C a l i f o r n i a Wa t e r S e r v i c e G r o u p 2 0 0 1 A n n u a l R e p o r t Rising to the challenge I n 2 0 0 1 , t h e wa t e r i n d u s t r y f a c e d s i g n i f i c a n t c h a l l e n g e s. B y k e e p i n g f o c u s e d o n t h e f u n d a m e n t a l s — a n d e x c e l l i n g i n t h e k e y o p e r a t i o n a l a r e a s t h a t s e t u s a p a r t f r o m t h e c o m p e t i t i o n — w e a r e t u r n i n g c h a l l e n g e s i n t o o p p o r t u n i t i e s. And turning challenge into opportunity. Building new relationships 5 A b o u t t h e C o m p a n y 8 F i n a n c i a l H i g h l i g h t s 9 L e t t e r t o S t o c k h o l d e r s 1 4 F i n a n c i a l S e c t i o n Maintaining financial strength Expanding our first-class infrastructure Providing excellent service R i s i n g t o t h e C h a l l e n g e 2001 brought with it a number of chal- lenges, and we responded to them by focusing on those things that are most important in our business—build- ing new relationships, maintaining financial strength, expanding our first-class infrastructure, and providing excellent service. In short, we responded by doing what we do best: we excelled in the fundamentals of our business while executing our carefully crafted, deliber- ate strategy for meeting challenges and turning them into opportunities. B u i l d i n g N e w R e l a t i o n s h i p s Washington Water Service Company made great strides in 2001, growing its regulated cus- tomer base by 10%. In California, we were awarded a utility billing contract in Stockton and the opportunity to negotiate a 15-year water system operating agree- ment with the City of Commerce, which we currently operate under a short-term agreement. 2001 also saw us renew an old partnership, as we entered into a con- tract to provide water quality testing services to San Jose Water Company. M a i n t a i n i n g F i n a n c i a l S t r e n g t h A tough regulatory climate, signifi- cantly higher electricity costs, and lower water usage due to cooler weather made maintaining our financial strength a challenge in 2001, but it was a challenge we tackled with determination. A company-wide cost con- 5 trol program helped curb expenses, while Continuous East Los Angeles District, and a new well in our King Improvement Process (CIP) teams made up of employ- City District. We also broke ground on a large treatment ees throughout the company worked on projects that plant in Bakersfield and expanded our infrastructure increased efficiency. For example, one team realized to serve 6,100 new customers. To ensure that we can company-wide savings by changing the way we handle continue to provide our customers with a reliable water customers’ returned mail; another team conducted supply that meets increasingly strict water quality energy use audits and developed a plan to reduce elec- standards, we will invest more in our infrastructure tricity costs; and yet another increased revenue by in 2002 than ever before. revising the process for metering new construction projects. These efforts, combined with numerous appli- cations we filed for rate relief with the California Public Utilities Commission, should reduce expenses and increase revenues in 2002. P r o v i d i n g E x c e l l e n t S e r v i c e Ask anyone at our company what we do, whether it is a member of the water quality team working in front of a microscope, a water service pro- fessional replacing a broken pipeline, or a customer service representative answering the telephone, and E x p a n d i n g O u r F i r s t - C l a s s I n f r a s t r u c t u r e A water utility that main- he or she will tell you that we are in the business of tains a first-class infrastructure is like a property providing excellent service. That is why we have an owner who invests time, effort, and resources into employee team dedicated to measuring our ability to upgrading his or her home to increase the property’s satisfy our customers. Recently, this team conducted value and reduce the costs associated with unexpected a series of surveys to measure our ability to meet repairs. We are diligent about maintaining and upgrad- customers’ needs the first time they called us. Why? ing our infrastructure. That means our invested capi- Because our research indicated that customers want tal grows each year along with the value of our water “quick and easy” telephone service, and that satisfac- systems and we spend less money on unanticipated tion levels drop 50% every time a customer is not sat- repairs. In 2001, we completed more than 500 capital isfied on the first contact. The most recent survey projects, including a new treatment plant in our Kern indicated that 95% of our customers were satisfied River Valley District, a new water storage tank in our on the first call. 6 7 Financial Highlights To Our Stockholders O u r w o r l d ch a n g e d i n 2 0 0 1 . Fr e e d o m - l o v i n g people everywhere suffered a great loss on September 11 when terrorists attacked the United States of America. As individuals, we mourned; we took pride in the courage and compassion that characterized our country’s response; and we gained from the experience a renewed sense of what is important in life. As a company, we faced a need to increase security and safeguard our water supplies. We also faced challenges unrelated to the attacks, such as higher electricity costs, a tough regulatory climate, and cool, wet weather. We responded to all of these challenges by focusing on the fundamentals of our business while executing an aggressive strategy for improving our financial results in years to come. Our two biggest challenges in 2001 were lower water usage due to cool, wet weather, a nd d ec is i ons b y t he C a li for ni a Pu bl i c U t i li t i es C o m mi s s io n ( C P UC ) t o d elay ou r re ques t s f or Year Ended December 31 2001 2000 1999 1998 1997 rate relief. Although we can have no influence over the weather, we are continuing our efforts Book value Market price Earnings per share Dividends per share $ 12.95 $ 13.13 $ 12.89 $ 12.49 $ 12.15 25.75 .97 1.115 27.00 1.31 1.10 30.31 1.44 1.085 31.31 1.31 1.07 29.53 1.71 1.055 Revenue (in thousands) 246,820 244,806 234,937 214,926 225,165 Net income (in thousands) 14,965 19,963 21,971 19,860 25,757 to grow our business and diversify our operations to lessen its impact on our earnings. The reg- ulatory climate had an even greater impact on our business in 2001, and we brought significant r e s o u r c e s t o b e a r i n e x e c u t i n g a m u l t i f a c e t e d s t r a t e g y t o h e l p e n s u r e t h a t w e r e c e i v e f a i r r e g u l a t o r y treatment in the future. For example, we are a leader in the water industry’s efforts to improve co mm uni ca ti ons wi th th e C PU C a nd i nf l uenc e k ey d e ci s io ns. E ve n m o re im p or t a nt l y, we have ta ken an aggr es s ive ap p ro a ch t o ra t e c as e s, fi l in g fo r i nc r ea se s f o r an u np r ec ed ent e d 15 d is tricts in California in 2001. We hope to receive decisions on these rate cases in the third quarter of 2002. O n e o f t h e m o s t s i g n i f i c a n t d e v e l o p m e n t s a t t h e C P U C i n 2 0 0 1 wa s a d e c i s i o n t o r e c o n s i d e r the way water industry offset expenses are processed. For more than two decades, water utilities have been able to include increases in certain unpredictable and uncontrollable expenses in rates, including electric cost increases, without having to wait to request r e c o v e r y i n g e n e r a l r a t e c a s e a p p l i c a t i o n s, w h i ch c a n o n l y b e f i l e d e v e r y t h r e e y e a r s. T h e C P U C has delayed our requests to recover a large portion of our higher electricity costs until it decides up on t he m a tt er of o ff s et exp ens es. Ou r el ec t ri ci ty co s t s ros e $ 6 m i lli o n i n 2 001 , a n d o u r u n s u c c e s s f u l e f f o r t s t o r e c o v e r a l l o f t h a t c o s t i n c r e a s e h a d a s i g n i f i c a n t n e g a t i v e i m p a c t a s a c o m p a n y a n d a s a n i n d u s t r y, i n a n e f f o r t t o p r o t e c t t h e i n t e r e s t s o f b o t h s t o ck h o l d e r s a n d c u s t o m e r s. We expect our efforts and the efforts of the water industry to yield positive results in future years, but 2001 financial results were clearly impacted by weather and regulatory treat- ment. Our operating revenues for 2001 were $247 million, compared to $245 million in 2000. N e t i n c o m e wa s $ 1 5 m i l l i o n , c o m p a r e d t o $ 2 0 m i l l i o n i n 2 0 0 0 , a n d e a r n i n g s w e r e $ 0 . 9 7 p e r share, compared to $1.31 per share in 2000. $1,280 o n o u r e a r n i n g s. We a r e p a r t i c i p a t i n g a c t i v e l y i n t h e C P U C p r o c e e d i n g o n t h i s i s s u e, b o t h Growth of $100 invested 20 years ago, assuming reinvestment of all dividends. $642 $453 $1,902 Shown in five-year increments 1982-1986 1987-1991 1992-1996 1997-2001 8 9 We remain committed to doing all we can to provide our stockholders a fair rate of return, and we will be relentless in pursuing every opportunity to increase stockholder value. Evidence of this commitment is born out by our track record. We have paid a dividend every year for the past 57 years; in 2001, it increased to $1.115 per share. The graph on page 8 reflects the long-term value of an investment in our company, showing that $100 invested in 1981 would be worth $1,902 today, assuming reinvestment of all dividends. Our growth strategy will be key in ensuring future success. In 2001, we continued to pursue growth opportunities that add to shareholders’ long-term value. As for regulated busi- ness, we purchased the assets of seven small systems in Washington, growing customer base by 10%. We added 5,000 metered connections in California, including infrastructure needed to serve 120 new subdivisions. And in New Mexico, we continued to pursue new growth opportuni- ties while the New Mexico Public Regulation Commission considered our request to purchase the Rio Grande Utility Corporation. We expect to receive a decision on the Rio Grande purchase in the second quarter of 2002. O n t h e n o n - r e g u l a t e d s i d e, w e s i g n e d f i v e wa t e r s y s t e m o p e r a t i o n a g r e e m e n t s i n < Far Left P e t e r C . N e l s o n P r e s i d e n t a n d C E O < Left R o b e r t W. F o y C h a i r m a n o f t h e B o a r d Whatever else we do, our future success depends on our ability to provide excellent customer service. And we have the right people to get the job done—people like Denise Diaz, a customer service representative who recently had the water turned on in 15 minutes for a Washington and were selected to negotiate a 15-year lease agreement with the City of Commerce, neighboring family that came to her door one night; people like Nadia Watson, a collector who California, whose 1,085-connection water system we are currently operating under a short-term contacted local agencies to assist an elderly customer in need, and even made the customer a agreement. We were also proud to be selected to provide utility billing services in the City of Stockton, California and water quality testing services to San Jose Water Company. In the coming year, we will continue to work diligently to ensure fair regulatory treat- ment, while we maintain our company-wide focus on operating efficiently and providing excel- lent service. We will also seek to expand the non-regulated side of the business by pursuing non-regulated service contracts, maximizing the value of our excess real estate, and leasing portions of our properties to partners like cellular telephone service providers. Our stockholders will earn on a growing capital investment, as we plan to invest more in our infrastructure in 2002 than ever before. Much of the capital investment planned for 2002 is needed to enable us to meet increasingly strict water quality standards, including the funds invested in the construction of a $49 million water treatment plant begun in Bakersfield in 2001 and expected to be completed in 2003. A notable development in the water quality arena in 2001 was the adoption of a new federal standard of 10 parts per billion for arsenic, which will require sandwich before she left; people like Al Welte, a pump operator who changed a customer’s flat t ire one fa l l d ay s o s he c oul d get he r ki ds to s cho ol o n ti m e. We a re for t una t e t o h ave s uch a caring and talented group of people on our team—people who cared so much about the victims of September 11 that they volunteered to forgo our annual Employee Celebration Day and instead send a significant employee contribution to help those in need...people who work hard every day, both individually and on teams, to ensure that we provide excellent service to our customers. There is no doubt about it, 2001 was a year fraught with challenges. But by focusing on excelling at the things we do best, we are turning those challenges into opportunities. We believe that our proven ability to grow profitably, maintain our financial strength, make wise investments in our infrastructure, and provide excellent customer service positions us well for future success. We thank you for your investment in California Water Service Group and look forward to a bright and rewarding future. significant capital investments by all water providers in the coming years. Sincerely, 10 11 R o b e r t W. F o y C h a i r m a n o f t h e B o a r d P e t e r C . N e l s o n P r e s i d e n t a n d C h i e f E x e c u t i v e O f f i c e r Customers Washington Harbor South Sound California District Name Antelope Valley Bakersfield Bear Gulch Chico† Dixon Dominguez California Chico Willows Oroville Marysville Redwood Valley Dixon Stockton South San Francisco Mid-Peninsula Bear Gulch Los Altos Livermore Salinas King City Selma Visalia Headquarters (General Office) Kern River Valley Bakersfield Antelope Valley Hawthorne East Los Angeles New Mexico Los Alamos Sante Fe Westlake Hermosa-Redondo Palos Verdes Dominguez California Water Service Company Washington Water Service Company Other Contract Including Fremont Valley, Lake Hughes, Lancaster & Leona Valley; Painted Turtle, Prayer Mountain and other operating agreements Regulated Non-regulated 1,300 400 O&M contracts for the City of Bakersfield, Spicer City & Lost Hills 58,400 27,000 Atherton, Woodside, Portola Valley, portions of Menlo Park & City of Menlo Park service contract Hamilton City Carson and portions of Compton, Harbor City, Long Beach, Los Angeles & Torrance East Los Angeles O&M contracts for cities of Commerce & Montebello Hawthorne 15-year lease — full-service water operations Hermosa-Redondo† A portion of Torrance; meter reading for Manhattan Beach 25,700 13,400 Kern River Valley Bodfish, Kernville, Lakeland, Mtn. Shadows, Onyx, Squirrel Valley, South Lake & Wofford Heights; numerous operating contracts King City† Livermore Los Altos Marysville† O&M contracts for Castlewood Country Club & Crane Ridge MWC 17,000 Portions of Cupertino, Los Altos Hills, Mtn. View & Sunnyvale Mid-Peninsula San Mateo & San Carlos Oroville Palos Verdes Palos Verdes Estates, Rancho Palos Verdes, Rolling Hills Estates & Rolling Hills Redwood Valley Lucerne, Duncans Mills, Guerneville, Dillon Beach and a portion of Santa Rosa Salinas Selma O&M contracts for Foothill Estates & Spreckels Water Co. South San Francisco Colma & Broadmoor 17,600 23,800 2,800 33,100 26,400 – 4,200 – – – 2,700 6,100 4,100 2,200 18,400 3,800 35,800 3,500 23,600 1,900 27,000 5,300 16,300 42,000 31,300 7,000 2,300 500 – 200 – – – – – – 300 – – – – – – Stockton Visalia† Westlake Willows† New Mexico A portion of Thousand Oaks Los Alamos Meter-reading contract Santa Fe Meter-reading contract Washington Harbor Numerous O&M contracts South Sound Numerous O&M contracts SUBTOTAL 430,600 54,800 – – – 22,000 27,000 49,000 10,800 2,900 13,700 1,100 1,200 2,300 444,300 106,100 SUBTOTAL SUBTOTAL TOTAL 12 13 MWC = Mutual Water Company | O&M = Operations and Maintenance | † = Billing Contract Ten-Year Financial Review Dollars in thousands, except common share data 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 $173,823 $171,234 $163,681 $150,491 $158,210 $148,313 Summary of Operations Operating revenue Residential Business Industrial Public authorities Other Total operating revenue Operating expenses Interest expense, other income and expenses, net 44,944 9,907 11,860 6,286 246,820 221,669 10,186 44,211 11,014 11,609 6,738 244,806 211,610 13,233 41,246 12,695 10,898 6,417 234,937 201,890 11,076 Net income $ 14,965 $ 19,963 $ 21,971 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 $ 0.97 1.115 115% $ 12.95 25.75 15,182 7.6% 2.87 $ 1.31 1.100 $ 1.44 1.085 84% 75% $ 13.13 $ 12.89 27.00 15,146 10.1% 3.58 30.31 15,094 11.5% 3.79 38,854 10,150 9,654 5,777 214,926 183,245 11,821 $ 19,860 40,520 10,376 11,173 4,886 225,165 188,020 11,388 $ 25,757 37,605 9,748 10,509 4,083 210,258 177,356 11,502 $ 21,400 $132,859 35,873 9,952 9,585 4,833 193,102 164,958 11,176 $ 16,968 $127,228 33,712 9,080 9,397 3,767 183,184 155,012 11,537 $ 16,635 $122,585 31,360 8,415 8,535 4,985 175,880 145,517 12,785 $ 17,578 $111,353 29,208 7,905 7,899 7,104 163,469 137,401 11,794 $ 14,274 $ 1.31 1.070 $ 1.71 1.055 $ 1.42 1.040 $ 1.13 1.020 $ 1.17 0.990 $ 1.26 0.960 $ 1.02 0.930 82% 62% 73% 90% 85% 76% 91% $ 12.49 31.31 15,015 10.8% 3.64 $ 12.15 29.53 15,015 14.5% 4.37 $ 11.47 21.00 15,015 12.8% 3.81 $ 10.97 16.38 14,934 10.6% 3.41 $ 10.72 16.00 14,890 11.1% 3.49 $ 10.03 $ 9.65 20.00 13,773 12.6% 3.34 16.50 13,773 10.7% 3.21 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 and surface supply Purchased Total water production Metered customers Flat-rate customers Customers at year-end, including Hawthorne New customers added Average revenue per customer Utility plant per customer at year-end Employees at year-end $624,342 $582,782 $564,390 $538,741 $515,917 $495,985 $471,994 $455,769 $437,065 $419,194 62,049 710,214 207,981 48.8% 0.9% 50.3% 65,283 61,343 126,626 371,281 79,146 450,427 6,081 37,161 666,605 189,979 51.1% 0.9% 48.0% 65,408 62,237 127,645 366,242 78,104 444,346 5,219 48,519 645,507 171,613 53.0% 0.9% 46.1% 65,144 58,618 123,762 361,235 77,892 439,127 6,727 41,061 613,143 152,674 54.6% 1.0% 44.4% 57,482 54,661 112,143 354,832 77,568 432,400 4,383 37,511 594,444 153,271 53.8% 1.0% 45.2% 63,736 59,646 123,382 350,139 77,878 428,017 4,719 40,310 569,745 151,725 52.7% 1.1% 46.2% 60,964 56,769 117,733 345,307 77,991 423,298 9,730 31,031 553,027 154,416 50.9% 1.1% 48.0% 54,818 57,560 112,378 335,238 78,330 413,568 2,263 32,435 516,507 138,628 52.9% 1.2% 45.9% 53,274 59,850 113,124 332,146 79,159 411,305 3,325 31,097 497,717 138,863 49.3% 1.2% 49.5% 48,598 59,103 107,701 326,564 81,416 407,980 2,906 37,698 451,754 130,971 49.7% 1.3% 49.0% 55,641 49,303 104,944 322,457 82,617 405,074 3,769 $ 552 $ 554 $ 539 $ 500 $ 529 $ 502 $ 468 $ 447 $ 433 $ 404 2,020 783 1,916 797 1,851 790 1,768 759 1,694 752 1,632 740 1,580 738 1,520 729 1,459 717 1,400 706 *Common share data is restated to reflect the effective two-for-one stock split on December 31, 1997 14 C A L I F O R N I A WA T E R S E R V I C E G R O U P 15 C A L I F O R N I A WA T E R S E R V I C E G R O U P 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 was formed in 2000 to provide regulated water services. Utility Services provides non-regulated water operations and related services to other private companies and municipalities. The following discussion and analysis provides information regarding the Company, its assets, operations and financial condition. F O R WA R D- L O O K I N G S T A T E M E N T S This annual report, including the Letter to Stockholders and Management’s Discussion and Analysis, contains forward-looking statements within the meaning established by the Private Securities Litigation Reform Act of 1995 (Act). The forward-looking statements are intended to qualify under provisions of the federal securities laws for “safe harbor” treatment established by the Act. Forward-looking statements are based on currently available information, expectations, estimates, assumptions and projections, and management’s judgment about the Company, the water utility industry and general economic conditions. Such words as expects, intends, plans, believes, estimates, anticipates, projects 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, changes in regulatory commissions’ policies or procedures, the timeliness of regulatory commissions’ actions concerning rate relief, new legislation, electric power interruptions, increases in suppliers’ prices and the availability of supplies including water and power, 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, especially as it impacts water sales. The Company assumes no obligation to provide public updates of forward-looking statements. accounting period. The unbilled revenue amount is recorded as a current asset on the balance sheet under the caption “Unbilled Revenue.” At December 31, 2001, the unbilled amount was $7.3 million and at December 31, 2000 the amount was $8.0 million. The amount recorded as unbilled revenue varies depending on water usage, the number of days between meter reads for each billing cycle, and the number of days between each cycle’s meter reading and the end of the accounting cycle. Flat rate customers are billed in advance at the beginning of the service period. The revenue is pro- rated so that the portion of revenue applicable to the current accounting period is included in that period’s rev- enue. The portion related to a subsequent accounting period is recorded as unearned revenue on the balance sheet and recognized as revenue in the subsequent accounting period. At December 31, 2001 and 2000, the unearned revenue liability was $1.7 million and $1.5 million, respectively. Expense Balancing Accounts. The Company does not record expense balancing accounts in revenue until the CPUC has authorized a change in customer rates and the customer has been billed. Expense balancing accounts include the amount of suppliers’ rate increases charged to the Company for purchased water, pur- chased power and pump tax expenses that are not included in customer water rates. The cost increases are referred to as “Offsetable Expenses” because under certain circumstances they are recoverable from customers in future rate increases designed to offset the higher costs. The Company tracks the cost increases in expense balancing accounts as allowed by the CPUC. At December 31, 2001, the amount included in these accounts was $6.5 million and relates primarily to higher elec- tric costs incurred by the Company during 2001 that have not been billed to customers. At December 31, 2000, the amount in the expense balancing accounts was $0.6 million. For the years 1996 through 2000, the average year-end balance was $1.2 million. To the extent the Company meets the criteria set forth by the CPUC in its interim balancing account recovery procedures, the Company expects to collect the balancing account amounts in future customer billings. The CPUC’s procedures are discussed in detail under the “Rates and Regulation” sec- tion of this report. The Company is uncertain if it will meet the CPUC’s criteria or what portion of the balanc- ing accounts will be recoverable in offset rate increases. Therefore, the Company’s accounting policy is not to record the balancing account amounts until they are included in customer billings. B U S I N E S S R E S U LT S O F O P E R A T I O N S Cal Water is a public utility supplying water service to 436,700 customers in 75 California communities through 25 separate water systems or districts. Cal Water’s 24 regulated systems, which are subject to regula- tion by the California Public Utilities Commission (CPUC) serve 430,600 customers. An additional 6,100 cus- tomers receive service through a long-term lease of the City of Hawthorne’s water system, which is not subject 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 13,700 customers in the Tacoma and Olympia areas. An additional 2,300 customers are served under operating agreements with private owners. In November 2000, New Mexico Water signed an agreement to acquire the water and wastewater 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 by the state’s Public Regulation Commission, which is now expected in the second quarter of 2002. 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 customers. It also leases communication antenna sites, operates recycled water systems, provides meter reading and customer services, and periodically sells surplus real estate. The Company expects the meter reading service it provides in Santa Fe, New Mexico to be assumed by the City of Santa Fe during the first quarter of 2002. Rates and operations for regulated customers are subject to the jurisdiction of the respective state’s regulatory 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. C R I T I C A L A C C O U N T I N G P O L I C I E S The Company maintains its accounting records in accordance with generally accepted accounting principles and as directed by the Commissions. This section addresses two areas that the Company believes are most important among its accounting policies. Revenue Recognition. Revenue from metered customers includes billings to customers based on monthly meter readings plus an estimate of water used since the customer’s last meter reading and the end of the Earnings and Dividends. Net Income in 2001 was $14,965,000 compared to $19,963,000 in 2000 and $21,971,000 in 1999. Diluted earnings per common share were $0.97 in 2001, $1.31 in 2000 and $1.44 in 1999. The weighted average number of common shares outstanding was 15,285,000 in 2001, 15,173,000 in 2000 and 15,142,000 in 1999. As explained below, the decline in 2001 net income resulted from three primary factors: lower water sales to existing customers due to weather conditions, significantly higher purchased power costs and delays in regulatory rate relief. At its January 2001 meeting, the Board of Directors increased the common stock dividend for the 34th consecutive year. 2001 also marked the 57th consecutive year that a dividend had been paid on the Company’s common stock. The annual dividend paid in 2001 was $1.115, a 1.4% increase over the $1.10 paid in 2000, which is an increase of 1.4% over the $1.085 paid in 1999. The dividend increases were based on projec- tions that the higher dividend could be sustained while still providing the Company with adequate financial resources and flexibility. Earnings not paid as dividends are reinvested in the business for the benefit of stock- holders. The dividend payout ratio was 115% in 2001, 84% in 2000 and 75% in 1999, an average of 91% during the three-year period. Operating Revenue. Operating revenue, including revenue from the City of Hawthorne lease, was $246.8 mil- lion, 0.8% more than the $244.8 million recorded in 2000. Revenue in 1999 was $234.9 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 2001 2000 1999 $ (5.7) $ 4.8 $ 14.0 5.4 2.3 $ 2.0 $ 3.0 2.1 9.9 $ 552 363 6,100 $ 554 371 5,200 3.2 2.8 $ 20.0 $ 539 349 6,700 16 C A L I F O R N I A WA T E R S E R V I C E G R O U P 17 C A L I F O R N I A WA T E R S E R V I C E G R O U P Management’s Discussion and Analysis (continued) During 2001, revenue from usage by existing customers declined $5.7 million. A cool, wet spring, mild summer and early fall rains throughout the Company’s service territories resulted in a weather pattern that caused water usage by existing customers to decline by 2%. Rainfall was near normal in the northern part of California, but well above normal in the south. The unusually heavy rains in southern California reduced water sales, a trend that continued all year because of the year’s weather pattern. Washington Water experi- enced dry conditions during the winter and spring months; however, summer rains reduced water sales in the normally high usage summer months. Rate increases in 2001 added $5.4 million in new revenue, offsetting the decline in revenue from usage by existing customers. The Company received CPUC decisions in 2001 for General Rate Case (GRC) increases in three districts providing $1.3 million in new revenue. Step rate increases of $2.6 million that had been authorized in prior GRCs and $0.8 million in offset increases to recover higher power costs in four districts were also granted. New water rates for the City of Hawthorne water system added $0.5 million to revenue, and a GRC decision for Washington Water added $0.2 million. During 2000, the first quarter was wetter than in the prior 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 and consequently reduced 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. Step rate increases that were effective at the start of the year and new water rates in the City of Hawthorne system accounted for the remainder of the new revenue from rate increases. The December 31, 2001 customer count, including the Hawthorne customers, was 450,400, an increase of 1.4% from the 444,300 customers at the end of 2000, which was an increase of 1.1% from the 439,100 customers at the end of 1999. The growth in customers was due to normal growth within existing ser- vice areas and several small system acquisitions. Operating and Interest Expenses. Total operating expenses were $221.7 million in 2001, $211.6 million in 2000, and $201.9 million in 1999. million for over collecting on water purchases in prior periods. The refunds were recorded as a reduction of purchased water costs. For 2002, wholesale rate increases are expected in seven districts ranging from 1% to 11%. One supplier plans to reduce rates 9%. Purchased power is required to operate wells and pumps. Its cost increased $6.0 million in 2001 and $0.7 million in 2000. Through much of 2001, the Company paid substantially higher energy costs that were not recovered in customer rates. The CPUC’s authorizations allowing the Company to recover a portion of the higher power costs were not effective until September and November, well after the high usage summer months. The purchased power cost increase in 2000 was due mainly to a 3% increase in water production. Prior to 2001, the Company had not been subjected to significant electric power cost increases. However, as has been widely publicized, California energy costs rose significantly in 2001. In January, the CPUC approved an energy surcharge that increased the Company’s cost of purchased electric power by 10%. A second, more significant 38% increase in electric power costs became effective in May, bringing the total increase to 48%. When the CPUC proposed electric cost increases, the Company believed the higher costs were recoverable from consumers on a pass-through basis under established CPUC procedures. However, as explained in the Rates and Regulation section of this report, the CPUC revised its rules regarding recovery of the higher costs, resulting in delays in recovering the higher costs. No new power rate increases are proposed at this time. Employee payroll and benefits charged to operations and maintenance were $47.8 million for 2001, $44.5 million for 2000 and $43.0 in 1999. The increases in payroll and related benefits are attributable to gen- eral wage increases effective at the start of each year and additional hours worked. At year-end 2001, 2000 and 1999, there were 783, 797 and 790 employees, respectively. During 2000, a curtailment of the Dominguez pension plan was recorded resulting in a non-taxable gain of $1.2 million that was offset against operating expenses. The curtailment occurred because the Dominguez pension 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 included in the $44.5 million reported for payroll and benefits charged to operations and maintenance expense. Wells provided 50.6% of water requirements in 2001 and purchased water provided 48.9%, with 0.5% Income tax expense was $9.7 million in 2001, $11.6 million in 2000 and $13.5 million in 1999. The obtained from surface supplies. For 2000, the corresponding percentages were 50.7%, 48.7% and 0.6%, and in 1999 the percentages were 52.4%, 47.2% and 0.4%. As a group, water production costs, which are purchased water, purchased power and pump taxes, comprise the largest segment of total operating costs. Together, water production costs accounted for 45% of total operating costs in 2001, 2000 and 1999. Rates charged for purchased water and pump taxes are set by various public agencies; the electric rates charged by power companies are authorized by the CPUC. As such, these rates are beyond the Company’s control. The table below provides comparative information regarding water production costs during the past three years: Dollars in millions Purchased water Purchased power Pump taxes Total water production costs Change from prior year Water production (billion gallons) Change from prior year 2001 2000 1999 $ 73.2 21.1 5.9 $100.2 5% 127 (1)% $73.8 15.1 6.3 $95.2 $69.4 14.4 6.9 $90.7 5% 15% 128 124 3% 10% Water production expenses vary with wholesale suppliers’ prices, the quantity of water produced to supply customer water usage, and the sources of supply. In 2001 and 2000, seven wholesale water suppliers increased rates from 2% to 7%. In December 2001, wholesale suppliers in the Los Angeles area refunded $1.4 changes in taxes are generally due to variations in taxable income. There is no state income tax in Washington. Interest on long-term debt increased $1.3 million over 2000. The issuance of $20 million of Series D senior notes in September 2001 and $20 million of Series C senior notes in October 2000, net of sinking fund payments on first mortgage bonds, resulted in a larger principal amount of long-term debt outstanding and thus increased interest expense. In 2000, long-term interest cost was unchanged from 1999. The added interest expense due to the Series C senior note issue was offset by lower interest due to sinking fund payments on first mortgage bonds. Capitalized interest was $0.9 million on construction projects in 2001 and $0.7 million in 2000. A larger amount is expected to be capitalized during 2002 because of the increase in the capital project expenditures. Interest coverage of long-term debt before income taxes was 2.9 times in 2001, 3.6 times in 2000 and 3.8 times in 1999. The reduction in interest coverage for 2001 resulted from lower earnings and the new senior note issues outstanding. Short-term bank borrowings to meet operating and interim construction funding needs increased other interest expense in 2001 by $0.1 million. The amount borrowed during the year was larger because of reduced cash flow from operations and an increase in capital project expenditures, but lower short-term rates reduced interest cost on the outstanding balances. There was $22.0 million in short-term borrowings at the end of 2001 and $14.6 million at the end of 2000. 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, sur- plus property sales, other non-utility sources and interest on short-term investments. Other income, net of expenses, was $5.8 million in 2001, $1.4 million in 2000 and $3.1 million in 1999. During 2001, $3.9 million in pre-tax profits were realized from surplus 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 and $1.3 million in 1999. 18 C A L I F O R N I A WA T E R S E R V I C E G R O U P 19 C A L I F O R N I A WA T E R S E R V I C E G R O U P Management’s Discussion and Analysis (continued) R A T E S A N D R E G U L A T I O N After analyzing 17 Cal Water districts that were eligible for general rate filings in 2001, and based on current earnings levels, projected expense increases, including higher electric power costs, and expected capital expen- ditures, applications were filed in July 2001 for 15 districts covering about 65% of Cal Water customers. The applications request an 11.5% return on equity including 75 basis points to reflect the increased risk associ- ated with the CPUC’s changes in recovery of water production expense increases. An application to increase customer rates to cover higher General Office expenses is also being processed by the CPUC. Combined the applications request $19 million in additional annual revenue. A decision from the CPUC on the General Office application is expected in the second quarter of 2002, and a decision on the district GRC applications is expected in 2002’s third quarter. There can be no assurance that the increases will be granted as requested. The CPUC has lengthened the time required to process the 2001 series of GRC applications. The schedule had required approximately 10 months, but for this series, it is expected to exceed one year. The regulatory delays are detri- mental to the Company because rate relief to cover increased costs are not issued on a timely basis, and rev- enue is effectively lost. In October 2001, the CPUC adopted a resolution implementing its staff ’s interim recommendation concerning practices and policies that enable water utilities to recover increases in purchased water, purchased power and pump taxes. These expenses are referred to as “offsetable expenses.” The CPUC also directed its staff to open a proceeding to evaluate offsetable expense recovery practices and policies, and recommend per- manent revisions. Historically, offset rate increases have enabled water utilities to recover increases in off- setable expenses that were not anticipated when customer rates were established and are beyond the utility’s control. Future Company requests to recover offsetable expenses will be processed only if a district has filed a GRC application within its three-year rate case cycle and the district is not earning more than its authorized rate of return on a forward-looking, pro-forma basis. Neither of these requirements applied to offset rate increases prior to adoption of the resolution. The Company can continue to track offsetable expenses in regula- tory memorandum accounts for potential recovery subject to the CPUC’s future determination of appropriate practices and policies. During 2001, the rates charged to the Company by electric power suppliers increased almost 50%. In May 2001, immediately after the CPUC authorized substantial electric rate increases for the state’s two largest power companies, the Company requested authorization to recover $5.9 million in higher power costs for 23 of its 24 regulated California districts. Late in 2001, the Company was authorized rate increases in four districts totaling $2.7 million in additional annual revenue. The Company’s requests to recover power cost increases in the other districts will be processed in accordance with the interim policies adopted by the CPUC. Although the Company is hopeful that it will be authorized to recover the additional offsetable expenses, it is unable to predict the timing or amount of such recoveries. During 2002, the Company expects to file GRCs for six of its California operating districts. Those fil- ings will be made in July 2002 with a decision expected from the CPUC about mid-year in 2003. A GRC was filed for Washington Water in February 2002 with a decision expected in April 2002. WA T E R S U P P LY 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 the supply from wholesale suppliers and other districts obtain the supply from a combination of well and purchased sources. A small portion of the supply is from surface sources and processed through three Company-owned treatment plants. On average, slightly more than half of the water produced is provided from wells and surface supply with the remainder purchased from wholesale suppliers. 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 and dry summers and declines in the cool winter months. Rain and snow during the winter months replenish underground water basins and fill reservoirs providing the water supply for subsequent delivery to customers. To date, snow and rainfall accumulation during the 2001-2002 water year has been above average. Precipitation in the prior five years has been near normal levels. Water storage in California’s reservoirs at the end of 2001 was at historic average. The Company believes that its supply from underground aquifers and purchased sources will be adequate to meet customer demand during 2002. The Company also develops long-term water supply plans for each of its districts to help assure an ade- quate water source under various operating and supply conditions. E N V I R O N M E N T A L M A T T E R S 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 handling 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 assess- ment and measurement 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 accor- dance 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 suppliers 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 stringent 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. During 2001, EPA released a new, lower Maximum Contaminant Level (MCL) of 10 parts per billion for arsenic, a naturally-occurring element, that is sometimes present in groundwater. Compliance with the new standard is required by January 2006. Of the Company’s almost 900 wells, 75 will require treatment to comply with the new MCL. The Company estimates the compliance cost at $125 million in capital expenditures over the next five years and $10 million in additional annual operating costs. The State of California could estab- lish a lower arsenic MCL standard. If the state were to set the standard at five parts per billion, the estimated capital expenditures necessary for compliance would be $250 million. At this time, the Company is unable to predict if the state will adopt the EPA standard or require a lower MCL. The Company is participating in test- ing alternate arsenic treatment technologies in order to meet the standard in the most cost efficient manner. It is anticipated that EPA will issue other regulations that will require further monitoring and possi- ble 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. L I Q U I D I T Y A N D C A P I T A L R E S O U R C E S Liquidity. The Company’s liquidity is provided by bank lines of credit and internally generated funds. The Company has a $60 million bank line of credit that expires on April 30, 2003. The Company expects the bank lines of credit will be renewed upon expiration. It replaced a previous $50 million credit line. Of the $60 mil- lion total, $10 million is designated for the parent and $50 million is available to Cal Water. The $10 million portion may be drawn on for use by the Company, including funding of its subsidiaries’ operations. Cal Water’s $50 million portion can be used solely for purposes of the regulated utility. The Company has committed $7.6 million of the $10 million credit line to a contractor for construc- tion of a customer/operation center where the Company will consolidate its South Bay Los Angeles operations, including the former Dominguez Water Company operations. At December 31, 2001, $6.3 million had been drawn to acquire land and construct the facility. The amount drawn on the credit line is an obligation of the contractor, but guaranteed by the Company. The new facility is pledged to the Company as security for the guar- antee. The Company occupied the new facility in January 2002 on a month-to-month rent basis. The transac- 20 C A L I F O R N I A WA T E R S E R V I C E G R O U P 21 C A L I F O R N I A WA T E R S E R V I C E G R O U P Management’s Discussion and Analysis (continued) tion is structured so that the Company will exchange on a tax-free basis surplus real property to the contractor for the new facility. The exchange is expected to occur after mid-year 2002 at which time the contractor will repay the construction loan and the Company’s commitment will be extinguished. Washington Water has a line of credit totaling $0.1 million from a bank to meet its operating and cap- ital equipment purchase requirements. At December 31, 2001, nothing was outstanding under the commitment. Generally, short-term borrowings under the commitment 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 cool, wet winter months when less water is used compared to the warm, dry summer months when water use is higher and more revenue is generated. During the winter period, the need for short-term borrowings under the bank lines of credit increases. The increase in cash flow during the summer allows short-term borrowings to be paid down. Short-term borrowings that remain outstanding more than one year have generally been converted to long-term debt. In years when more than normal precipitation falls in the Company’s service areas or temperatures are lower than normal, especially in the summer months, customer water usage can be lower than normal. The reduction in water usage reduces cash flow from operations and increases the need for short-term bank borrowings. Regulatory lag, the delay in receiving authorization to increase customer rates to cover capital expenditures and higher operating costs, can also result in the need for increased short-term bank borrowings. 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. The Company’s bank line of credit agreement contains a provision that if the Company’s Standard & Poor’s or Moody’s senior debt ratings fall below investment grade, the credit line may be terminated by the banks. The senior note covenants include cross default provisions that would be triggered if the bank line of credit provisions are not met. The Company believes the credit rating agencies will maintain investment grade ratings for the Company’s first mortgage bonds. 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 contribu- tions in aid of construction which are not refundable and refundable advances for construction are sources of funds for various contractor funded 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 borrowings and long-term debt is presented in Notes 7 and 8 to the financial statements. In both 2001 and 2000, long-term financing was provided by issuance of $20 million, 30-year senior notes for a total of $40 million. The Series D, 7.13% senior notes were issued in September 2001, and in October 2000, the Series C, 8.15% notes were issued. The senior notes do not require sinking fund payments. Cash flow during 2001 was lower than expected because of reduced water usage by existing customers, regulatory lag in receiving rate relief and increased operating costs, especially for purchased power. As a result, funds required to pay 2001 dividends exceeded net income by $2.1 million, resulting in a reduction of stock- holders’ equity. The reduced cash flow also required the Company to borrow additional funds under the bank line of credit agreement. In 2000 and 1999, $3.6 million and $6.6 million of net income had been reinvested in the business after payment of dividends. The Company has a Dividend Reinvestment 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 presents the Company with an alternative means of developing additional equity if new shares were issued. During 2001 and 2000, 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 dilu- tive because of the additional shares outstanding. Also, stockholders may experience dilution of their owner- ship percentage. Contractual Obligations. The Company’s contractual obligations as of December 31, 2001 are summarized in the table below. Long-term debt payments include annual sinking fund payments on first mortgage bonds, maturities of first mortgage bonds and annual payments on other long-term obligations. Advances for con- struction represent annual contract refunds to developers for the cost of water systems paid for by the develop- ers. The contracts are non-interest bearing with refunds generally on a straight-line basis over a 40-year period. Operating leases are generally rents for office space. The total amount presented for operating leases is for a 20- year period. Contractual Obligations (In thousands) Long-term debt Advances for construction Operating leases Total $207,981 106,657 21,000 Less Than 1 Year $5,381 4,475 750 2-3 Years 4-5 Years $7,783 9,630 1,610 $ 5,184 10,621 1,778 After 5 Years $189,633 81,931 16,862 The Company has water supply contracts with wholesale suppliers in 16 of its operating districts. For each contract, the cost of water is established by the wholesale supplier and is generally beyond the Company’s control. In the past two years, wholesaler price increases have averaged 2.5%. The amount paid annually to the wholesale suppliers is charged to purchased water expense on the Company’s statement of income. Three contracts noted below require minimum payments. The other contracts do not require minimum annual pay- ments. The amount paid under the contracts, except for the contract with Stockton East Water District (SEWD), varies with the volume of water purchased from the wholesalers. The contract with SEWD requires an annual payment of $3,198,000. The amount paid under this contract is fixed annually and does not vary with the quan- tity of water delivered by the district. Because of the fixed price arrangement, the Company operates to receive as much water as possible from SEWD in order to minimize the cost of operating wells to supplement SEWD deliveries. Two contracts require the Company to purchase minimum quantities of water at the contractors’ current wholesale rate for purchased water. Under both contracts, the Company operates so that purchases exceed the contractual minimum amount. The Company plans to continue to purchase at least the minimum water requirement under both contracts in the future. Capital Requirements. Capital requirements consist primarily of new construction expenditures for expand- ing 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 first mortgage bonds. Utility plant expenditures in 2001 totaled $62.0 million compared to $37.2 million in 2000 and $48.6 million in 1999. The 2001 construction program included $53.4 million of Company-funded projects and $8.6 million of projects funded by funds received from developers for non-refundable contributions in aid of construc- tion and refundable advances for construction. The Company’s 2001 projects were funded by internally gener- ated funds, borrowings under bank credit lines, and issuance of the $20 million Series D senior notes. The 2000 expenditures included $33.5 million provided by Company funds and $3.6 million received from developers. The Company’s 2000 projects were funded by internally generated funds, short-term bank borrowings, and issuance of the $20 million Series C senior notes. The 2002 Company-funded construction budget was authorized at $76.8 million. It includes $32.0 mil- lion for the fourth year of a five-year program to construct a water treatment plant to accommodate growth and meet water quality standards in the Bakersfield district. Over the five-year period, the plant and related pump- ing and pipeline facilities are estimated to cost $49.0 million. Also in the 2002 budget is $12.0 million for new and replacement water mains and $5.0 million for new wells and storage facilities. The budget will be funded by funds from operations, bank borrowings and long-term debt and equity financing. New subdivision construc- tion will be financed by developers’ contributions and advances for construction. Company-funded construction budgets over the next five years are projected to be about $350 million. Included in the estimated amount is $125 million for compliance with arsenic water quality regulations, com- pletion of the Bakersfield treatment plant and expansion and replacement of water plant infrastructure. An application was filed in January 2002 requesting authorization from the CPUC for $250 million of debt and equity financing through 2005. Capital Structure. Common stockholders’ equity was reduced in 2001 by the $2.1 million that dividends paid exceeded net income. In 2000 and 1999, common stockholders’ equity increased by annual retained earnings of $3.6 million and $6.6 million. New equity was issued in 2001 to acquire a water system. The long-term debt portion of the capital structure increased in 2001 and 2000 due to the issuance of Series C and Series D, $20 million senior notes. It was reduced by first mortgage bond sinking fund payments. 22 C A L I F O R N I A WA T E R S E R V I C E G R O U P 23 C A L I F O R N I A WA T E R S E R V I C E G R O U P Management’s Discussion and Analysis (continued) The Company’s total capitalization at December 31, 2001, was $402.7 million and at the end of 2000 was $389.4 million. Capital ratios were: Common equity Preferred stock Long-term debt 2001 2000 48.8% 0.9% 50.3% 51.1% 0.9% 48.0% The return on average common equity was 7.6% in 2001 compared to 10.1% in 2000. The decline in 2001 was caused by the lower net income. Other Acquisitions. On January 25, 2001, the CPUC approved the Company’s acquisition of the Nish water systems in Visalia. The four systems serve 1,100 customers and had annual revenue of $1.2 million. The Company issued 36,180 shares of its common stock valued at $0.9 million and assumed debt of $0.3 million to complete the transaction, which was accounted for as a pooling of interests. The effect of pooling was deemed not to be material; therefore, prior year financial statements have not been restated and pro-forma disclosures were not considered significant. The net equity of Nish was recorded as an adjustment to retained earnings as of January 1, 2001. In 2001, Washington Water purchased the assets of seven water companies that serve 681 customers and generate about $0.3 million in annual revenue. The combined purchase price was $0.7 million. In 2000, Washington Water purchased the assets of two water companies that together serve almost 800 customers and produce annual revenue of about $0.3 million. Washington Water also purchased the assets of Robischon Engineers, Inc. in April 2000. This acquisition added in-house engineering capabili- ties to the Washington operation, enabling Washington Water to provide water system design services to other water providers. The Company agreed to acquire the Rio Grande Utility Corporation that serves 2,300 water and 1,600 wastewater customers near Albuquerque in November 2000. The acquisition, which will be made for $2.3 mil- lion in cash and assumed debt of $3.1 million, is pending approval of the New Mexico Public Regulation Commission. Approval is expected in the second quarter 2002. 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 pro- gram 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 could be completed. In 2001, $3.9 million in pretax sales were completed. No transactions were completed during 2000. During 2002, the Company expects to complete sales in excess of $3 million. 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 distribution 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 unsolicited takeover proposal by encouraging a prospective acquirer to negotiate with the Board. F I N A N C I A L R I S K M A N A G E M E N T 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, produc- tion or contractual commitments. The Company operates only in the United States, and therefore, is not sub- ject 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 sub- ject 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 2001, the Company issued a single series of $20 mil- lion, 30-year senior notes at 7.13%. To expand access to capital debt markets, the Company may investigate the use of private and public markets for future debt issues. It may also consider financing on a parent com- pany 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 operat- ing 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 has 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 less- ened; however, regulated parameters also can be recognized as limitations to operations and earnings, and the ability to respond to certain business condition changes. Also, changes in regulatory practices can impact the Company’s operations as was experienced during 2001 when the CPUC adopted a new policy for recovery of off- setable expenses. Non-regulated operations are subject to risk of contract constraints 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 considering 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. N E W A C C O U N T I N G S T A N D A R D S In July 2001, the Financial Accounting Standards Board issued Statement No. 141, “Business Combinations,” and Statement No. 142, “Goodwill and Other Intangible Assets.” Statement No. 141 requires that the pur- chase method of accounting be used for all business combinations initiated after June 30, 2001 as well as for all purchase method business combinations completed after June 30, 2001. Statement No. 141 also specifies conditions that intangible assets acquired in a purchase method business combination must meet to be recog- nized and reported apart from goodwill. Statement No. 142 specifies that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accor- dance with the provisions of Statement No. 142. The statement also requires that intangible assets with deter- minable useful lives be amortized over their useful lives to their estimated residual values and reviewed for impairment. Statement No. 142 is effective for the Company on January 1, 2002. Its adoption is not expected to have a material impact on the Company’s financial position or results of operations. In June 2001, Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” of long-lived assets was issued. The statement is effective for fiscal years beginning after June 15, 2002. The Company has not yet completed a full review of the impact that adopting the statement will have on its financial position or results of operations, and therefore is unable to state the impact that adopting the statement will have on its financial position or results of operations. In August 2001, Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” was issued. The statement sets forth requirements for measuring impairment of a long-lived asset that is defined as the condition that exists when the carrying amount of a long-lived asset exceeds its fair value. The statement also establishes criteria in which an impairment loss must be recognized. The Company has not yet completed a full assessment of the impact of adopting this statement, and therefore is uncertain as to the impact that adopting the statement will have on its financial position or results of operations. The statement is effective for the Company on January 1, 2002. 24 C A L I F O R N I A WA T E R S E R V I C E G R O U P 25 C A L I F O R N I A WA T E R S E R V I C E G R O U P Consolidated Balance Sheet In thousands, except per share data December 31, 2001 and 2000 A S S E T S 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 2001 2000 2001 2000 $ 10,709 859,846 26,826 12,277 909,658 285,316 624,342 $ 10,641 797,403 31,400 11,837 851,281 268,499 582,782 953 3,241 14,572 8,228 7,291 2,147 7,224 40,415 38,893 3,800 2,764 45,457 15,163 5,450 7,964 2,718 5,483 40,019 38,133 3,817 1,854 43,804 C A P I T A L I Z A T I O N A N D L I A B I L I T I E S Capitalization: Common stock, $.01 par value; 25,000 shares authorized, 15,182 and 15,146 shares $ 152 $ 151 outstanding in 2001 and 2000, 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 Commitments 49,984 147,299 (816) 196,619 3,475 202,600 402,694 5,381 22,000 24,032 3,813 2,535 21,228 78,989 2,882 28,816 20,680 106,657 69,496 49,984 149,185 (486) 198,834 3,475 187,098 389,407 2,881 14,598 26,493 3,976 2,579 13,209 63,736 2,989 25,620 20,316 105,562 58,975 $710,214 $666,605 $710,214 $666,605 See accompanying notes to consolidated financial statements. 26 C A L I F O R N I A WA T E R S E R V I C E G R O U P 27 C A L I F O R N I A WA T E R S E R V I C E G R O U P Consolidated Statement of Income In thousands, except per share data For the years ended December 31, 2001, 2000 and 1999 2001 2000 1999 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 $246,820 $244,806 $234,937 73,174 21,130 5,910 36,521 34,109 12,131 19,226 9,728 9,740 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 9,138 221,669 211,610 201,890 Net operating income 25,151 33,196 33,047 Other income and expenses, net Income before interest expense Interest expense: Long-term debt interest Other interest Total interest expense Net income Earnings per share: Basic Diluted 5,843 30,994 14,187 1,842 16,029 1,413 34,609 12,901 1,745 14,646 3,089 36,136 13,084 1,081 14,165 $ 14,965 $ 19,963 $ 21,971 $ 0.98 $ 0.97 $ 1.31 $ 1.31 $ 1.45 $ 1.44 Consolidated Statement of Common Stockholders’ Equity and Comprehensive Income In thousands For the years ended December 31, 2001, 2000 and 1999 Stock Common Additional Paid-in Capital Other Total Total Retained Comprehensive Stockholders’ Comprehensive Earnings Income (Loss) Equity Income Accumulated Balance at December 31, 1998 $150 $48,372 $139,054 $ — $187,576 $ — Issuance of common stock Net income Dividends paid: Preferred stock Common stock Total dividends paid Other comprehensive loss 1 — — — — — 968 — — — — — — 21,971 153 15,262 15,415 — 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 Other comprehensive income — — — — — — 644 — — — — — — 19,963 152 16,236 16,388 — — — — — — (517) (517) — — — — — 31 969 21,971 — 21,971 153 15,262 15,415 (517) 194,584 644 19,963 152 16,236 16,388 31 — — — (517) 21,454 — 19,963 — — — 31 Balance at December 31, 2000 151 49,984 149,185 (486) 198,834 19,994 Acquisition Net income Dividends paid: Preferred stock Common stock Total dividends paid Other comprehensive loss 1 — — — — — — — — — — — 220 14,965 153 16,918 17,071 — — — — — — 221 14,965 153 16,918 17,071 — 14,965 — — — (330) (330) (330) Balance at December 31, 2001 $152 $49,984 $147,299 $(816) $196,619 $14,635 Weighted average number of common shares outstanding: Basic Diluted 15,182 15,285 15,126 15,173 15,090 15,142 See accompanying notes to consolidated financial statements. See accompanying notes to consolidated financial statements. 28 C A L I F O R N I A WA T E R S E R V I C E G R O U P 29 C A L I F O R N I A WA T E R S E R V I C E G R O U P Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements In thousands December 31, 2001, 2000, and 1999 For the years ended December 31, 2001, 2000, 1999 2001 2000 1999 N O T E 1. O R G A N I Z A T I O N A N D O P E R A T I O N S Net cash used in investing activities (62,049) (37,161) 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 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 by financing activities Change in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental disclosures of cash flow information: Cash paid during the year for: Interest (net of amounts capitalized) Income taxes Non-cash financing activity - common stock issued in acquisitions See accompanying notes to consolidated financial statements. $14,965 $19,963 $21,971 19,226 18,368 17,246 2,919 (3,203) 1,360 (2,186) 673 (2,461) 6,642 (1,191) 23,622 38,587 (1,503) 235 (255) 1,093 (71) 14,664 34,627 (53,379) (8,670) — (33,540) (3,621) — 7,402 — 20,524 6,498 (4,166) 10,868 (2,881) (17,071) 21,174 (2,288) 3,241 $ 953 599 644 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 $ 3,241 $ 1,655 $14,378 6,238 899 $14,785 11,775 — $13,796 11,499 922 California Water Service Group (Company) is a holding company incorporated in Delaware that through its wholly owned subsidiaries provides water utility and other related services in California, Washington and New Mexico. 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 commis- sions (jointly referred to as Commissions). CWS Utility Services provides non-regulated water utility and util- ity-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. N O T E 2. S U M M A R Y O F S I G N I F I C A N T A C C O U N T I N G P O L I C I E S The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The financial statements give retroactive effect to acquisitions, 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), which was merged into the Company on May 25, 2000, 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 accounting principles gener- ally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue Revenue consists of monthly cycle customer billings for regulated water 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. The unearned portion is deferred into the following accounting period. Expense balancing accounts are used to track suppliers’ rate increases for purchased water, purchased power and pump taxes that are not included in customer water rates. The cost increases are referred to as “Offsetable Expenses” because under certain circumstances they are recoverable from customers in future rate increases designed to offset the higher costs. The Company does not record the balancing accounts until the CPUC has authorized a change in customer rates and the customer has been billed. 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 eliminated from utility plant accounts and such costs are charged against accumulated deprecia- tion. Maintenance of utility plant is charged primarily to operation expenses. Interest is capitalized on plant expenditures during the construction period and amounted to $858,000 in 2001, $703,000 in 2000 and $324,000 in 1999. 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 evalu- ates the recoverability of utility plant by assessing whether the amortization of the balance over the remaining life can be recovered through the expected and undiscounted future cash flows. 30 C A L I F O R N I A WA T E R S E R V I C E G R O U P 31 C A L I F O R N I A WA T E R S E R V I C E G R O U P Notes (continued) 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 2001 and 2000, and 2.5% in 1999. 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. 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 obligations and is classified in other prepaid expenses. At December 31, 2001 and 2000, the amounts restricted were $887,000 and $755,000, respectively. Regulatory Assets The Company records regulatory assets for future revenues expected to be realized as the tax effects of certain temporary differences previously passed through to customers reverse. The temporary dif- ferences relate primarily to the difference between book and income tax depreciation on utility plant that was placed in service before the regulatory Commissions adopted normalization for ratemaking purposes. The reg- ulatory assets are net of revenue related to deferred income taxes that were provided at prior tax rates and the amount that would be provided at current tax rates. The differences will reverse over the remaining book lives of the related assets. Long-term Debt Premium, Discount and Expense The discount and issuance expense on long-term debt is amortized over the original lives of the related debt issues. Premiums paid on the early redemption of certain debt issues and 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 (net of income tax) as a separate component of Stockholders’ Equity. Advances for Construction Advances for construction consist of payments received from developers for installation of water production and distribution facilities to serve new developments. Advances are excluded from rate base for rate setting purposes. Annual refunds are made to developers without interest 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, 2001, the amounts refundable under the 20-year contracts were $4,320,000 and under 40-year contracts were $102,337,000. Estimated refunds for 2002 for all water main extension contracts are $4,475,000. 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 contributions 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 liabilities of a change in tax rates is recognized in the period that includes the enact- ment 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 subse- quent 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 stockholders by the weighted average shares outstanding during the year. Diluted EPS is calculated by divid- ing income available to common stockholders by the weighted average shares outstanding and potentially dilu- tive 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 mar- ket price on the date of the option grant. Business Combinations In July 2001, the Financial Accounting Standards Board issued Statement No. 141, “Business Combinations.” Statement No. 141 requires that the purchase method of accounting be used for all business combinations after June 30, 2001. Statement No. 141 also specifies conditions that intangible assets acquired in a purchase method of business combinations must meet to be recognized and reported apart from goodwill. The Company adopted Statement No. 141 immediately. The Company is not involved in a business combination initiated prior to July 1, 2001 that would be accounted for using the pooling-of-interest method. N O T E 3. M E R G E R W I T H D O M I N G U E Z S E R V I C E S C O R P O R A T I O N 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. 32 C A L I F O R N I A WA T E R S E R V I C E G R O U P 33 C A L I F O R N I A WA T E R S E R V I C E G R O U P Notes (continued) The Merger was accounted for as a pooling of interests. There were no intercompany transactions as a New Mexico Water has agreed to acquire the Rio Grande Utility Corporation, which serves 2,300 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: water and 1,600 wastewater customers, for $2.3 million in cash and assumed debt of $3.1 million. The acquisi- tion is expected to be completed in the second quarter of 2002 after approval of the state’s regulatory authority is received. Unaudited – In thousands Revenue: Company Dominguez Net income: Company Dominguez 6 Months Ended 6-30-00 Year Ended 12-31-99 $ 98,428 14,232 $112,660 $ 6,139 1,147 $ 7,286 $206,440 28,497 $234,937 $ 19,919 2,052 $ 21,971 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. N O T E 4. O T H E R A C Q U I S I T I O N S In 2001, the Company acquired four companies operating in the Company’s Visalia district. The companies serve 1,100 customers. The acquisitions were completed in February 2001, in exchange for 36,180 shares of Company common stock worth $899,000 and assumed debt of $218,000. The acquisitions were accounted for under the pooling of interests method; however, due to the results from operations not being material to the Company’s consolidated results from operations, prior periods were not restated. The net equity acquired was recorded as an increase to retained earnings at the beginning of the year. In addition, the Company purchased the assets of seven Washington water systems for cash of $701,000. The acquired companies serve approxi- mately 700 customers and produce annual revenue of about $270,000. The acquisitions were accounted for under purchase accounting. During 2000, the Company purchased the assets of Mirrormount Water Services and Lacamas Farmsteads Water Company 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 under purchase accounting. During 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 customers. The acquisitions were accounted for under the pooling of interests method 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 separate entities are included in the accompanying consolidated financial state- ments. Two other water company asset acquisitions were completed in 1999. The acquired companies served 288 customers. The acquisitions were accounted for under purchase accounting. During 1998, the Company agreed to purchase 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 acquisitions 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 pur- chases were completed on a non-cash basis in which the Company issued common stock valued at $922,000 and assumed debt obligations of $1,108,000. N O T E 5. P R E F E R R E D S T O C K As of December 31, 2001 and 2000, 380,000 shares of preferred stock were authorized. Dividends on outstanding shares are payable quarterly at a fixed rate before any dividends can be paid on common stock. 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 convertible 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. N O T E 6. C O M M O N S T O C K H O L D E R S’ E Q U I T Y The Company is authorized to issue 25,000,000 shares of $.01 par value common stock. As of December 31, 2001 and 2000, 15,182,046 and 15,145,866 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 (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 circum- stances. 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 dividend equal to 100 times any dividend paid on common stock and 100 votes per share in any stockholder election. The Rights become exercisable upon occurrence of a Distribution Date. A Distribution Date event occurs if (a) any person accumulates 15% of the then outstanding Common Stock, (b) any person presents a tender offer which 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 sep- arately transferable. When a Distribution Date occurs: (a) the Company would distribute separate Rights Certificates to Common Stockholders and the Rights would subsequently trade separate from the Common Stock; and (b) each holder of a Right, other than the acquiring person (whose Rights would thereafter be void), would have the right to receive upon exercise at its then current Purchase Price that number of shares of Common Stock having a market value of two times the Purchase Price of the Right. If the Company merges into the acquiring person or enters into any transaction that unfairly favors the acquiring person or disfavors the Company’s other stockholders, the Right becomes a right to purchase Common Stock of the acquiring person having a market value of two times the Purchase Price. The Board may determine that in certain circumstances a proposal that would cause a Distribution Date is in the Company stockholders’ best interest. Therefore, the Board may, at its option, redeem the Rights at a redemption price of $.001 per Right. 34 C A L I F O R N I A WA T E R S E R V I C E G R O U P 35 C A L I F O R N I A WA T E R S E R V I C E G R O U P Notes (continued) N O T E 7. S H O R T- T E R M B O R R O W I N G S As of December 31, 2001, the Company maintained a bank line of credit providing unsecured borrowings of up to $10,000,000 at the prime lending rate or lower rates as quoted by the bank. Approximately $7,562,000 of the line is committed 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- owned land on a tax-free basis. Cal Water maintained a bank line of credit for an additional $50,000,000 on the same terms as the Company. The line of credit agreements, which expire in April 2003 and which the Company expects to renew, do not require minimum or specific compensating balances. Washington Water has a $0.1 million bank line of credit with nothing outstanding at December 31, 2001. The following table represents borrowings under the bank lines of credit: Dollars in thousands 2001 2000 1999 Maximum short-term borrowings Average amount outstanding Weighted average interest rate Interest rate at December 31 N O T E 8. L O N G- T E R M D E B T As of December 31, 2001 and 2000, long-term debt outstanding was: In thousands Series J K P S BB CC DD EE FF GG A B C D 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% 7.13% 3.0% to 8.1% $36,800 24,453 5.29% 3.16% $26,750 16,810 7.77% 7.88% $25,500 9,093 6.52% 7.11% Maturity Date 2001 2000 2023 2012 2002 2003 2008 2020 2022 2023 2023 2023 2025 2028 2030 2031 2011-32 $ 4,000 $ 4,000 5,000 2,565 2,580 11,520 18,500 19,100 19,200 19,200 19,200 5,000 2,580 2,595 13,230 18,600 19,200 19,300 19,300 19,300 120,865 123,105 20,000 20,000 20,000 20,000 2,886 4,230 207,981 5,381 20,000 20,000 20,000 — 3,176 3,698 189,979 2,881 Long-term debt excluding current maturities $202,600 $187,098 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 principal 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 financial institu- tions. Aggregate maturities and sinking fund requirements for each of the succeeding five years (2002 through 2006) are $5,381,000, $5,204,000, $2,579,000 $2,579,000, and $2,605,000. N O T E 9. I N C O M E T A X E S Income tax expense consists of the following: In thousands 2001 2000 1999 Current Deferred Total Current Deferred Total Current Deferred Total Federal State Total $ 6,472 1,456 $ 7,928 $ 7,961 1,554 $ 9,515 $ 8,291 2,769 $11,060 $2,136 (336) $1,800 $2,519 (463) $2,056 $2,560 (105) $2,455 $ 8,608 1,120 $ 9,728 $10,480 1,091 $11,571 $10,851 2,664 $13,515 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 2001 2000 1999 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 The components of deferred income tax expense were: In thousands Depreciation Developer advances and contributions Bond redemption premiums Investment tax credits Other $8,643 $11,037 $12,420 1,170 (156) 71 $9,728 1,336 (155) (647) 1,624 (184) (345) $11,571 $13,515 2001 2000 1999 $2,337 (783) (42) (94) (298) $2,031 (814) (61) (61) (4) $2,974 (749) (62) (94) 595 Total deferred income tax expense $1,120 $1,091 $2,664 36 C A L I F O R N I A WA T E R S E R V I C E G R O U P 37 C A L I F O R N I A WA T E R S E R V I C E G R O U P $41,531 $40,458 Pension Benefits Other Benefits Notes (continued) The tax effects of differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2001 and 2000 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 2001 2000 5,744 1,703 537 938 868 51,321 79,348 789 80,137 $28,816 5,648 1,765 632 736 4,860 54,099 78,894 825 79,719 $25,620 A valuation allowance was not required during 2001 and 2000. 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. N O T E 10. E M P L O Y E E B E N E F I T P L A N S Pension Plan The Company provides a qualified defined benefit, non-contributory pension plan for substan- tially all employees. The cost of the plan was charged to expense and utility plant. The Company makes annual contributions to fund the amounts accrued for pension cost. Plan assets are invested in mutual funds, 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 fully funded and additional contributions to the plan could not be funded, although plan annual expense was recorded. At the merger date, the Dominguez plan was curtailed. As a result of the curtailment, accrued pension 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 18% of pre-tax compensation in 2001 and 2000, and 15% in 1999. The Company matches fifty cents for each dollar contributed by the employee up to a maximum Company match of 4%. Company contributions were $1,425,000, $1,298,000, and $1,126,000, for the years 2001, 2000 and 1999. 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 service 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 mutual funds, short-term money market instruments and commercial paper. The Company records the costs of postretirement benefits during the employees’ years of active ser- vice. The Commissions have issued decisions that authorize rate recovery of tax deductible funding of postre- tirement benefits and permit recording of a regulatory asset for the portion of costs that will be recoverable in future rates. The following table reconciles the funded status of the plans with the accrued pension liability and the net postretirement benefit liability as of December 31, 2001 and 2000: In thousands 2001 2000 2001 2000 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: $59,098 $ 55,692 $ 12,052 $10,195 2,786 4,333 1,326 11 2,289 — (9,484) $60,359 2,846 4,079 825 1,215 (34) (1,347) (4,178) 625 858 1,943 — 15 — (785) $ 59,098 $ 14,708 544 790 394 — 558 — (429) $12,052 Fair value of plan assets at beginning of year $63,648 $ 61,008 $ 2,067 $ 1,561 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 1,356 1,820 — (9,484) $57,340 3,140 3,678 — (4,178) $ 63,648 237 781 415 (1,201) 228 707 370 (799) $ 2,299 $ 2,067 $ (3,019) $ 4,550 $(12,408) $ (9,985) (6,191) 4,525 — — (13,534) 5,279 — 228 3,339 817 3,321 (276) 1,422 888 3,597 (276) $ (4,685) $ (3,477) $ (5,207) $ (4,354) Amounts recognized on the balance sheet consist of: In thousands 2001 2000 2001 2000 Pension Benefits Other Benefits Accrued benefit costs Additional minimum liability Intangible asset Accumulated other comprehensive loss Net amount recognized $(4,685) (1,396) 580 816 $(3,477) (1,363) 877 486 $(5,207) $(4,354) — — — — — — $(4,685) $(3,477) $(5,207) $(4,354) Pension Benefits Other Benefits 2001 2000 2001 2000 Weighted average assumptions as of December 31: Discount rate Long-term rate of return on plan assets Rate of compensation increases 7.00% 8.00% 4.25% 7.25% 8.00% 4.50% 7.00% 8.00% — 7.25% 8.00% — 38 C A L I F O R N I A WA T E R S E R V I C E G R O U P 39 C A L I F O R N I A WA T E R S E R V I C E G R O U P Notes (continued) Net periodic benefit costs for the pension and other postretirement plans for the years ending December 31, 2001, 2000 and 1999 included the following components: In thousands Service cost Interest cost Expected return on plan assets Net amortization and deferral Net periodic benefit cost Pension Benefits Other Benefits 2001 2000 1999 2001 2000 1999 $2,786 4,333 (4,946) 855 $3,028 $2,846 4,079 (4,498) 486 $2,913 $2,899 3,894 (4,450) 871 $3,214 $ 625 $ 544 $ 498 858 (212) 363 790 (152) 357 689 (144) 401 $1,634 $1,539 $1,444 Postretirement benefit expense recorded in 2001, 2000, and 1999 was $885,000, $781,000, and $1,064,000, respectively. $4,186,000, 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 2001 measurement purposes, the Company assumed an 8% annual rate of increase in the per capita cost of covered benefits with the rate decreasing 1% per year to a long-term annual rate of 5% per year after three years. The health care cost trend rate assumption has a significant effect on the amounts reported. A one- percentage point change in assumed health care cost trends is estimated to have the following effect: In thousands Effect on total service and interest costs Effect on accumulated postretirement benefit obligation N O T E 11. S T O C K- B A S E D C O M P E N S A T I O N P L A N S Increase Decrease $ 278 2,350 $ (220) (1,904) At the Company’s 2000 annual meeting, stockholders approved a Long-Term Incentive Plan that allows grant- ing 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 anniver- sary date over their first four years and are exercisable over a ten-year period. At December 31, 2001, 11,875 options were vested. Certain key Dominguez executives participated in the Dominguez 1997 Stock Incentive Plan that was terminated 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 provisions 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 No. 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, 2001, 2000 and 1999 would be as presented in the following table: In thousands As reported Pro forma 2001 2000 1999 $14,965 14,898 $19,963 19,939 $21,971 21,937 The fair value of stock options used to compute pro forma net income and earnings per share disclo- sures is the estimated fair value at grant date using the Black-Scholes option-pricing model with the following assumptions: Expected dividend Expected volatility Risk-free interest rate Expected holding period in years 2 0 0 1 2 0 0 0 1 9 9 9 4.3% 30.4% 4.6% 5.0 4.3% 22.0% 4.9% 5.0 4.3% 22.6% 6.2% 10.0 The following table summarizes the activity for the stock option plans: Outstanding at December 31, 1998 Exercised Outstanding at December 31, 1999 Granted Exercised Outstanding at December 31, 2000 Granted Cancelled Outstanding at December 31, 2001 Shares 56,221 (3,864) 52,357 53,500 (52,357) 53,500 58,000 (12,000) 99,500 Weighted Average Exercise Price Weighted Average Remaining Contractual Life Options Exercisable Weighted Average Fair Value $23.38 22.54 23.45 23.06 23.45 23.06 25.94 24.50 24.57 — — 9.5 8.8 8,901 19,092 — 11,875 — — $3.74 — 5.65 — N O T E 12. FA I R VA L U E O F F I N A N C I A L I N S T R U M E N T S 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 including current installments is estimated at $214,046,000 as of December 31, 2001, and $199,890,000 as of December 31, 2000, using a discounted cash flow analysis, 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 $32,000,000 as of December 31, 2001 and $27,000,000 as of December 31, 2000, based on data provided by brokers. 40 C A L I F O R N I A WA T E R S E R V I C E G R O U P 41 C A L I F O R N I A WA T E R S E R V I C E G R O U P Notes (continued) N O T E 13. C O M M I T M E N T S The Company leases office facilities in many of its operating districts. The total paid and charged to operations for such leases was $720,000 in 2001, $760,000 in 2000, and $663,000 in 1999. Payments under the lease com- mitments over the succeeding five years 2002 through 2006 are estimated to be $750,000, $780,000, $830,000, $867,000 and $911,000. Over the 20-year period through 2022, payments under lease commitments, assuming renewal of existing or replacement leases, is estimated to be $21,000,000. The Company has long-term contracts with two wholesale water suppliers that require the Company to purchase minimum annual water quantities. Purchases are priced at the suppliers’ then current wholesale water rate. The Company operates to purchase sufficient water to equal or exceed the minimum quantities under both contracts. The total paid under the contracts was $6,208,000 in 2001, $5,400,000 in 2000 and $4,766,000 in 1999. The estimated payments under the contracts for the five years 2002 through 2006 are esti- mated to be $7,000,000, $7,280,000, $7,571,000, $7,874,000 and $8,190,000. The water supply contract with Stockton East Water District (SEWD) requires a fixed, annual pay- ment and does not vary with the quantity of water delivered by the district. Because of the fixed price arrangement, the Company operates to receive as much water as possible from SEWD in order to minimize the cost of operating wells to supplement SEWD deliveries. The total paid under the contract was $3,496,000 in 2001, $3,269,000 in 2000 and $3,086,000 in 1999. Pricing under the contract varies annually. For 2002, the estimated payment is $3,198,000. The Company has committed $7.6 million of its $10 million bank credit line to a contractor for con- struction of a new operation facility. At December 31, 2001, $6.3 million had been drawn to acquire land and construct the facility. The amount drawn on the credit line is an obligation of the contractor, but guaranteed by the Company. The new facility is pledged to the Company as security for the guarantee. The Company occupied the new facility in January 2002 on a month-to-month rent basis. The Company expects to exchange surplus real property for the new facility on a tax-free basis after mid-year 2002 at which time the contractor will repay the construction loan and the Company’s commitment would be extinguished. N O T E 14. Q UA R T E R LY F I N A N C I A L D A T A ( U N AU D I T E D) The Company’s common stock is traded on the New York Stock Exchange under the symbol “CWT.” Quarterly dividends have been paid on common stock for 228 consecutive quarters and the quarterly rate has been increased each year since 1968. 2001 – in thousands except per share amounts First Second Third Fourth Operating revenue Net operating income Net income Diluted earnings per share Common stock market price range: High Low Dividends paid $47,008 3,792 221 .01 28.60 23.38 .27875 $66,958 $76,310 $56,544 8,050 5,764 .37 27.70 24.10 .27875 9,517 5,920 .39 27.00 23.77 .27875 3,792 3,060 .20 27.50 24.00 .27875 2000 – in thousands except per share amounts First Second Third Fourth Operating revenue Net operating income Net income Diluted earnings per share Common stock market price range: High Low Dividends paid $46,694 $65,966 4,902 1,533 .10 31.38 22.25 .275 8,977 5,753 .38 26.75 21.50 .275 $76,580 12,782 9,205 .60 26.88 22.50 .275 $55,566 6,535 3,472 .23 27.81 24.88 .275 Independent Auditors’ Report T H E B O A R D O F D I R E C T O R S C A L I F O R N I A WA T E R S E R V I C E G R O U P: We have audited the accompanying consolidated balance sheet of California Water Service Group and sub- sidiaries as of December 31, 2001 and 2000, 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, 2001. 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 for the year ended December 31, 1999, 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 consoli- dated financial statements of Dominguez Services Corporation and subsidiaries, which financial statements reflect total revenue constituting 12.1 percent of the related consolidated total as of December 31, 1999. Those financial 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 for the year ended December 31, 1999, 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 reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of California Water Service Group and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001 in conformity with account- ing principles generally accepted in the United States of America. Mountain View, California January 30, 2002 42 C A L I F O R N I A WA T E R S E R V I C E G R O U P 43 C A L I F O R N I A WA T E R S E R V I C E G R O U P Corporate Information Board of Directors S T O C K T R A N S F E R , D I V I D E N D D I S B U R S I N G A N D R E I N V E S T M E N T A G E N T A N N U A L M E E T I N G The Annual Meeting of Stockholders will be held on Wednesday, April 24, 2002, 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 25, 2002. D I V I D E N D D A T E S F O R 2 0 0 2 Quarter Declaration Record Date Payment Date First Second Third Fourth January 30 April 24 July 24 October 23 February 8 May 6 August 5 November 4 February 22 May 20 August 19 November 18 A N N U A L R E P O R T F O R 2 0 0 1 O N F O R M 1 0 - K A copy of the Company’s report for 2001 filed with the Securities and Exchange Commission on Form 10-K will be available in April 2002 and can be obtained by any stockholder at no charge upon written request to the address below. S T O C K H O L D E R I N F O R M A T I O N 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 Fleet National Bank c/o EquiServe L.P. P.O. Box 43010 Providence, RI 02940-3010 (800) 736-3001 T O T R A N S F E R S T O C K 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 transfer 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 guaranteed by an eligible guarantor institution (banks, stock brokers, savings and loan associations and credit unions with membership in approved signature medallion programs) pursuant to SEC Rule 17Ad-15. A notary’s acknowledgement is not accept- able. This certificate should then be sent to EquiServe, L.P. Stockholder Services, by registered or certified mail with complete transfer instructions. B O N D R E G I S T R A R US Bank Trust, N.A. One California Street San Francisco, CA 94111-5402 (415) 273-4580 E X E C U T I V E O F F I C E California Water Service Group 1720 North First Street San Jose, CA 95112-4598 (408) 367-8200 Officers C A L I F O R N I A WA T E R S E R V I C E C O M PA N Y Robert W. Foy 1, 2, 3 Chairman of the Board Peter C. Nelson 1, 2, 3 President and Chief Executive Officer Christine L. McFarlane Vice President, Human Resources Raymond H. Taylor Vice President, Operations Paul G. Ekstrom 4 Vice President, Customer Service and Corporate Secretary Dan L. Stockton Vice President, Chief Information Officer Gerald F. Feeney 1, 2, 3 Vice President, Chief Financial Officer and Treasurer Calvin L. Breed 1 Controller, Assistant Secretary and Assistant Treasurer Francis S. Ferraro 5 Vice President, Regulatory Matters and Corporate Development WA S H I N G T O N WA T E R S E R V I C E C O M PA N Y Robert R. Guzzetta 2 Vice President, Engineering and Water Quality 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 4 Also Corporate Secretary of California Water Service Group, CWS Utility Services, Washington Water Service Company and New Mexico Water Service Company 5 Holds the same position with New Mexico Water Service Company Peter C. Nelson * President and Chief Executive Officer C.H. Stump # Former Chairman of the Board and CEO of California Water Service Company Langdon W. Owen † President, Don Owen & Associates; Member of the Board of Directors, Metropolitan Water District of Southern California Edward D. Harris, Jr., M.D. ‡* George DeForest Barnett Professor of Medicine, Stanford University Medical Center Douglas M. Brown ‡ President and CEO of Tuition Plan Consortium; Chairman of Talbot Financial Services Robert W. Foy * Chairman of the Board Linda R. Meier †‡ Member, National Advisory Board, Haas Public Service Center; Member of the Board of Directors, Greater Bay Bancorp George A. Vera † Vice President and Chief Financial Officer, the David & Lucile Packard Foundation Richard P. Magnuson †‡ Private Venture Capital Investor † Member of the Audit Committee ‡ Member of the Compensation Committee * Member of the Executive Committee # Director Emeritus California Water Service Group (Company) provides high-quality water utility services to 1.5 million people through its four subsidiaries: California Water Service Company (Cal Water), Washington Water Service Company (Washington Water), New Mexico Water Service Company (New Mexico Water) and CWS Utility Services. Regulated by state utility commissions, Cal Water and Washington Water provide water utility services to customers in 96 communities throughout California and Washington. New Mexico Water is nearing completion of its acquisition of a regulated water utility in that state. CWS Utility Services conducts the Company’s non-regulated business, which includes providing billing and meter reading services, as well as full-system water operations, for cities and companies in California, Washington and New Mexico. D E S I G N : D o u g l a s Jo s e p h Pa r t n e r s, L o s A n g e l e s C a l i f o r n i a Wa t e r S e r v i c e G r o u p 1 7 2 0 N o r t h F i r s t S t r e e t S a n Jo s e, C a l i f o r n i a 9 5 1 1 2 - 4 5 9 8 ( 4 0 8 ) 3 6 7 - 8 2 0 0 w w w. c a l wa t e r. c o m E W M EXI C O N S H I NGT O N A W