In a variance from its past practice, future rate increases for operating costs and capital requirements over the next five years in the Oroville and Selma districts are tied to changes in a price index. The decision maintained the Return on Equity (ROE) at 10.35%. Water Supply The Company’s source of supply varies among its 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 their supply from a combination of well and purchased sources. A small portion of the supply is from surface sources. On average, approximately half of the water is provided from wells and about half purchased. California’s normal weather pattern yields little precipitation between mid-spring and mid-fall. The Washington service areas receive precipitation in all seasons with the heaviest amounts during the winter. Water usage is highest during the warm summers and declines in the cool winter months. Rain and snow during the win- ter months replenish underground water basins and fill reservoirs providing the water supply for subsequent deliv- ery to customers. To date, snow and rainfall accumulation during the 2000-2001 water year has been less than normal; however, the prior four years were at or exceeded normal levels. Water storage in California’s reservoirs at the end of 2000 was at 107% of historic average, so the state will enter 2001 with ample storage. The Company believes that its supply from underground aquifers and purchased sources should be adequate to meet customer demand during 2001. Environmental Matters The Company is subject to regulations of the United States Environmental Protection Agency (EPA), state health service departments and various local health departments concerning water quality matters. It is also subject to the jurisdiction of various state and local regulatory agencies relating to environmental matters, including han- dling and disposal of hazardous materials. The Company strives for complete compliance with all requirements set forth by the various agencies. The Safe Drinking Water Act (SDWA) was amended in 1996 to provide a new process for the EPA to select and regulate waterborne contaminants. The EPA can now regulate only contaminants that are known or likely to occur at levels expected to pose a risk to public health when regulation would provide a meaningful opportunity to reduce a health risk. New drinking water regulations will be based primarily on risk assessment and measure- ment of cost/benefit considerations for minimizing overall health risk. The amended SDWA allows EPA to require monitoring of up to 30 contaminants in any five-year cycle. Also, every five years the EPA must select at least five listed contaminants and determine if they should be regulated. The Company has an established water supply monitoring program to test for contaminants in accordance with SDWA requirements. Water pumped from underground sources is treated as necessary or required by regulations. The Company owns and operates three surface water treatment plants. The cost of existing treatment is being recovered in customer rates as authorized by the regulatory authorities. Water purchased from wholesale suppli- ers is treated before delivery to the Company’s systems. Enforcement of the EPA standards is the responsibility of individual states. The states can impose more strin- gent regulation than mandated by EPA. In addition to the EPA’s requirements, various regulatory agencies could require increased monitoring and possibly require additional treatment of water supplies. In January 2001, EPA released a new, lower regulatory limit for arsenic, a naturally-occurring element, that is sometimes present in groundwater. It is anticipated that EPA will issue other regulations that will require fur- ther monitoring and possible treatment for specific contaminants. Depending on the action levels contained in the regulations, the cost of compliance with the new regulations could be significant in certain Company districts. The Company intends to request recovery for capital investments and additional treatment costs needed to remain in compliance with established health standards through the ratemaking process. Liquidity and Capital Resources LIQUIDITY. The Company’s liquidity is provided by bank lines of credit and internally generated funds. The Company has a $50 million line of credit with a bank, of which $20 million is designated for the parent and $30 million is available to Cal Water. The $20 million portion may be drawn on for use by the Company, including funding of its subsidiaries’ operations. Cal Water’s $30 million portion can be used solely for purposes of the regulated utility. The Company has committed $7.6 million of the $20 million credit line to a contractor who is constructing a combined customer/operation center to serve the South Bay Los Angeles operations. When complete in the fall of 2001, the Company will exchange real property on a tax-free basis with the contractor for the customer/oper- ation center. At December 31, 2000, $3.5 million had been drawn to acquire land and commence construction. Washington Water has loan commitments from two banks to meet its operating and capital equipment pur- chase requirements. At December 31, 2000, the total available under these commitments was $0.4 million. Generally, short-term borrowings under the commitments are converted annually to long-term borrowings with repayment terms tied to system and equipment acquisitions. The water business is seasonal. Revenue is lower in the winter months when water usage declines from the higher-use summer period. During the winter period, the need for short-term borrowings under the bank lines of credit increases. The larger summer cash flow allows short-term borrowings to be paid down. Short-term borrow- ings that remain outstanding more than one year have generally been converted to long-term debt. The Company believes that long-term financing is available to it through debt and equity markets. Standard & Poor’s and Moody’s have maintained their ratings of Cal Water’s first mortgage bonds at AA- and Aa3, respectively. These are the highest ratings for senior debt in the water industry. Long-term financing, which includes common stock, first mortgage bonds, senior notes and other debt securities has been used to replace short-term borrowings and fund construction. Developer contributions in aid of construction and refundable advances for construction are also sources of funds for various construction projects. Internally generated funds come from retention of earnings not paid out as dividends, depreciation and deferred income taxes. Additional information regarding the bank bor- rowings and long-term debt is presented in notes 7 and 8 to the financial statements. In October 2000, Series C, 8.15%, 30-year senior notes were issued and in March 1999, Series B, 6.77%, 30-year senior notes were issued. Each issue is for $20 million. During the four years prior to the Series B issue, the Company’s operating and capital requirements were met by borrowings under the bank short-term line of credit and internally generated funds. The Company has a Dividend Reinvestment Plan and Stock Purchase Plan (Plan). Under the Plan, stock- holders may reinvest dividends to purchase additional Company common stock. The Plan also allows existing stockholders and other interested investors to purchase Company common stock through the transfer agent. The Plan provides that shares required for the Plan may be purchased on the open market or be newly issued shares. Therefore, the Plan provides the Company with an alternative means of developing additional equity if new shares were issued. During 2000 and 1999 shares were purchased on the open market. At this time, the Company intends to continue purchasing shares required for the Plan on the open market. However, if new shares were issued to satisfy future Plan requirements, the impact on earnings per share could be dilutive because of the additional shares outstanding. Also, stockholders may experience dilution of their ownership percentage. CAPITAL REQUIREMENTS. Capital requirements consist primarily of new construction expenditures for expanding and replacing the Company’s utility plant facilities and the acquisition of new water properties. They also include refunds of advances for construction and retirement of bonds. The 2000 utility plant expenditures totaled $37.1 million. During 1999, total utility plant expenditures were $48.6 compared to $41.1 million in 1998. The 2000 expenditures included $33.5 million provided by Company funds and $3.6 million received from developers for contributions in aid of construction and refundable advances for construction. Company projects were funded by internally generated funds, borrowings under bank credit lines and commitments, and issuance of the $20 million Series C senior notes. 24 California Water Service Group California Water Service Group 25 Management’s Discussion and Analysis (continued) Several major projects account for an increase in the 2001 construction budget to $53.9 million. In 2001, construction will commence on a three-year project to construct a treatment plant to accommodate growth and meet water quality standards in the Bakersfield district. $10.8 million is budgeted for this project in 2001. Over the three-year period, the plant and related pumping and pipeline facilities are estimated to cost $45 million. Also in the 2001 budget is $4.6 million for construction of office/operation centers in the Chico and Stockton districts. These facilities will replace existing office/operation centers that have become inadequate due to age and district growth. The budget will be funded by operations, bank borrowings and long-term debt and equity financing. New subdivision construction will be financed by developers’ contributions and refundable advances for construction. The Company-funded construction budgets over the next five years are projected to be about $275 million. CAPITAL STRUCTURE. Common stockholders’ equity increased by the amount of earnings not paid out for dividends. New equity issued in 1999 and 1998 was to acquire water systems. The long-term debt portion of the capital structure increased due to the issuance of Series B and C senior notes. It was reduced by first mortgage bond sinking fund payments. The Company’s total capitalization at December 31, 2000, was $389.4 million and at the end of 1999 was $366.9 million. Capital ratios were: Common equity Preferred stock Long-term debt 2000 1999 51.1% 0.9% 48.0% 53.0% 0.9% 46.1% The 2000 return on average common equity was 10.1% compared to 11.5% in 1999 and 10.8% in 1998. OTHER ACQUISITIONS. On January 25, 2001, the CPUC approved the Company’s acquisition of the Nish water sys- tems in Visalia. The four systems serve 1,100 customers and have annual revenue of $1.2 million. The Company will issue common stock valued at $0.8 million and assume debt of $0.2 million to complete the transaction. On April 12, 2000, Washington Water received approval from the WUTC to purchase the assets of Mirrormount Water Services and Lacamas Farmsteads Water Company. The acquisitions were completed in April 2000. Together the companies serve almost 800 customers and produce annual revenue of about $250,000. Washington Water also purchased the assets of Robischon Engineers, Inc. in April 2000. This acquisition added in-house engineering capabilities to the Washington operation, enabling Washington Water to provide water sys- tem design services to other water providers. During 1999 the Company invested in a firm that provides meter-reading services in Santa Fe, New Mexico and assumed responsibility for this contract in April 2000. The Company’s agreement is with Avistar, a subsidiary of Public Service of New Mexico, which operates the 26,000-account water system for the city. The acquisition of the Rio Grande Utility Corporation, which serves 2,300 water and 1,600 wastewater customers, for $2.3 mil- lion in cash and assumed debt of $3.1 million is expected to be completed in the third quarter of 2001. REAL ESTATE PROGRAM. The Company’s subsidiaries own more than 900 real estate parcels. Certain parcels are not necessary for or used in water utility operations. Most surplus properties have a low cost basis. A program has been 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. During the next four years, the Company estimates that gross property transactions totaling over $10 million dollars could be completed. In 1999, $1.3 million in pretax sales were completed. No transactions were completed during 2000; however, $4 million in pretax property sales are anticipated to close during 2001. STOCKHOLDER RIGHTS PLAN. As explained in Note 6 to the Consolidated Financial Statements, in January 1998, the Board of Directors adopted a Stockholder Rights Plan (Plan). In connection with the Plan, a dividend distri- bution of one right for each common share to purchase preferred stock under certain circumstances was also authorized. The Plan is designed to protect stockholders and maximize stockholder value in the event of an unso- licited takeover proposal by encouraging a prospective acquirer to negotiate with the Board. 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. INTEREST RATE RISK. The Company does have exposure to market risk that includes changes in interest rates. Interest rate risk exists because the Company’s financing includes the use of long-term debt obligations with maturity dates up to 30 years from the date of issue and during the outstanding period interest rates are subject to fluctuation. The Company’s long-term obligations are first mortgage bonds and senior note obligations that are generally placed with insurance companies. Washington Water’s long-term obligations are for periods of up to 10 years and are placed with two banks. During 2000, the Company issued a single series of $20 million, 30-year senior notes at 8.15%. To expand access to capital debt markets, the Company may investigate the use of pri- vate and public markets for future debt issues. It may also consider financing on a company-wide basis, rather than on a subsidiary-by-subsidiary basis. The Company’s short-term financing is provided by bank lines of credit that are discussed under the “Liquidity and Capital Resources” section of this report. Short-term borrowings that are not repaid from operating cash or funded by retained earnings are generally converted to long-term debt issues. The Company plans to continue the financing of its construction program in this manner. Financing of acquisitions have been done using Company common stock or through the debt financing vehicles available to the subsidiary companies. VALUE RISK. Because the Company operates primarily in a regulated industry, its value risk is somewhat lessened; however, regulated parameters also can be recognized as limitations to operations and earnings, and the ability to respond to certain business condition changes. Non-regulated operations are subject to risk of contract con- straints and performance by the Company in achieving its objectives. Value risk management is accomplished using various financial models that consider changing business parameters. It is also supplemented by consider- ing various risk control processes that may be available as circumstances warrant. EQUITY RISK. The Company does not have equity investments, therefore, it does not have equity risks. New Accounting Standard In 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The statement as amended, establishes new accounting and reporting standards for derivative financial instruments and hedging activities. The Company adopted the standard on January 1, 2001. Its adoption is not anticipated to have a material impact on the Company’s results of operations or financial position. 26 California Water Service Group California Water Service Group 27 Consolidated Balance Sheet In thousands, except per share data December 31, 2000 and 1999 Assets Utility plant: Land Depreciable plant and equipment Construction work in progress Intangible assets Total utility plant Less accumulated depreciation and amortization Net utility plant Current assets: Cash and cash equivalents Receivables: Customers Other Unbilled revenue Materials and supplies at average cost Taxes and other prepaid expenses Total current assets Other assets: Regulatory assets Unamortized debt premium and expense Other Total other assets 2000 1999 December 31, 2000 and 1999 2000 1999 In thousands, except per share data $ 10,641 797,403 31,400 11,837 851,281 269,273 582,008 $ 10,440 776,795 14,661 10,790 812,686 248,296 564,390 3,241 1,655 15,163 5,450 7,964 2,718 6,257 40,793 38,133 3,817 1,854 43,804 14,333 4,777 8,199 2,247 7,140 38,351 37,441 3,503 1,822 42,766 Capitalization and Liabilities Capitalization: Common stock, $.01 par value; 25,000 shares authorized, 15,146 and 15,094 shares outstanding in 2000 and 1999, respectively Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total common stockholders’ equity Preferred stock without mandatory redemption provision, $25 par value; 380 shares authorized, 139 shares outstanding Long-term debt, less current maturities Total capitalization Current liabilities: Current maturities of long-term debt Short-term borrowings Accounts payable Accrued taxes Accrued interest Other accrued liabilities Total current liabilities Unamortized investment tax credits Deferred income taxes Regulatory and other liabilities Advances for construction Contributions in aid of construction $ 151 49,984 149,185 (486) $ 151 49,340 145,610 (517) 198,834 194,584 3,475 187,098 389,407 3,475 168,866 366,925 2,881 14,598 26,493 3,976 2,579 13,209 63,736 2,989 25,620 20,316 105,562 58,975 2,747 13,999 26,748 3,556 2,092 13,569 62,711 3,096 25,796 22,544 105,556 58,879 $666,605 $645,507 $666,605 $645,507 See accompanying notes to consolidated financial statements. 28 California Water Service Group California Water Service Group 29 Consolidated Statement of Income Consolidated Statement of Common Stockholders’ Equity and Comprehensive Income In thousands, except per share data In thousands Common For the years ended December 31, 2000, 1999 and 1998 2000 1999 1998 For the years ended December 31, 2000, 1999 and 1998 Stock Accumulated Additional Paid-in Capital Other Total Total Retained Comprehensive Stockholders’ Comprehensive Earnings Income (Loss) Equity Income $244,806 $234,937 $214,926 Balance at December 31, 1997 $ 150 $ 48,372 $ 134,236 $ — $ 182,758 $ — Operating revenue Operating expenses: Operations: Purchased water Purchased power Pump taxes Administrative and general Other Maintenance Depreciation and amortization Income taxes Property and other taxes Total operating expenses 73,768 15,136 6,275 32,974 32,308 11,592 18,368 11,571 9,618 69,351 14,355 6,856 32,266 28,963 10,200 17,246 13,515 9,138 60,958 12,541 5,162 29,784 28,131 10,191 16,309 11,425 8,744 211,610 201,890 183,245 Net operating income 33,196 33,047 31,681 Other income and expenses, net Income before interest expense 1,413 34,609 3,089 36,136 1,746 33,427 Interest expense: Long-term debt interest Other interest Total interest expense Net income Earnings per share: Basic Diluted Weighted average number of common shares outstanding: Basic Diluted See accompanying notes to consolidated financial statements. 12,901 1,745 14,646 13,084 1,081 14,165 12,125 1,442 13,567 $ 19,963 $ 21,971 $ 19,860 $ $ 1.31 1.31 $ $ 1.45 1.44 $ $ 1.31 1.31 15,126 15,173 15,090 15,142 15,014 15,061 Net income Dividends paid: Preferred stock Common stock Total dividends paid Income reinvested in business Balance at December 31, 1998 Issuance of common stock Net income Dividends paid: Preferred stock Common stock Total dividends paid Income reinvested in business Other comprehensive loss — — — — — 150 1 — — — — — — — 19,860 — 19,860 19,860 — — — — 153 14,889 15,042 4,818 — — — — 153 14,889 15,042 4,818 — — — — 48,372 139,054 — 187,576 19,860 968 — — 969 — — 21,971 — 21,971 21,971 — — — — — 153 15,262 15,415 6,556 — — — — — 153 15,262 15,415 6,556 — — — — (517) (517) (517) (517) 194,584 21,454 Balance at December 31, 1999 151 49,340 145,610 Issuance of common stock Net income Dividends paid: Preferred stock Common stock Total dividends paid Income reinvested in business Other comprehensive income Balance at December 31, 2000 — — — — — — — 644 — — 19,963 — — — — — 152 16,236 16,388 3,575 — $151 $49,984 $149,185 — — — — — — 644 — 19,963 19,963 152 16,236 16,388 3,575 — — — — 31 31 $(486) $198,834 31 $19,994 See accompanying notes to consolidated financial statements. 30 California Water Service Group California Water Service Group 31 Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements In thousands For the years ended December 31, 2000, 1999 and 1998 2000 1999 1998 December 31, 2000, 1999, and 1998 NOTE 1. Operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Deferred income taxes, investment tax credits, and regulatory assets and liabilities, net Changes in operating assets and liabilities Receivables Unbilled revenue Accounts payable Other current assets and liabilities Other changes, net Net adjustments Net cash provided by operating activities Investing activities: Utility plant expenditures Company funded Developer advances and contributions in aid of construction Other investments Net cash used in investing activities Financing activities: Net short-term borrowings Issuance of common stock Issuance of long-term debt Advances for construction Refunds of advances for construction Contributions in aid of construction Retirement of long-term debt Dividends paid Net cash provided (used) in financing activities Change in cash and cash equivalents Cash and cash equivalents at beginning of year $ 19,963 $ 21,971 $ 19,860 18,368 17,246 16,309 (3,203) 1,360 503 (1,503) 235 (255) 1,093 (71) 14,664 34,627 (33,540) (3,621) — (37,161) 599 644 20,326 3,846 (3,870) 1,883 (2,920) (16,388) 4,120 1,586 1,655 (2,324) (1,187) 7,623 (649) 3,334 25,403 47,374 (35,535) (12,984) (80) (48,599) (8,951) 46 20,062 7,480 (4,056) 4,814 (2,318) (15,415) 1,662 437 1,218 2,224 (780) 332 2,272 892 21,752 41,612 (35,963) (5,098) — (41,061) 8,450 — — 3,972 (3,939) 3,982 (785) (15,042) (3,362) (2,811) 4,029 Cash and cash equivalents at end of year $ 3,241 $ 1,655 $ 1,218 Supplemental disclosures of cash flow information: Cash paid during the year for: Interest (net of amounts capitalized) Income taxes $ 14,785 11,775 Non-cash financing activity - common stock issued in acquisitions — $ 13,796 11,499 923 $ 11,922 9,501 — See accompanying notes to consolidated financial statements. 32 California Water Service Group Organization and Operations California Water Service Group (Company) is a holding company that through its wholly owned subsidiaries pro- vides water utility and other related services in California, Washington and New Mexico. During 1999, the Company reincorporated as a Delaware corporation. California Water Service Company (Cal Water) and Washington Water Service Company (Washington Water) provide regulated utility services under the rules and regulations of their respective regulatory commissions (jointly referred to as Commissions). CWS Utility Services provides non- regulated water utility and utility-related services in all three states. New Mexico Water Service Company was formed in 2000 to provide regulated utility services. The Company operates primarily in one business segment, providing water and related utility services. NOTE 2. Summary of Significant Accounting Policies The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The financial statements give retroactive effect to acquisitions, which were accounted for as pooling of interests. Accordingly, the Company’s consolidated financial statements and footnotes have been restated to include Dominguez Services Corporation and subsidiaries (Dominguez) as if the merger had been completed as of the beginning of the earliest period presented. Intercompany 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. Certain prior years’ amounts have been reclassified, where necessary, to conform to the current presentation. The preparation of consolidated financial statements in conformity with generally accepted accounting princi- ples requires management to make estimates and assumptions that affect the reported amounts of assets and lia- bilities 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 service 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. 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 dates of acquisition. Cost of depreciable plant retired is elim- inated from utility plant accounts and such costs are charged against accumulated depreciation. Maintenance of utility plant is charged primarily to operation expenses. Interest is capitalized on plant expenditures during the construction period and amounted to $703,000 in 2000, $324,000 in 1999 and $224,000 in 1998. 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. Included in intangible assets is $6,500,000 paid to the City of Hawthorne to lease the city’s water system and associated water rights. The lease payment is being amortized on a straight-line basis over the 15-year life of the lease. The Company continually evaluates the recov- erability of utility plant by assessing whether the amortization of the balance over the remaining life can be recov- ered through the expected and undiscounted future cash flows. DEPRECIATION Depreciation of utility plant for financial statement purposes is computed on the straight-line remaining life method at rates based on the estimated useful lives of the assets, ranging from 5 to 65 years. The provision for depreciation expressed as a percentage of the aggregate depreciable asset balances was 2.4% in 2000 and 2.5% in 1999 and 1998. For income tax purposes, as applicable, the Company computes deprecia- tion 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. California Water Service Group 33 Notes (continued) CASH EQUIVALENTS Cash equivalents include highly liquid investments, primarily U.S. Treasury and U.S. Government agency interest bearing securities, stated at cost with original maturities of three months or less. RESTRICTED CASH Restricted cash represents proceeds collected through a surcharge on certain customers’ bills plus interest earned on the proceeds. The restricted cash is to service California Safe Drinking Water Bond obli- gations and is classified in other prepaid expenses. At December 31, 2000 and 1999, the amounts restricted were $755,000 and $724,000, respectively. LONG-TERM DEBT PREMIUM, DISCOUNT AND EXPENSE The discount and issuance expense on long-term debt is amor- tized over the original lives of the related debt issues. Premiums paid on the early redemption of certain debt issues and unamortized original issue discount and expense of such issues are amortized over the life of new debt issued in conjunction with the early redemption. ACCUMULATED OTHER COMPREHENSIVE LOSS The Company has an unfunded Supplemental Executive Retirement Plan. The unfunded accumulated benefit obligation of the plan exceeds the accrued benefit cost. This amount exceeds the unrecognized prior service cost; therefore accumulated other comprehensive loss has been recorded as a separate component of Stockholders’ Equity. ADVANCES FOR CONSTRUCTION Advances for Construction consist of payments received from developers for instal- lation 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 over a 20-year or 40-year period. Refund amounts under the 20-year contracts are based on annual revenues from the extensions. Unrefunded balances at the end of the contract period are credited to Contributions in Aid of Construction and are no longer refundable. Refunds on contracts entered into since 1982 are made in equal annual amounts over 40 years. At December 31, 2000, the amounts refundable under the 20-year contracts were $8,688,000 and under 40-year contracts were $96,874,000. Estimated refunds for 2001 for all water main extension contracts are $4,100,000. 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 contri- butions are included in utility plant, but excluded from rate base. Depreciation related to contributions is charged to Contributions in Aid of Construction. 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 liabil- ities 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 customer rate increases to reflect the normalization of the tax benefits of the federal accelerated methods and available Investment Tax Credits (ITC) for all assets placed in service after 1980. ITC are deferred and amortized over the lives of the related properties for book purposes. Advances for Construction and Contributions in Aid of Construction received from developers subsequent to 1986 were taxable for federal income tax purposes and subsequent to 1991 were subject to California income tax. In 1996 the federal tax law, and in 1997 the California tax law, changed and only deposits for new services were taxable. In late 2000, federal regulations were further modified to exclude fire services from tax. EARNINGS PER SHARE Basic earnings per share (EPS) is calculated by dividing income available to common stock- holders by the weighted average shares outstanding during the year. Diluted EPS is calculated by dividing income available to common stockholders by the weighted average shares outstanding and potentially dilutive shares. STOCK-BASED COMPENSATION The Company adopted Statement on Financial Accounting Standard No. 123, “Accounting for Stock-Based Compensation.” The Company elected to adopt the provision of the statement that allows the continuing practice of not recognizing compensation expense related to the granting of employee stock options to the extent that the option price of the underlying stock was equal to or greater than the market price on the date of the option grant. NOTE 3. Merger with Dominguez Services Corporation The Merger between the Company and Dominguez was completed on May 25, 2000. On the merger date, each outstanding Dominguez common share was exchanged for 1.38 shares of Company common stock. The Company issued 2,210,254 new common shares in exchange for the 1,601,679 outstanding Dominguez shares. Dominguez provided water service to about 40,000 customers in 21 California communities. The former Dominguez operations became districts within Cal Water. The Merger was accounted for as a pooling of interests. There were no intercompany transactions as a result of the Merger. Certain reclassifications were made to the historic financial statements of the companies to conform presentation. For the periods indicated below, the Company and Dominguez reported the following items: Unaudited – In thousands Revenue: Company Dominguez Net income: Company Dominguez 6 Months Ended 6-30-00 Year Ended 12-31-99 Year Ended 12-31-98 $ 98,428 14,232 $112,660 $206,440 28,497 $234,937 $189,659 25,267 $214,926 $ 6,139 1,147 $ 7,286 $ 19,919 2,052 $ 21,971 $ 18,936 924 $ 19,860 Dominguez previously reported net of tax extraordinary items related to merger transaction expenses. The Company reclassified the extraordinary items into “Operating expenses” in the income statement. The reclassi- fied amounts were for the six months ended June 30, 2000, $167,000; for the year ended December 31, 1999, $190,000; and for the year ended December 31, 1998, $499,000. No adjustments were made to the Dominguez net assets in applying the accounting practices of the Company. Dominguez previously reported common stock of $1,542,000 that was reclassified by the Company to “Paid-in- Capital” in accordance with the Company’s financial statement presentation. The Company and Dominguez each had December 31 year-ends; therefore no adjustment was required to retained earnings due to a change in fiscal year-ends. NOTE 4. Other Acquisitions In 1999, the Company acquired all of the outstanding stock of Harbor Water Company and South Sound Utility Company, which form the operations of Washington Water, serving 14,900 regulated and non-regulated cus- tomers. The acquisitions were accounted for as pooling of interests in exchange for 316,472 shares of Company stock and assumption of long-term debt of $2,959,000. The results of operations previously reported by the sep- arate entities are included in the accompanying consolidated financial statements. During 1998, the Company purchased the assets of Lucerne Water Company, Rancho del Paradiso Water Company and Armstrong Valley Water Company. These investor-owned systems serve 1,624 accounts. The acqui- sitions were completed effective January 1, 1999, in exchange for the equivalent of 75,164 shares of Company common stock. The acquisitions were accounted for under purchase accounting. The purchases were completed on a non-cash basis in which the Company issued common stock valued at $922,000 and assumed debt obliga- tions of $1,108,000. Two other water company asset acquisitions were completed in 1999. The acquired companies served 288 customers. The acquisitions were accounted for under purchase accounting. 34 California Water Service Group California Water Service Group 35 Notes (continued) On April 12, 2000, Washington Water received approval from the Washington Utilities and Transportation Commission to purchase the assets of Mirrormount Water Services and Lacamas Farmsteads Water Company. The acquisitions were completed in April 2000 for $639,000 in cash and assumed debt. Together the companies serve almost 800 customers and produce annual revenue of about $250,000. To provide in-house engineering, Washington Water also purchased the assets of Robischon Engineers, Inc. in April 2000 for $70,000 in cash. The acquisitions were accounted for by purchase accounting. During 1999 the Company invested in a firm that provides meter-reading services in Santa Fe, New Mexico. In April 2000, the Company assumed responsibility for this contract. The Company’s agreement is with Avistar, a subsidiary of Public Service of New Mexico, which operates the 26,000-account water system for the city. New Mexico Water has agreed to acquire the Rio Grande Utility Corporation, which serves 2,300 water and 1,600 wastewater customers, for $2.3 million in cash and assumed debt of $3.1 million. The acquistion is expected to be completed in the third quarter of 2001 after approval of the state’s regulatory authority is received. NOTE 5. Preferred Stock As of December 31, 2000 and 1999, 380,000 shares of preferred stock were authorized. Dividends on out- standing shares are payable quarterly at a fixed rate before any dividends can be paid on common stock. Preferred shares are entitled to sixteen votes, each with the right to cumulative votes at any election of directors. The outstanding 139,000 shares of $25 par value cumulative, 4.4% Series C preferred shares are not con- vertible to common stock. A premium of $243,250 would be due upon voluntary liquidation of Series C. There is no premium in the event of an involuntary liquidation. NOTE 6. Common Stockholders’ Equity The Company is authorized to issue 25,000,000 shares of $.01 par value common stock. As of December 31, 2000 and 1999, 15,145,866 and 15,093,627 shares of common stock were issued and outstanding, respectively. All shares of common stock are eligible to participate in the Company’s dividend reinvestment plan. Approximately 10% of the outstanding shares participate in the plan. STOCKHOLDER RIGHTS PLAN The Company’s Stockholder Rights Plan (the Plan) is designed to provide stockholders protection 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 ten-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 (the Purchase Price). Each share of Series D Preferred Stock is entitled to receive a divi- dend equal to 100 times any dividend paid on common stock and 100 votes per share in any stockholder elec- tion. 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 causes 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 mar- ket 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 redemp- tion price of $.001 per Right. NOTE 7. Short-term Borrowings As of December 31, 2000, the Company maintained a bank line of credit providing unsecured borrowings of up to $20,000,000 at the prime lending rate or lower rates as quoted by the bank. $7,562,000 of the line is com- mitted to a contractor for construction of an office complex for combined Los Angeles South Bay operations. When completed, the office complex will be exchanged with the contractor for surplus company land on a tax-free basis. Cal Water maintained a bank line of credit for an additional $30,000,000 on the same terms as the Company. The line of credit agreements, which expire April 2001 and which the Company expects to renew, do not require minimum or specific compensating balances. The following table represents borrowings under the bank lines of credit: Dollars in thousands 2000 1999 1998 Maximum short-term borrowings Average amount outstanding Weighted average interest rate Interest rate at December 31 NOTE 8. $26,750 16,810 7.77% 7.88% $25,500 9,093 $25,700 15,755 6.52% 7.11% 7.09% 6.97% Long-term Debt As of December 31, 2000 and 1999, long-term debt outstanding was: In thousands Series J K P S BB CC DD EE FF GG A B C First Mortgage Bonds: Senior Notes: California Department of Water Resources loans Other long-term debt Total long-term debt Less current maturities Interest Rate 8.86% 6.94% 7.875% 8.50% 9.48% 9.86% 8.63% 7.90% 6.95% 6.98% 7.28% 6.77% 8.15% 3.0% to 7.4% Maturity Date 2023 2012 2002 2003 2008 2020 2022 2023 2023 2023 2025 2028 2030 2011-32 2000 1999 $ 4,000 5,000 2,580 2,595 13,230 18,600 19,200 19,300 19,300 19,300 123,105 20,000 20,000 20,000 $ 4,000 5,000 2,595 2,610 14,940 18,700 19,300 19,400 19,400 19,400 125,345 20,000 20,000 — 3,176 3,698 3,236 3,032 189,979 2,881 171,613 2,747 Long-term debt excluding current maturities $187,098 $168,866 36 California Water Service Group California Water Service Group 37 Notes (continued) The first mortgage bonds are obligations of Cal Water. All bonds are held by institutional investors and secured by substantially all of Cal Water’s utility plant. The unsecured senior notes are also obligations of Cal Water. They are held by institutional investors and require interest-only payments until maturity. The Department of Water Resources (DWR) loans were financed under the California Safe Drinking Water Bond Act. Repayment of princi- pal and interest on the DWR loans is through a surcharge on customer bills. Other long-term debt is primarily equipment and system acquisition financing arrangements with other financial institutions. Aggregate maturities and sinking fund requirements for each of the succeeding five years (2001 through 2005) are $2,881,000, $5,381,000, $5,283,000, $2,663,000, and $2,669,000. NOTE 9. Income Taxes Income tax expense consists of the following: In thousands 2000 1999 1998 Current Deferred Total Current Deferred Total Current Deferred Total Federal State Total $ 7,961 1,554 $ 9,515 $ 8,291 2,769 $11,060 $ 6,667 2,679 $ 9,346 $2,519 (463) $2,056 $2,560 (105) $2,455 $2,388 (309) $2,079 $10,480 1,091 $11,571 $10,851 2,664 $13,515 $ 9,055 2,370 $11,425 Income tax expense computed by applying the current federal 35% tax rate to pretax book income differs from the amount shown in the Consolidated Statement of Income. The difference is reconciled in the table below: In thousands 2000 1999 1998 Computed “expected” tax expense Increase (reduction) in taxes due to: State income taxes net of federal tax benefit Investment tax credits Other Total income tax $11,037 $12,420 $10,950 1,336 (155) (647) $11,571 1,624 (184) (345) $13,515 1,442 (167) (800) $11,425 The components of deferred income tax expense were: In thousands 2000 1999 1998 Depreciation Developer advances and contributions Bond redemption premiums Investment tax credits Other Total deferred income tax expense $2,031 (814) (61) (61) (4) $1,091 $2,974 (749) (62) (94) 595 $2,664 $3,007 (798) (62) (93) 316 $2,370 The tax effects of differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2000 and 1999 are presented in the following table: In thousands Deferred tax assets: Developer deposits for extension agreements and contributions in aid of construction Federal benefit of state tax deductions Book plant cost reduction for future deferred ITC amortization Insurance loss provisions Pension plan Other Total deferred tax assets Deferred tax liabilities: Utility plant, principally due to depreciation differences Premium on early retirement of bonds Total deferred tax liabilities Net deferred tax liabilities 2000 1999 $40,458 5,648 1,765 632 736 4,860 54,099 78,894 825 79,719 $25,620 $40,595 6,040 1,679 821 794 2,886 52,815 77,520 1,091 78,611 $25,796 A valuation allowance was not required during 2000 and 1999. Based on historic 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. NOTE 10. Employee Benefit Plans PENSION PLAN The Company provides a qualified defined benefit, non-contributory pension plan for substantially all employees. The cost of the plan was charged to expense and utility plant. The Company makes annual con- tributions to fund the amounts accrued for pension cost. Plan assets are invested in mutual funds, pooled equity, bonds and short-term investment accounts. The data below includes the unfunded, non-qualified, supplemental executive retirement plan. Benefits earned by Dominguez employees under the Dominguez pension plan were frozen as of the merger date and future pension benefits to those employees will be provided under the Company pension plan. The Dominguez plan was curtailed. The Dominguez plan was fully funded and additional contributions to the plan could not be funded, although plan annual expense was recorded. As a result of the curtailment, accrued pen- sion liability of $1,218,000 that had been expensed by Dominguez in prior years was reversed by the Company in 2000. The amount was offset against other operations expense. SAVINGS PLAN The Company sponsors a 401(k) qualified, defined contribution savings plan that allowed partici- pants to contribute up to 15% of pre-tax compensation in 1999, increasing to 18% in 2000. The Company matches fifty cents for each dollar contributed by the employee up to a maximum Company match of 4.0%. Company contributions were $1,298,000, $1,126,000, and $1,078,000 for the years 2000, 1999 and 1998. OTHER POSTRETIREMENT PLANS The Company provides substantially all active employees with medical, dental and vision benefits through a self-insured plan. Employees retiring at or after age 58 with 10 or more years of ser- vice are offered, along with their spouses and dependents, continued participation in the plan by payment of a premium. Retired employees are also provided with a $5,000 life insurance benefit. Plan assets are invested in a mutual fund, short-term money market instruments and commercial paper. The Company records the costs of postretirement benefits during the employees’ years of active service. The Commissions have issued decisions that authorize rate recovery of tax deductible funding of postretirement ben- efits and permit recording of a regulatory asset for the portion of costs that will be recoverable in future rates. 38 California Water Service Group California Water Service Group 39 Notes (continued) The following table reconciles the funded status of the plans with the accrued pension liability and the net Net periodic benefit costs for the pension and other postretirement plans for the years ending December 31, postretirement benefit liability as of December 31, 2000 and 1999: 2000, 1999 and 1998 included the following components: In thousands 2000 1999 2000 1999 In thousands 2000 1999 1998 2000 1999 1998 Pension Benefits Other Benefits Pension Plan Other Benefits Change in benefit obligation: Beginning of year Service cost Interest cost Assumption change Plan amendment Experience (gain) or loss Curtailment gain Benefits paid End of year Change in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Retiree contributions Benefits paid Fair value of plan assets at end of year Funded status Unrecognized actuarial (gain) or loss Unrecognized prior service cost Unrecognized transition obligation Unrecognized net initial asset Net amount recognized $ 55,692 2,846 4,079 825 1,215 (34) (1,347) (4,178) $ 59,098 $ 61,008 3,140 3,678 — (4,178) $ 63,648 $ 4,550 (13,534) 5,279 — 228 $ (3,477) $ 61,396 2,899 3,894 (6,669) 744 (3,900) — (2,672) $ 55,692 $ 57,050 6,453 177 — (2,672) $ 61,008 $ 5,317 (16,204) 4,971 — 455 $ (5,461) $10,195 544 790 394 — 558 — (429) $12,052 $ 1,561 228 707 370 (799) $ 2,067 $ (9,985) 1,422 888 3,597 (276) $ (4,354) $ 9,900 498 689 (929) — 433 — (396) $10,195 $ 1,723 206 28 343 (739) $ 1,561 $ (8,634) 556 959 3,228 369 $ (3,522) Amounts recognized on the balance sheet consist of: In thousands 2000 1999 2000 1999 Pension Benefits Other Benefits Accrued benefit costs Additional minimum liability Intangible asset Accumulated other comprehensive loss Net amount recognized $ (3,477) (1,363) 877 486 $ (3,477) $ (5,461) (1,460) 943 517 $ (5,461) $ (4,354) — — — $ (4,354) $ (3,522) — — — $ (3,522) Pension Benefits Other Benefits 2000 1999 2000 1999 Weighted average assumptions as of December 31: Discount rate Long-term rate of return on plan assets Rate of compensation increases 7.25% 8.00% 4.50% 7.50% 8.00% 4.50% 7.25% 8.00% — 7.50% 8.00% — Service cost Interest cost Expected return on plan assets Net amortization and deferral Net periodic benefit cost $2,846 4,079 (4,498) 486 $2,913 $2,899 3,894 (4,450) 871 $3,214 $2,399 3,747 (4,199) 683 $2,630 $ 544 790 (152) 357 $1,539 $ 498 689 (144) 401 $1,444 $ 405 623 (117) 360 $1,271 Postretirement benefit expense recorded in 2000, 1999, and 1998 was $781,000, $1,064,000, and $666,000 respectively. $3,437,000, which is recoverable through future customer rates, is recorded as a regu- latory asset. The Company intends to make annual contributions to the plan up to the amount deductible for tax purposes. For 2000 measurement purposes, the Company assumed a 5% annual rate of increase in the per capita cost of covered benefits with the rate remaining at that level thereafter. 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: In thousands Effect on total service and interest costs Effect on accumulated postretirement benefit obligation NOTE 11. 1-percentage Point Increase 1-percentage Point Decrease $ 269 $1,815 $ (166) $(1,471) Stock-Based Compensation Plans At the Company’s 2000 annual meeting, stockholders approved a Long-Term Incentive Plan that allows for the granting of nonqualified stock options, performance shares and dividend units. Under the plan, a total of 1,500,000 common shares are authorized for option grants. Options are granted at an exercise price that is not less than the per share common stock market price on the date of grant. The options vest at a 25% rate on their anniversary date over their first four years and are exercisable over a ten-year period. No options were vested at December 31, 2000. Certain key Dominguez executives participated in the Dominguez 1997 Stock Incentive Plan which was ter- minated at the time Dominguez merged with the Company. The plan provided that in the event of a merger of Dominguez into another entity, granted but unexercised stock options issued became exercisable. Prior to the Merger, all outstanding Dominguez options were exercised and converted into Dominguez shares and subse- quently converted to 52,357 shares of Company common stock. Under SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company elected to apply the provi- sions of APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation cost has been recognized in the consolidated financial statements for stock options that have been granted. If the Company had elected to adopt the optional recognition provisions of SFAS 123 for its stock option plans, basic and diluted earnings per share would be unchanged from the amounts reported, except for 2000 diluted earnings per share which was reported as $1.31, but on a pro forma basis would be $1.30. Net income for the years ended December 31, 2000, 1999 and 1998 would be as presented in the following table: In thousands As reported Pro forma 2000 1999 1998 $19,963 19,939 $21,971 21,937 $19,860 19,825 40 California Water Service Group California Water Service Group 41 Notes (continued) Independent Auditors’ Report The fair value of stock options used to compute pro forma net income and earnings per share disclosures is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions: The Board of Directors California Water Service Group: Expected dividend Expected volatility Risk-free interest rate Expected holding period in years 2000 1999 1998 4.3% 22.0% 4.9% 5.0 4.3% 22.6% 6.2% 10.0 4.3% 22.6% 5.7% 10.0 The following table summarizes the activity for the stock option plans: Weighted Average Exercise Price $22.54 24.84 23.38 22.54 23.45 23.06 23.45 23.06 Weighted Average Remaining Contractual Life — — — Options Exercisable — 8,901 19,092 9.5 — Shares 35,604 20,617 56,221 (3,864) 52,357 53,500 (52,357) 53,500 Weighted Average Fair Value — $5.15 — — 3.74 — Outstanding at January 1, 1998 Granted Outstanding at December 31, 1998 Exercised Outstanding at December 31, 1999 Granted Exercised Outstanding at December 31, 2000 NOTE 12. 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, the carrying amount approximates fair value because of the short- term maturity of the instruments. The fair value of the Company’s long-term debt is estimated at $199,890,000 as of December 31, 2000, and $189,400,000 as of December 31, 1999, using a discounted cash flow analy- sis, based on the current rates available to the Company for debt of similar maturities. The fair value of advances for construction contracts is estimated at $27,000,000 as of December 31, 2000, and $33,000,000 as of December 31, 1999, based on data provided by brokers. NOTE 13. Quarterly Financial Data (Unaudited) The Company’s common stock is traded on the New York Stock Exchange under the symbol “CWT.” Quarterly div- idends have been paid on common stock for 224 consecutive quarters and the quarterly rate has been increased each year since 1968. 2000 – in thousands except per share amounts First Second Third Fourth Operating revenue Net operating income Net income Diluted earnings per share $46,694 4,902 1,533 .10 $65,966 8,977 5,753 .38 $76,580 12,782 9,205 .60 $55,566 6,535 3,472 .23 1999 – in thousands except per share amounts First Second Third Fourth Operating revenue Net operating income Net income Diluted earnings per share 42 California Water Service Group $45,628 4,777 2,868 .19 $59,232 8,440 6,089 .40 $72,280 11,922 8,706 .57 $57,797 7,908 4,308 .28 We have audited the accompanying consolidated balance sheet of California Water Service Group and sub- sidiaries as of December 31, 2000 and 1999, 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, 2000. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. The consolidated financial statements of California Water Service Group as of and for each of the years ended December 31, 1999 and 1998, have been restated to reflect the pooling-of-interests transaction with Dominguez Services Corporation and subsidiaries as described in Note 3 to the consolidated financial statements. We did not audit the consolidated financial statements of Dominguez Services Corporation and subsidiaries, which financial statements reflect total assets constituting 9.0 percent as of December 31, 1999 and total revenue constituting 12.1 percent and 11.8 percent, in 1999 and 1998 respectively, of the related consolidated totals. Those finan- cial statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Dominguez Services Corporation and subsidiaries as of December 31, 1999, and for the years ended December 31, 1999 and 1998, is based solely on the report of the other auditors. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 and the report of the other auditors provide a rea- sonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to in the first paragraph present fairly, in all material respects, the financial position of California Water Service Group and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000 in conformity with account- ing principles generally accepted in the United States of America. Mountain View, California January 22, 2001 California Water Service Group 43 Corporate Information Officers Board of Directors Stock Transfer, Dividend Disbursing and Reinvestment Agent Fleet National Bank c/o EquiServe L.P. P.O. Box 43010 Providence, RI 02940-3010 800.736.3001 California Water Service Company Robert W. Foy 1,2,3 Chairman of the Board Peter C. Nelson 1,2,3 President and Chief Executive Officer Gerald F. Feeney 1,2,3 Vice President, Chief Financial Officer and Treasurer Francis S. Ferraro Vice President, Regulatory Matters James L. Good 2 Vice President, Corporate Communications and Marketing Robert R. Guzzetta 2 Vice President, Engineering and Water Quality Christine L. McFarlane Vice President, Human Resources Raymond H. Taylor Vice President, Operations Raymond L. Worrell Vice President, Chief Information Officer Calvin L. Breed 1 Controller, Assistant Secretary and Assistant Treasurer Paul G. Ekstrom 1,2,3 Corporate Secretary John S. Simpson Assistant Secretary, Manager of New Business Washington Water Service Company Michael P. Ireland President 1 Holds the same position with California Water Service Group 2 Holds the same position with CWS Utility Services 3 Also an officer of Washington Water Service Company and New Mexico Water Service Company To Transfer Stock A change of ownership of shares (such as when stock is sold or gifted or when owners are deleted from or added to stock certificates) requires a transfer of stock. To trans- fer stock, the owner must complete the assignment on the back of the certificate and sign it exactly as his or her name appears on the front. This signature must be guar- anteed by an eligible guarantor institution (banks, stock brokers, savings and loan associations and credit unions with membership in approved signature medallion pro- grams) pursuant to SEC Rule 17AD-15. A notary’s acknowledgement is not acceptable. This certificate should then be sent to Boston EquiServe, Stockholder Services, by registered or certified mail with complete transfer instructions. Bond Registrars US Bank Trust, N.A. One California Street San Francisco, CA 94111-5402 415.273.4580 Chase Manhattan Bank and Trust 101 California Street San Francisco, CA 94111-5830 415.954.9526 Executive Office California Water Service Group 1720 North First Street San Jose, CA 95112-4598 408.367.8200 Annual Meeting The Annual Meeting of Stockholders will be held on Wednesday, April 18, 2001, at 10 a.m. at the Company’s Executive Office, located at 1720 North First Street in San Jose, California. Details of the business to be trans- acted during the meeting will be contained in the proxy material, which will be mailed to stockholders on or about March 16, 2001. Annual Report for 2000 on Form 10-K A copy of the Company’s report for 2000 filed with the Securities and Exchange Commission on Form 10-K will be available in April 2001 and can be obtained by any stockholder at no charge upon written request to the address below. Stockholder Information California Water Service Group Attn: Stockholder Relations 1720 North First Street San Jose, CA 95112-4598 408.367.8200 or 800.750.8200 http://www.calwater.com l s e e g n A s o L , s r e n t r a P h p e s o J l s a g u o D : n g i s e D Peter C. Nelson * President and Chief Executive Officer Robert W. Foy * Chairman of the Board C.H. Stump ‡* Former Chairman of the Board and former CEO of California Water Service Company Linda R. Meier †‡ Member, National Advisory Board, Haas Public Service Center; Member of the Board of Directors, Greater Bay Bancorp Langdon W. Owen† President, Don Owen & Associates; Member of the Board of Directors, Metropolitan Water District of Southern California George A. Vera † Chief Financial Officer, the David & Lucile Packard Foundation Edward D. Harris, Jr., M.D. ‡* George DeForest Barnett Professor of Medicine, Stanford University Medical Center Richard P. Magnuson †‡ Private Venture Capital Investor Robert K. Jaedicke †‡* Professor Emeritus of Accounting and former Dean, Stanford Graduate School of Business † Member of the Audit Committee ‡ Member of the Compensation Committee * Member of the Executive Committee E W M EXI C O N S H I NGT O N A W California Water Service Group 1720 North First Street San Jose, California 95112-4598 408.367.8200 www.calwater.com 

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