California Water Service Group Annual Report 2002

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FY2002 Annual Report · California Water Service Group

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Califor nia Water Service Group
A refreshingly clear c hoice

2 0 0 2 A N N UA L R E P O RT

C A L I F O R N I A WAT E R S E RV I C E G RO U P ( C O M PA N Y ) P ROV I D E S H I G H - QUA L I T Y WAT E R

U T I L I T Y S E RV I C E S TO 2 M I L L I O N P E O P L E B Y M E A N S O F F O U R S U B S I D I A R I E S :

C A L I F O R N I A WAT E R S E RV I C E C O M PA N Y ( C A L WAT E R ) , WA S H I N G TO N WAT E R S E RV I C E

C O M PA N Y ( WA S H I N G TO N WAT E R ) , N E W M E X I C O WAT E R S E RV I C E C O M PA N Y ( N E W

M E X I C O WAT E R ) , A N D C W S U T I L I T Y S E RV I C E S. R E G U L AT E D B Y S TAT E U T I L I T Y

C O M M I S S I O N S , C A L WAT E R , WA S H I N G TO N WAT E R , A N D N E W M E X I C O WAT E R

P ROV I D E WAT E R U T I L I T Y S E RV I C E S TO C U S TO M E R S I N 9 8 C O M M U N I T I E S

T H RO U G H O U T C A L I F O R N I A , WA S H I N G TO N, A N D N E W M E X I C O. T H E C O M PA N Y

E X P E C T S TO B E G I N P ROV I D I N G R E G U L AT E D WAT E R S E RV I C E S I N H AWA I I B Y

M I D - 2 0 0 3 U P O N C O M P L E T I O N O F I T S AC QU I S I T I O N O F T H E K A A N A PA L I WAT E R

C O R P O R AT I O N. C W S U T I L I T Y S E RV I C E S C O N D U C T S T H E C O M PA N Y ’ S N O N - R E G U -

L AT E D BU S I N E S S, W H I C H I N C L U D E S P E R F O R M I N G B I L L I N G A N D M E T E R R E A D I N G

S E RV I C E S A N D F U L L - S YS T E M WAT E R O P E R AT I O N S F O R C I T I E S A N D C O M PA N I E S I N

C A L I F O R N I A , WA S H I N G TO N, A N D N E W M E X I C O.

C O N T E N T S

L e t t e r t o S t o c k h o l d e r s 2

F i n a n c i a l S e c t i o n 1 8

I n d e p e n d e n t A u d i t o r ' s R e p o r t 5 5

C o r p o r a t e I n f o r m a t i o n 5 6

B o a r d o f D i r e c t o r s 5 7

F i n a n c i a l H i g h l i g h t s

In thousands, except per share amounts

Year ended December 31

2002

2001

2000

1999

1998

B o o k v a l u e

$ 13.12

$ 12.95

$ 13.13

$ 12.89

$ 12.49

M a r k e t p r i c e a t y e a r - e n d

E a r n i n g s p e r s h a r e

D i v i d e n d s p e r s h a r e

R e v e n u e

N e t i n c o m e

23.65

1.25

1.12

25.75

0.97

1.115

27.00

1.31

1.10

30.31

1.44

1.085

31.31

1.31

1.07

263,151

246,820

244,806

234,937

214,926

19,073

14,965

19,963

21,971

19,860

To Our Stockholders

What does it mean to be the refreshingly clear choice? To us,

it means being the company that stockholders choose because we offer value.

It means being the company that customers trust because we provide the high-

est quality ser vice and the highest quality product. And it means being the

company that attracts the best water professionals in the industry because

we expect and reward excellent performance.

California Water Service Group is the largest investor-owned

INDUSTRY

OVERVIEW

water utility west of the Mississippi, and the second largest in the United

States. After a period of considerable consolidation, only 12 investor-owned

2002

FINANCIAL

RESULTS

water utilities remain in our country. Investors continue to like the industry

because it is regulated and subject to lower business cycle risk than non-regulat-

ed industries, its ear nings drivers are straightforward, it has a long record

of paying dividends, and it provides a life-sustaining, essential product, the

demand for which continues to grow. So what sets an industry leader apar t

from the rest of the pack? What makes Califor nia Water Ser vice Group the

refreshingly clear choice?

In our estimation, leaders emerge in the most challenging of

times. Last year, we reported on the significant challenges facing the industry–

most notably, the tough regulatory climate in California and cool, wet weather.

We laid out our strategy for tackling these challenges, which included pursu-

ing growth in new and existing ser vice areas, initiating a comprehensive plan

to counteract unfair delays in regulatory decisions, and continuing to be dili-

gent in our effor ts to reduce expenses and increase our efficiency.

We are pleased to repor t that our strategy has yielded

success, as reflected in our improved financial results for 2002. We posted

earnings per share of $1.25, a 29% increase over 2001 earnings per share of

$0.97. Net income increased to $19,073,000 in 2002, compared to net income

of $14,965,000 in 2001. And revenue rose to $263,151,000, a 7% increase

over last year. While our results are significantly better than they were in

2001, we recognize that we must continue executing our strategy to deliver

even better results in the coming years.

I N C R E A S E I N E A R N I N G S P E R S H A R E

29%
N U M B E R O F N E W C O N N E C T I O N S8,600
58 years

C O N S E C U T I V E Y E A R S A D I V I D E N D H A S B E E N PA I D

GROWTH IN

REGULATED

BUSINESS

Weather is a key earnings driver in the water industry, and

there is no question that the climate played a role in our improved results;

in fact, increased water sales to existing customers added $6,887,000 to 2002

revenue. But our effor ts to grow and to win fair regulatory treatment paid off

too, as sales to new customers added $2,813,000 in revenue and rate increases

added another $6,631,000.

In 2002, we continued to execute our disciplined and

strategic growth plan. On the regulated side of the business, we added 8,600

customer connections. Nearly half of these new customers are ser ved by our

New Mexico subsidiary, which completed its acquisition of the Rio Grande

Utility Corporation in 2002 and signed an agreement to purchase National

Utilities Corporation, an acquisition we expect to complete in the third

quar ter of 2003. Washington Water added 600 customers with its purchase

of the Agotaras and Cascade Highlands Nor th water systems. In California,

we expanded existing ser vice areas, adding 3,900 connections in 2002.

We also took steps last year to establish our presence in yet

another state. In August, we signed an agreement to purchase for book value

the Kaanapali Water Corporation, a premium system ser ving several large,

high-end water users on the island of Maui in Hawaii. We expect to complete

this first transaction in the Aloha State by mid-2003.

On the non-regulated side of the business, we focused on

NON-

REGULATED

BUSINESS

improving the profitability of our contract operations, renegotiating agreements

and improving efficiency to enhance results. Our water rights brokering busi-

ness improved, and we leased additional antenna sites and sold several surplus

properties. We also began providing billing ser vices to the City of Stockton.

Our prog ress for the year was quite remarkable, consider-

RATE RELIEF

IN 2002

ing the fact that we did not have any new General Rate Cases approved in

Califor nia in 2002. However, we relentlessly pursued rate relief throughout

the year, and secured author ization to recover $1.9 million in previously-

incur red higher power costs, $2 million in step rate increases, and $2.7

million from General Rate Case decisions approved in 2001. Also, in

Washington, our General Rate Case was approved, adding $800,000 to

2002 revenues.

Although we did not receive the magnitude of rate relief

we feel we were entitled to in 2002, we did help bring about two significant

developments in the regulatory arena. First, we joined our colleagues in the

water utility industry to promote the passage of California Assembly Bill 2838,

a law intended to protect water utilities from losses resulting from regulatory

delays. Second, we were successful in urging the Califor nia Public Utilities

Commission (Commission) to allow water utilities to recover higher purchased

water and electricity costs incurred prior to November 29, 2001, but not yet

billed to customers. In the first quar ter of 2003, we filed a request with the

Commission to recover $6.4 million as a result of this decision; we expect the

Commission to respond to our request by mid-year 2003.

In January 2003, the Commission authorized additional step

OTHER

PENDING RATE

CASES AND

REGULATORY

ISSUES

rate increases in several California districts totaling $1.6 million in annual

revenue. More significantly, the Commission finally issued a draft of a pro-

posed decision on the 15 General Rate Case applications that we filed in

mid-2001. We expect final decisions in the first or second quar ter of 2003,

which could add nearly $13 million to annual revenue. Decisions on the

General Rate Case applications submitted in 2002 are expected in the third

PRUDENT

FISCAL

MANAGEMENT

quar ter of 2003.

Another significant development at the Commission was

Governor Gray Davis’ January 1, 2003, appointment of a new Commission

president and a new commissioner. The Company is encouraged by these

appointments and hopeful that with the new leadership, the Commission will

return to processing rate applications in a timely fashion and granting fair and

reasonable rate relief.

Rounding out our efforts to grow the business and seek better

regulatory treatment was our continued focus on prudent fiscal management.

We launched a program late in 2002 to refinance several series of first mor t-

gage bonds with lower interest rate senior notes. As a result of the refinancing

program, which will be completed in May 2003, we expect to realize a $1.5

million annual reduction in interest costs, which will benefit both stockholders

and customers.

In 2002, we faced a 6% increase in purchased water and

purchased power costs and pump taxes, as well as higher wage and benefit

expenses and increases in income taxes resulting from higher income. We

responded to increased costs by improving efficiency and applying strict

budgetary controls in every area of our operation. It is a reflection of our

employees’ commitment that we made such strides in reducing costs without

adversely impacting customer ser vice or water quality, and we commend

each and every employee for helping us achieve improved results.

After carefully considering 2002 operating results and the

DIVIDEND

INCREASE

outlook for the future, on January 29, 2003, our Board of Directors increased

the dividend for the 36th consecutive year to $1.125 per share. Our stockhold-

ers place great value on dividends, and 2002 marked the 58th consecutive year

that we have paid a dividend.

OUR VISION

that resulted in improved performance in 2002. We will pursue strategic growth

In the coming year, we will continue to execute the strategy

oppor tunities in the western United States; we will proactively seek fair and

timely rate relief; and we will maintain discipline in our fiscal management.

Most impor tantly, we will continue to transact all of our business prudently,

forthrightly, and with integrity.

We invite you to read on to see how our Vision, Value,

Quality, and Commitment make us the refreshingly clear choice–not just for

investors, but for customers and employees as well. In our view, financial per-

formance is but one of the measures of our success in 2002.

We look forward to achieving even better results in the com-

ing years, and we thank you for your continued investment in the California

Water Ser vice Group.

Sincerely,

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

Pe 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

We are the refreshingly
clear choice...

...for stockholders, who have
come to know us for our reliable
dividends and our solid financial
performance; for customers, who
rely on us to provide a high-quality
product and excellent service; and
for employees, who have come to
work where they are appreciated
and their contributions are valued.

v i s i o n

1
1

B e i n g s u c c e s s f u l m e a n s m e e t i n g
t h e d i ve r s e b u t i n t e r d e p e n d e n t
needs of stockholders, customers,
a n d e m p l oye e s.

When employees are engaged, customers are well

served. When customers are well served, stockholders see good

results. But does meeting the needs of one constituent preclude the

Company from meeting the needs of another? We think not, because

we see a common denominator in our ability to meet the needs of

all three, and that common denominator is resources. To achieve

our vision, we are executing a strategic plan that will enable us to

secure and deploy resources to meet the needs of stockholders,

customers, and employees.

First, we are continuing to seek growth in the western

United States, because disciplined expansion results in a more

valuable company, higher sales, and economies of scale. Second,

we are pursuing fair and reasonable rates, because no one wins

when we are not allowed to recover the true costs of providing

water service. Third, we are augmenting our regulated business

by maximizing non-regulated business performance, because doing

so enables us to ser ve more people while adding to the bottom

line. And fourth, we are staying focused on excellent ser vice and

efficiency, because our stockholders, customers, and employees

expect no less.

v a l u e

2
2

S o m e i nve s t o r s t a k e c h a n c e s
o n b u s i n e s s e s t h a t p r o m i s e
s k y - r o ck e t i n g r e s u l t s, b u t o u r
s t o ck h o l d e r s c h o o s e u s b e c a u s e
w e p r ov i d e va l u e .

Our business is straightforward–we are providing

a critical, essential product to a growing population. And as the

demand for an increasingly high-quality water supply grows, we

will continue to increase our investment in infrastructure. We will

need more projects like our Bakersfield Treatment Plant, which

will add 20 million gallons of treated surface water per day to our

supply. We will need wellhead treatment to meet new water quality

standards, like the one for arsenic, which will cost roughly $61

million by the time it takes effect in 2006. We will need reverse

osmosis plants, like the one in our Kern River Valley District

that helps ensure we have plenty of water to meet summertime

demands. That is where our stockholders come in–they earn

a return on these investments.

California Water Ser vice Group is not a risky new
venture. We are a solid, disciplined, 77-year-old company that

provides a life-sustaining, basic necessity. To our stockholders we

have delivered steady, reliable results through the decades, paying

dividends every year for 58 years and increasing them for 36 con-

secutive years.

q u a l i t y

3
3

C u s t o m e r s e x p e c t q u a l i t y,
b o t h i n o u r s e r v i c e a n d i n
o u r p r o d u c t .

We are committed to meeting the needs of our

customers, both for friendly, responsive ser vice and for clean,

good-tasting water. To evaluate our efforts to continuously improve

our service, we conduct regular surveys. In 2002, we again tracked

our performance in meeting customers’ needs the first time they

called us and asked customers how they would rate our knowledge,

professionalism, and courtesy. Satisfaction levels continue to climb,

with 92% of the respondents ranking our ser vice “excellent” or

“very good.” In addition to our ongoing program of ser vice

enhancement and satisfaction measurement, we seek new and

innovative ways to serve our customers. For example, last year, we

embarked on a quest to determine the best ways of communicating

with customers in emergencies, and we expect to implement an

automated telephone notification system by the end of 2003.

The only thing more important to us than providing

excellent ser vice is providing a safe, high-quality product that

meets increasingly stringent water quality standards. Doing so

requires a dedicated, knowledgeable team of scientists and water

professionals, diligent monitoring, and state-of-the-art equipment

and facilities. In addition to its efforts to ensure that we deliver a

high-quality product every minute of every day, our best-in-class

water quality team is working in concert with state and federal

agencies to enhance the security of our water supplies.

c o m m i t m e n t

E ve r y j o b i s i m p o r t a n t i n t h i s
C o m p a ny, a n d e ve r y e m p l oye e
i s k e y i n e n a bl i n g u s t o m e e t
t h e n e e d s o f o u r s t o ck h o l d e r s
a n d c u s t o m e r s.

Every success we have can be traced back to the

efforts of committed employees, whether it is on-time, on-budget

completion of a water facility, identification of a new way to

increase efficiency, implementation of a process that saves a busy

customer from having to call us twice, or development of a system

that allows for better tracking of water quality trends.

Every employee contributes to the overall success

of the Company, and that is why every employee works on

Continuous Improvement Process teams to increase our efficiency

and enhance our customer service. That is why every employee is

encouraged to continue his or her education through professional

development and certification programs and tuition reimbursement.

That is why every employee is compensated fairly and treated as a

vital part of the team. Because every employee makes a difference,
and it takes the commitment of every employee to make the
Company the leader in providing traditional and innovative utility

services to our customers and communities.

CALIFORNIA WATER SERVICE COMPANY

WASHINGTON WATER SERVICE COMPANY
NEW MEXICO WATER SERVICE COMPANY
HAWAII WATER SERVICE COMPANY

Harbor
South Sound

WASHINGTON

CALIFORNIA

Chico
Willows

Redwood Valley

South San Francisco
Mid-Peninsula
Bear Gulch
Los Altos
Salinas
King City

Westlake
Hermosa-Redondo
Palos Verdes

Oroville
Marysville

Dixon
Stockton

Livermore

General Office
Selma

Visalia

Kern River Valley
Bakersfield

Antelope Valley
Hawthorne

East Los Angeles
Dominguez

Kauai

Oahu

Kaanapali

Molokai

Maui

HAWAIIAN ISLANDS
(Pending regulatory approval,
expected by mid-2003)

Hawaii

Los Alamos

Belen

NEW MEXICO

C u s t o m e r s

District Name

Including

Regulated

Non-regulated

CALIFORNIA

Antelope Valley

Bakersfield

Bear Gulch

Chico

Dixon

Dominguez

Fremont Valley, Lake Hughes, Lancaster & Leona Valley;
Painted Turtle, Prayer Mountain and other operating agreements

O&M contracts for the City of Bakersfield, Spicer City & Lost Hills

Atherton, Woodside, Portola Valley, portions of Menlo Park
& City of Menlo Park service contract

Hamilton City

Rural North Vacaville Water District

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

1,300

59,300

17,600

24,400

2,800

33,100

26,500

–

500

29,000

4,200

–

300

–

2,700

6,100

Hermosa-Redondo

A portion of Torrance; meter reading for Manhattan Beach

25,800

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

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

Stockton

Visalia

Westlake

Willows

A portion of Thousand Oaks

SUBTOTAL

NEW MEXICO

Meter-reading contract

WASHINGTON

Numerous O&M contracts

TOTAL

MWC = Mutual Water Company
O&M = Operations and Maintenance

4,100

2,200

17,400

18,400

3,800

35,900

3,500

23,800

1,900

27,300

5,400

16,500

41,900

32,200

7,000

2,300

500

–

200

–

300

–

434,400

57,200

4,100

23,000

14,400

452,900

3,900

84,100

Te n - Ye a r F i n a n c i a l R e v i e w

Dollars in thousands, except per share amounts

2002

2001

2000

SUMMARY OF OPERATIONS
Operating revenue
Residential
Business
Industrial
Public authorities
Other
Total operating revenue

Operating expenses
Interest expense, other income and expenses, net

Net income

COMMON SHARE DATA
Earnings per share – diluted
Dividend declared
Dividend payout ratio
Book value
Market price at year-end
Common shares outstanding at year-end (in thousands)
Return on average common stockholders’ equity
Long-term debt interest coverage

BALANCE SHEET DATA
Net utility plant
Utility plant expenditures

Total assets

Long-term debt including current por tion
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
Revenue per customer
Utility plant per customer
Employees at year-end

$184,894
46,404
11,043
12,706
8,104
263,151
232,854
11,224

$ 19,073

$ 1.25
1.12

90%

$ 13.12
23.65
15,182

9.7%

2.73

$696,988
88,800
800,582
251,365

44.0%
0.7%
55.3%

67,488
64,735
132,223
380,087
78,901
458,988
8,561
$ 579
2,182
802

$173,823
44,944
9,907
11,860
6,286
246,820
221,669
10,186

$ 14,965

$ 0.97
1.115

115%

$ 12.95
25.75
15,182

7.6%

2.64

$624,342
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
$ 552
2,020
783

$171,234
44,211
11,014
11,609
6,738
244,806
211,610
13,233

$ 19,963

$ 1.31
1.100

84%

$ 13.13
27.00
15,146

10.1%
3.31

$582,782
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
$ 554
1,916
797

C A L I F O R N I A WA T E R S E RV I C E G R O U P

1999

1998

1997

1996

1995

1994

1993

$163,681
41,246
12,695
10,898
6,417
234,937
201,890
11,076

$ 21,971

$ 1.44
1.085

75%

$ 12.89
30.31
15,094

11.5%
3.79

$564,390
48,599
645,507
171,613

53.0%
0.9%
46.1%

65,144
58,618
123,762
361,235
77,892
439,127
6,727
$ 539
1,851
790

$150,491
38,854
10,150
9,654
5,777
214,926
183,245
11,821

$ 19,860

$ 1.31
1.070

82%

$ 12.49
31.31
15,015

10.8%
3.64

$538,741
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
$ 500
1,768
759

$158,210
40,520
10,376
11,173
4,886
225,165
188,020
11,388

$ 25,757

$ 1.71
1.055

62%

$ 12.15
29.53
15,015

14.5%
4.37

$515,917
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
$ 529
1,694
752

$148,313
37,605
9,748
10,509
4,083
210,258
177,356
11,502

$ 21,400

$ 1.42
1.040

73%

$ 11.47
21.00
15,015

12.8%
3.81

$495,985
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
$ 502
1,632
740

$132,859
35,873
9,952
9,585
4,833
193,102
164,958
11,176

$ 16,968

$ 1.13
1.020

90%

$ 10.97
16.38
14,934

10.6%
3.41

$471,994
31,031
553,027
154,416

$127,228
33,712
9,080
9,397
3,767
183,184
155,012
11,537

$ 16,635

$ 1.17
0.990

85%

$ 10.72
16.00
14,890

11.1%
3.49

$455,769
32,435
516,507
138,628

50.9%
1.1%
48.0%

52.9%
1.2%
45.9%

54,818
57,560
112,378
335,238
78,330
413,568
2,263
$ 468
1,580
738

53,274
59,850
113,124
332,146
79,159
411,305
3,325
$ 447
1,520
729

$122,585
31,360
8,415
8,535
4,985
175,880
145,517
12,785

$ 17,578

$ 1.26
0.960

76%

$ 10.03
20.00
13,773

12.6%
3.34

$437,065
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
$ 433
1,459
717

C A L I F O R N I A WA T E R S E RV I C E G R O U P

M a n age m e n t ’s D i s c u s s i o n a n d A n a ly s i s o f
R e s u l t s o f O p e ra t i o n s a n d F i n a n c i a l C o n d i t i o n

California Water Service Group (Company) is a holding company, incorporated in Delaware,

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, New Mexico Water and Washington Water are regulated public utilities. Their
assets and operating revenues currently comprise the majority of the Company’s assets and revenues. The regu-
lated utilities also provide some non-regulated water-related services. Utility Services provides non-regulated
water operations and related services to 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 TA 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 man-
agement’s judgment about the Company, the water utility industry and general economic conditions. Such
words as expects, intends, plans, forecasts, predicts, 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. They are subject to uncertainty and changes in circum-
stances. Actual results may vary materially from what is contained in a forward-looking statement. Factors
that may cause a result different than expected or anticipated include: future economic conditions, govern-
mental and regulatory commissions’ decisions, changes in regulatory commissions’ policies or procedures,
the timeliness of regulatory commissions’ actions concerning rate relief, new legislation, electric power inter-
ruptions, access to capital, 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, espe-
cially as it impacts water sales. When considering forward-looking statements, the reader should keep in mind
the cautionary statements included in this paragraph. The Company assumes no obligation to provide public
updates of forward-looking statements.

B U S I N E S S
Cal Water, which began operation in 1926, is a public utility supplying water service to

440,500 customers in 75 California communities through 25 separate water systems or districts. Cal Water’s
24 regulated systems, which are subject to regulation by the California Public Utilities Commission (CPUC),
serve 434,400 customers. An additional 6,100 customers receive service through a long-term lease of the
City of Hawthorne’s water system, which is not subject to CPUC regulation. Cal Water accounts for 96%
of the Company’s total customers and 98% of the Company’s operating revenue.

Washington Water’s utility operations are regulated by the Washington Utilities and Transportation
Commission (WUTC). Washington Water, which started operations in 1999, provides domestic water service
to 14,400 customers in the Tacoma and Olympia areas, and accounts for 2% of the Company’s operating rev-
enue. An additional 3,900 customers are served under operating agreements with private owners.

New Mexico Water acquired the assets of Rio Grande Utility Corporation in July 2002. New
Mexico Water provides service to 2,400 water and 1,700 wastewater customers south of Albuquerque. Its
regulated operations, which account for less than 1% of the Company’s operating revenue, are subject to the
jurisdiction of the New Mexico Public Regulation Commission. It also provides non-regulated meter reading
service under contract with a county.

Rates and operations for regulated customers are subject to the jurisdiction of the respective
state’s regulatory commissions. The commissions require that water rates for each regulated district be inde-
pendently determined. The commissions are expected to authorize water rates sufficient to recover normal

C A L I F O R N I A WA T E R S E RV I C E G R O U P

operating expenses and allow the utility to earn a fair and reasonable return on invested capital. Rates for the
City of Hawthorne water system are established in accordance with an operating agreement and are subject to
ratification by the Hawthorne City Council. Fees for other operating agreements are based on contracts nego-
tiated between the parties.

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. It also leases commu-
nication antenna sites, operates recycled water systems and conducts real estate sales of surplus properties.

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 accounting principles

generally accepted in the United States of America and as directed by the regulatory commissions to which
the Company’s operations are subject. The process of preparing financial statements requires the use of esti-
mates on the part of management. The estimates used by management are based on historic experience and an
understanding of current facts and circumstances. Management believes that the following accounting policies
are critical because they involve a higher degree of complexity and judgement and can have a material impact
on the Company’s results of operations and financial condition.

Revenue Recognition. Revenue from metered customers includes billings to customers
based on monthly meter readings plus an estimate for unbilled revenue which represents water used
between the last reading of the customer’s meter and the end of the accounting period. The unbilled
revenue amount is recorded as a current asset on the balance sheet under the caption “Unbilled Revenue.”
At December 31, 2002, the unbilled revenue amount was $8.0 million and at December 31, 2001, was $7.3
million. The unbilled revenue amount is generally higher during the summer months when water sales are
higher. The amount recorded as unbilled revenue varies depending on water usage in the preceding period,
the number of days between meter reads for each billing cycle, and the number of days between each cycle’s
meter reading and the end of the accounting cycle.

Flat-rate customers are billed in advance at the beginning of the service period. The revenue
is prorated so that the portion of revenue applicable to the current accounting period is included in that
period’s revenue. The portion related to a subsequent accounting period is recorded as unearned revenue on
the balance sheet and recognized as revenue when earned in the subsequent accounting period. The unearned
revenue liability was $1.7 million at December 31, 2002 and 2001. It is included in “Other accrued liabilities”
on the balance sheet.

Expense-balancing and Memorandum Accounts. Expense-balancing accounts and

memorandum accounts represent costs incurred, but not billed to Cal Water customers. The amounts
included in these accounts relate to rate increases charged to the Company by suppliers of purchased water
and purchased power, and increases in pump taxes. The Company does not record expense-balancing or
memorandum accounts in its financial statements as revenue, nor record a receivable until the CPUC has
authorized recovery of the higher costs and customers have been billed. The accounts are only used to
track the higher costs. The cost increases, which are beyond the Company’s control, are referred to as
“offsetable expenses” because under certain circumstances they are recoverable from customers in future
offset rate increases.

In October 2001, the CPUC adopted a resolution implementing its staff’s interim recommen-

dation concerning practices and policies that enable water utilities to recover cost increases in purchased
water, purchased power and pump taxes.The interim recommendation directed that future Company requests
to recover offsetable expenses will be processed only if an operating district has filed a General Rate Case
(GRC) application within a three-year period 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 increase
recovery prior to adoption of the resolution. The CPUC also directed its staff to open a proceeding to evalu-
ate offsetable expense recovery practices and policies and to recommend permanent revisions.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

Historically, offset rate increases enabled water utilities to recover as a pass-through cost

increases for offsetable expenses that were not known or anticipated when customer rates were established
and were beyond the utility’s control. Offsetable expenses incurred prior to the CPUC’s adoption of
the staff’s interim recommendation were frozen as of November 29, 2001 in the balancing accounts. The
Company was authorized to track offsetable expenses incurred after the CPUC changed its policy with regard
to regulatory memorandum accounts for potential recovery subject to the CPUC’s future determination of
appropriate practices and policies. Because of the uncertainty of collection, the Company’s accounting policy
is to not record the expense-balancing and memorandum account amounts in its financial statements until
such amounts are billed to customers.

In September 2002, the assigned administrative law judge recommended that the CPUC

adopt as permanent the interim recommendation regarding recovery of expense-balancing and memorandum
accounts as described above, but modify the limit on the amount subject to recovery. Under the interim
rules, a utility is not allowed to recover any of the balancing or memorandum account balance if it is earning
more than its authorized return on equity. However, the proposed modification by the administrative law
judge would allow recovery of a portion of the balancing or memorandum account up to the amount by
which the Company’s over earning of its authorized rate of return did not exceed the amount in the balancing
account. While this recommendation was an improvement over the interim rules currently in place, the
Company believes there should be no limit on allowed recovery of the balancing and memorandum accounts.
The Company is continuing to present its arguments to the CPUC staff.

In December 2002, the CPUC issued a decision that will allow the Company to recover

offsetable expenses tracked in the frozen balancing accounts. The decision provided that recovery of these
expenses will not be subject to the interim rules adopted in October 2001. The CPUC is now expected
to adopt permanent rules regarding recovery of memorandum accounts during the first half of 2003. The
Company is unable to predict what the final rules will comprise or their financial impact.

At December 31, 2001, the amount included in the balancing and memorandum accounts was
$6.5 million. At December 31, 2002, the amount had increased to $12.5 million after reflecting collection
of $1.9 million of balancing account power costs during 2002. The increase in balancing and memorandum
accounts was attributable primarily to higher electric costs incurred by the Company since 2001 when power
rates charged to the Company by electric suppliers, as authorized by the CPUC, increased an average of 48%.
Increases in the memorandum accounts are expected to be smaller once current power rates are reflected in
customer rates through future GRC decisions and assuming there are no large increases in purchased water
or power costs.

Regulated Utility Accounting. Because the Company operates extensively in a regulated

business, it is subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71,
“Accounting for the Effects of Certain Types of Regulation.” Regulators establish rates that are expected
to permit the recovery of the cost of service and a return on investment. In the event a portion of the
Company’s operations were no longer subject to the provisions of SFAS No. 71, the Company would be
required to write off related regulatory assets and liabilities that are not specifically recoverable and deter-
mine if other assets might be impaired. If a regulatory commission determined that a portion of the
Company’s assets were not recoverable in customer rates, the Company would be required to determine
if it had suffered an asset impairment that would require a write-down in the assets’ valuation. There had
been no such asset impairment as of December 31, 2002.

Income Taxes. Significant judgment by management is required in determining the provision

for income taxes. The preparation of consolidated financial statements requires the estimation of income
tax expense. The process involves the estimating of current tax exposure together with assessing temporary
differences resulting from different treatment of certain items, such as depreciation, for tax and financial
statement reporting. These differences result in deferred tax assets and liabilities, which are reported in
the consolidated balance sheet. The Company must also assess the likelihood that deferred tax assets will
be recovered in future taxable income. To the extent recovery is unlikely, a valuation allowance would be
recorded. If a valuation allowance were required, it could significantly increase income tax expense. In
management’s view, a valuation allowance was not required at December 31, 2002.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

Pension Benefits. The Company incurs costs associated with its pension and postretirement

health care benefits plans. To measure the expense of these benefits, management must estimate compensation
increases, mortality rates, future health cost increases and discount rates used to value related liabilities and
to determine appropriate funding. Different estimates used by management could result in significant vari-
ances in the cost recognized for pension benefit plans. The estimates used are based on historical experience,
current facts, future expectations and recommendations from independent advisors and actuaries. The
Company uses an investment advisor to provide expert advice in managing its benefit investments. To diver-
sify investment risk, the plan’s goal is to invest 60% of the assets in equity mutual funds and 40% in bond
funds. At December 31, 2002, 48% of the assets were invested in equity mutual funds and 52% in bond
funds. Based on the market values of the investment funds, for the year ended December 31, 2002, the total
return on the pension plan assets was a decline of 3.7%, and for the year ended December 31, 2001, pension
plan assets had a positive 2.6% total return. For December 31, 2002, the discount rate used for pension plan
obligations or pension plan expense was 6.7%, which was based on high-quality bond rates in December
2002. The long-term rate of return used to determine the Company’s pension obligation was 8%. By compari-
son, a 20-year return of assets invested using the same investment diversification as for the Company’s
pension plan would have returned 11.8%. The Company anticipates any increase in funding for the pension
and postretirement health care benefits plans will be recovered in future customer rates.

R E S U L T S O F O P E R A T I O N S
Ear nings and Dividends. Net income in 2002 was $19,073,000 compared to $14,965,000
in 2001 and $19,963,000 in 2000. Diluted earnings per common share were $1.25 in 2002, $0.97 in 2001
and $1.31 in 2000. The weighted average number of common shares outstanding was 15,185,000 in 2002,
15,186,000 in 2001, and 15,129,000 in 2000. As explained below, the decline in 2001 net income resulted
from three primary factors: low water sales to existing customers due to weather conditions, significantly
higher purchased power costs and delays in receipt of regulatory rate relief.

At its January 2002 meeting, the Board of Directors increased the common stock dividend for
the 35th consecutive year. 2002 also marked the 58th consecutive year that a dividend had been paid on the
Company’s common stock. The annual dividend paid in 2002 was $1.12, a 0.4% increase over the $1.115
paid in 2001, which was an increase of 1.4% over the $1.100 paid in 2000. The dividend increases were based
on projections 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 stockholders. The dividend payout ratio was 90% in 2002, 115% in 2001, and 84% in 2000, an average of
97% during the three-year period.

Operating Revenue. Operating revenue, including revenue from the City of Hawthorne lease,
was $263.2 million, 6.6% more than the $246.8 million recorded in 2001. Revenue in 2000 was $244.8 mil-
lion. The sources 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

2002

$ 6.9
6.6
2.8
$ 16.3

$ 579
373
8,600

2001

2000

$ (5.7)
5.4
2.3
$ 2.0

$ 552
363
6,100

$ 4.8
3.0
2.1
$ 9.9

$ 554
371
5,200

Temperatures and rainfall in the Company’s service territories were relatively normal through-

out 2002. In 2001, the weather patterns were cooler and more rainy than normal. From a water sales
perspective, 2002’s weather resulted in a 2% increase in customer’s water usage compared to 2001 and a
$6.9 million increase in revenue.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

Rate increases added $6.6 million to 2002 revenue. Revenue from GRC decisions received in
2001 accounted for $2.7 million of the increase, $2.0 million came from step rate increases and $1.9 million
from offset rate increases to recover electric costs included in expense-balancing accounts for four California
districts. No new GRC decisions were authorized by the CPUC during 2002. Washington Water did receive a
GRC decision in 2002. The “RATES AND REGULATION” section of this report provides a detailed discussion
of regulatory activity.

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 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 experienced dry conditions dur-
ing the winter and spring months; however, summer rains reduced water sales in the normally high usage
summer months.

The December 31, 2002, customer count including the Hawthorne customers was 459,000,
an increase of 2% from the 450,400 customers at the end of 2001, which was an increase of 1% from the
444,300 customers at the end of 2000. The increase in customers is due to normal growth within existing
service areas and acquisitions of water systems. The acquisition in July 2002 of the Rio Grande Utility
Corporation’s 4,100 customers is included in the customer count increase.

Operating Income and Expenses. Total operating expenses, including those for the

Hawthorne operation, were $232.9 million in 2002, $221.7 million in 2001 and $211.6 million in 2000.

Water pumped from Company-owned wells provided 50.4% of water delivered to customers

in 2002. Water purchased from wholesale suppliers provided 49.0% and the remaining 0.6% was obtained
from surface supplies. For 2001, the corresponding percentages were 50.6%, 48.9% and 0.5%.

As a group, water production costs, which consist of purchased water, purchased power and

pump taxes, comprise the largest segment of total operating costs. Water production costs accounted for
45% of total operating costs in 2002, 2001 and 2000. The rates charged for wholesale water supplies,
electricity and pump taxes are established by various public agencies. 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 (billions of gallons)

Change from prior year

2002

$ 76.7
22.9
6.3
$105.9

132

2001

$ 73.2
21.1
5.9
$100.2

127

(1)%

2000

$73.8
15.1
6.3
$95.2

128

Water production expenses vary with wholesale suppliers’ prices, the quantity of water pro-
duced to supply customer water usage, and the sources of supply. In 2002, four wholesale water suppliers
increased their rates charged to the Company. The increases ranged from 2% to 5%. One wholesale supplier
reduced its rate by 9%. In 2001, seven wholesale water suppliers increased rates with increases ranging from
2% to 7%. In December 2001, wholesale suppliers in the Los Angeles area refunded $1.4 million for over-
collection of prior period water purchases. The refunds were recorded as a reduction of purchased water
costs. There were no comparable refunds in 2002. During 2003, wholesale rate increases are expected in 17
districts ranging from 1% to 47%. The 47% increase will add an estimated $1.0 million to purchased water
cost. The increased costs will be tracked in regulatory memorandum accounts that the Company will include
in future rate proceedings for recovery.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

Purchased power is required to operate wells and pumps. Prior to 2001, the Company had not
been subjected to significant electric power cost increases. However, California energy costs rose significantly
in 2001. In January 2001, the CPUC approved an energy surcharge that increased the Company’s cost of pur-
chased electricity by 10%. A second, more significant 38% increase in electric costs became effective in May
2001, 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 regarding expense-balancing accounts. However, the CPUC subsequently revised its rules regard-
ing recovery of the higher costs, resulting in delays in recovering the higher costs. While no new power rate
increases are proposed or known at this time, the Company continues to purchase electricity from suppliers
at rates greater than it is recovering from its water customers in 20 California districts.

Purchased power increased $1.8 million in 2002, $6.0 million in 2001 and $0.7 million in
2000. The 2002 cost increase was caused by higher electric rates paid through May 2002 as compared to
2001’s electric rates and a 5% increase in well production. The purchased power cost increase in 2000 was
due mainly to a 3% increase in water production.

Employee payroll and benefits charged to operations and maintenance was $50.3 million in
2002, $47.8 million for 2001, and $44.5 million for 2000. The increases in payroll and related benefits are
attributable to general wage increases effective at the start of each year and additional hours worked. At year-
end 2002, there were 802 employees, including 12 employees added in New Mexico with the acquisition of
Rio Grande Utility Corporation. At the end of 2001 and 2000, there were 783 and 797 employees, respec-
tively. Most non-supervisory employees are represented by the Utility Workers Union of America, AFL-CIO,
with the exception of certain engineering and laboratory employees who are represented by the International
Federation of Professional and Technical Engineers, AFL-CIO. In December 2002, the Company successfully
negotiated new three-year agreements with both unions covering 2003 through 2005. Wage increases under
the new agreements will be 1% in 2003, 1.5% in 2004 and 2% in 2005. Improvements in employee benefit
plans were also negotiated.

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’s 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.

Income tax expense was $12.6 million in 2002, $9.7 million in 2001 and $11.6 million in

2000. The changes in taxes are generally due to variations in taxable income.

Long-term debt interest expense increased $1.4 million compared to 2001. Series E, 7.11%
$20 million senior notes were issued in May 2002 and Series F, 5.90% $20 million senior notes were issued
in August 2002. Proceeds from the issues were used to repay short-term bank borrowings and to fund the
Company’s construction program.

As part of a program to refinance certain high interest rate first mortgage bonds, Series G and
Series H, 5.29% senior notes were issued in November and December 2002, each for $20 million. With the
proceeds from these two issues, three series of first mortgage bonds totaling $33 million were redeemed.
The remaining proceeds were used to repay short-term bank borrowings.

The issuance of the new senior notes caused long-term interest expense to increase because
of the higher principal amount outstanding. In 2001, 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 2002, 2001 and 2000,
interest capitalized on construction projects was $1.5 million, $0.9 million, and $0.7 million, respectively.
The increase in the amount capitalized in 2002 is attributable to an increase in the Company’s construction
expenditures, particularly those associated with construction of a water treatment plant in the Bakersfield
district. Interest coverage of long-term debt before income taxes was 2.7 times in 2002, 2.6 times in 2001
and 3.3 times in 2000. The reduction in interest coverage for 2002 and 2001 compared to 2000 resulted from
lower earnings and the new senior note issues outstanding. The interest coverage is expected to improve once
GRC decisions are authorized by the CPUC and as a result of the lower interest costs realized by refinancing
certain first mortgage bond issues.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

Other interest expense, which includes short-term bank borrowings needed to meet operating
and interim construction funding, decreased $0.6 million in 2002. The amount borrowed in 2002 was larger
because of an increase in capital expenditures. In 2001, other interest increased by $0.1 million because
higher borrowings were necessary due to reduced cash flow from operations and increased capital expendi-
tures. Lower interest rates on short-term borrowings in both years offset the interest cost that resulted from
higher borrowing levels. There was $36.4 million in short-term borrowings outstanding at December 31,
2002 and $22.0 million at December 31, 2001.

Other Income and Expenses. Other income is derived from management contracts under

which the Company operates private and municipally-owned water systems and recycled water systems and
provides meter reading, water testing and billing services to various cities; leases of communication antenna
sites; sales of surplus property; and interest on short-term investments. Other income, net of expenses, was
$5.6 million in 2002, $5.8 million in 2001 and $1.4 million in 2000. During 2002, $3.0 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 $3.9 mil-
lion of gains from surplus property sales in 2001 and no property sales in 2000.

R A T E S A N D R E G U L A T I O N
2002 Regulatory Activity. Washington Water filed a GRC application in February 2002. The

WUTC issued its decision early in April 2002 granting a $1 million increase in annual revenue to cover higher
operating costs and capital expenditures.

In June 2002, the CPUC authorized the Company to increase rates in its Bakersfield district by
$796,000 on an annual basis. This decision was based on an advice letter filing to cover approximately $6 mil-
lion of construction cost incurred to date for a new water treatment plant.

The Company filed a Notice of Intent to file GRC applications for three California districts in

July 2002. The Commission’s staff accepted the applications in November. Four additional district GRC appli-
cations, including the General Office operation, were submitted in January 2003. Combined, these districts
represent 17% of the California customers. The Commission staff has indicated that a decision on these filings
should be expected in late 2003.

2001 Regulatory Activity. After analyzing 17 Cal Water districts that were eligible for gen-
eral rate filings in 2001, and based on current earnings levels, projected expense increases, including higher
electric power costs, and expected capital expenditures, applications were filed in July 2001 for 15 districts
covering about 70% of Cal Water’s customers. The applications requested an 11.5% return on equity includ-
ing 75 basis points to reflect the increased risk associated with the CPUC’s changes in recovery of water
production expense increases and $21 million in new annual revenue. Under the CPUC’s rate case processing
schedule, a decision on the district GRC applications was expected by the third quarter of 2002. However,
despite the filing of briefs by all parties in May 2002, a Proposed Decision has not been issued. At this time,
a final decision is expected in April 2003, about 20 months after filing of the applications. Based on the
administrative law judge’s Draft of a Proposed Decision (DPD) released in January 2003, the Company would
be authorized a $12.8 million increase in annual revenue. Additionally, the DPD recommends a return on
equity of 9.7% with an equity percentage of capitalization at 51.5%. While that is positive news, it does not
recognize that regulatory delays have resulted in the loss of revenues, which the DPD finds just and reasonable.

The DPD also recommends an allocation method for sharing expenses between regulated and

non-regulated activities that is inconsistent with a prior Commission decision that was issued following a
Commission rulemaking investigation. Furthermore, the DPD proposes changing the rate-setting practice
regarding the treatment of gain on the sale for surplus property. The existing rules are based on legislation
adopted in 1995 by the California legislature, which requires that gains realized on the sale of surplus prop-
erty be reinvested in new utility plant and that the Company be allowed to earn a reasonable rate of return on
the reinvestment. As proposed in the DPD, the Company would be required to treat the reinvestment of gains
on the sale of surplus property as contributed plant and it would not be allowed to earn a return on its rein-
vestment. The Company, along with other California water utilities, opposes these rate-setting changes and
will aggressively defend the legislation administratively and, if necessary, pursue legislative remedies. If these
proposals were adopted by the Commission, they would have a detrimental impact on the Company’s non-

C A L I F O R N I A WA T E R S E RV I C E G R O U P

regulated activities and surplus real estate program. The DPD on treatment of gains on sale of properties
could result in a reduction of earnings and the rate base on which the Commission determines the Company’s
future earnings. However, because this is only a draft that does not recommend specific actions, the Company
cannot predict the final outcome of this matter. Since 1997, the Company has recorded $10.4 million in pre-
tax gains under its surplus property sale program.

In October 2001, the CPUC adopted a resolution implementing its staff’s interim recommen-

dation 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 permanent revisions. Historically, offset rate increases have enabled water utilities to recover
increases in offsetable 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 off-
setable expenses in regulatory 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 were increased

48%. 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. The CPUC’s authorization allowing the Company to
recover a portion of the higher power costs in four districts was not effective until September and November
2001, well after the high usage summer months. The authorization will allow recovery in four districts total-
ing $2.7 million in additional annual revenue. The CPUC did not authorize any additional recovery of the
higher electric costs during 2002. However, in December 2002, the CPUC did authorize the Company to file
for recovery of up to $6.4 million of electric cost increases tracked in expense-balancing accounts. In January
2003, the Company applied to the CPUC requesting authorization to recover the $6.4 million of electric
increases included in the expense-balancing accounts. A resolution regarding these advice letter filings is
expected in the first half of 2003.

Leg islative Initiative. Regulatory delays in obtaining GRC decisions have been costly to

California regulated water utilities. In recent years, the Company has experienced significant revenue losses
due to regulatory delays. The Company normally files its GRC applications in July. The CPUC’s stated rate
processing plan provides for a decision within ten months of accepting a GRC application. When decisions
are not issued in a timely manner, customer rates are not increased. As a result, the Company loses revenue
and does not recover costs during the period the decisions are delayed.

California Assembly Bill 2838 became effective January 1, 2003. This bill is intended to pre-

serve the cash flow and financial ratings of regulated water utilities by providing interim rate relief based on
inflation and a procedure for applying the final adopted GRC rates on a retroactive basis. In December 2002,
the Company filed for protection of its 2002 GRC applications under the new law. The Commission staff
rejected the application on the basis that the legislation does not apply to GRC applications submitted prior
to January 1, 2003. An appeal of the Commission staff rejection has been filed with the Commission.

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 processed through three Company-owned water treatment plants. In 2003, the
Company expects to complete construction of a new water treatment plant in the Bakersfield district that
will increase the amount of surface water delivered to that system and reduce the amount of water pumped
from wells. On average, slightly more than half of the water delivered to customers is produced from wells
and surface supply, with the remainder purchased from wholesale suppliers.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

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.
New Mexico’s rainfall is heaviest in the summer monsoon season. Water usage in all service areas is highest
during the warm and dry summers and declines in the cool winter months. Rain and snow during the winter
months replenish underground water basins and fill reservoirs providing the water supply for subsequent
delivery to customers. To date, snow and rainfall accumulation during the 2002-2003 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 2002 was at historic average. The Company believes that its supply from underground
aquifers and purchased sources should be adequate to meet customer demand during 2003. The Company also
develops long-term water supply plans for each of its districts to help assure an adequate water source under
various operating and supply conditions.

E N V I R O N M E N TA 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 mat-
ters. 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 compli-
ance with all requirements set forth by the various agencies.

The Safe Drinking Water Act (SDWA) was amended in 1996 to provide a new process for
the EPA to select and regulate waterborne contaminants. The EPA can now regulate only contaminants
that are known or likely to occur at levels expected to pose a risk to public health when regulation would
provide a meaningful opportunity to reduce a health risk. New drinking water regulations will be based
primarily on risk assessment and measurement of cost/benefit considerations for minimizing overall
health risk. The amended SDWA allows the EPA to require monitoring of up to 30 contaminants in any
five-year cycle. Also, every five years the EPA must select at least five listed contaminants and determine
if they should be regulated.

The Company has an established water supply monitoring program to test for contaminants in
accordance with SDWA requirements. Employees are provided training in water operations and water treat-
ment procedures. 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 sup-
pliers 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 regulations 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) standard 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 600 wells, 56 will require
treatment to comply with the new MCL. The Company estimates the compliance cost at $61 million in capi-
tal expenditures over the next three years and $10 million in additional annual operating costs. The State of
California could establish 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 approximately $125 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 testing alternate arsenic treatment technologies in order to meet the stan-
dard in the most cost-efficient manner. The required capital expenditures to meet the new standards and the
increased operating costs associated with new treatment are expected to be recovered in customers’ future
water rates.

The Company anticipates that the EPA will issue other regulations that will require further

monitoring and possible treatment for specific contaminants. Depending on the MCLs contained in the regula-
tions, 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.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

The Company is also working with regional water quality control boards and air quality dis-
tricts to meet current and upcoming regulations. The focus of this work is to meet more stringent National
Pollutant Discharge Elimination System requirements for water discharged from wells and for diesel exhaust
emissions from operation of emergency generators.

L I Q U I D I T Y A N D C A P I TA L R E S O U R C E S
Liquidity. The Company’s short-term liquidity is provided by bank lines of credit and inter-
nally generated funds. On a long-term basis, the Company obtains financing through its access to debt and
equity markets.

Shor t-ter m Financing. Negotiations to renew separate bank credit agreements for the

Company and Cal Water that were scheduled to expire on April 30, 2003, have been completed. The new
agreements, which replace a combined $60 million credit line, became effective on February 28, 2003, and
expire on April 30, 2005. Under the new agreements the Company will have available a total of $65 million.
Of the total, $55 million is designated for Cal Water and $10 million for the Company, including funding of
its subsidiaries’ operations. Cal Water’s $55 million portion can be used solely for purposes of the regulated
California utility. As of July 1, 2003, the credit facility available to Cal Water will be reduced to $45 million.
The reduction will lower the commitment fee paid by Cal Water on the unused portion of the credit line. The
prior agreements required a 30-day out-of-debt period for borrowings under the agreements in calendar year
2002. However, on September 23, 2002, the agreements were amended to extend the out-of-debt compliance
period to between January 1, 2002 and April 30, 2003. The new agreements will also have a 30-day out-of-
debt requirement that must be met by December 31, 2003.

During 2002 and 2001, the Company had committed $7.6 million of the $10 million credit

line to a contractor for construction of a customer and operation center. The Company has occupied the new
facility where four of its southern California district operations were consolidated. The combined operations
will provide for more efficient service to customers in the South Bay area of Los Angeles County. The tax-free
exchange of seven surplus Company properties to the contractor for the new customer and operations center
was completed on September 30, 2002. Because the transaction was structured as a property exchange,
acquiring the new facility did not require a significant expenditure of cash. Under terms of the exchange
agreement, during the construction period the Company had guaranteed the contractor’s bank loan. The
new facility, which is valued at over $7 million, served as security to the Company for the guarantee. When
the property exchange was completed, the contractor paid off the bank loan, and the Company was released
from its guarantee.

Washington Water has loan commitments from two banks to meet its operating and capital

equipment purchase requirements at interest rates negotiated with the banks. At December 31, 2002,
nothing was outstanding under the short-term commitments. Generally, short-term borrowings under the
commitments are converted annually to long-term borrowings with repayment terms tied to system and
equipment acquisitions.

New Mexico Water Company has a credit arrangement with a New Mexico bank that was

renewed in January 2003 for a 16-month period. The interest rate for the agreement is based on prime rate
plus 75 basis points. At December 31, 2002, the amount borrowed was $2,380,000. The renewal increased
the amount available under the line to $2.9 million.

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 tem-
peratures are lower than normal, especially in the summer months, customer water usage can be lower than
normal. The reduction in water usage reduces cashflow from operations and increases the need for short-term
bank borrowings. During 2002 and 2001, the need for short-term borrowings was greater due to an increase
in construction expenditures primarily related to construction of the Bakersfield water treatment plant.
Regulatory lag, which is the delay in receiving authorization to increase customer rates to cover capital
expenditures and higher operating costs, resulted in the need for increased short-term bank borrowings in
both 2002 and 2001.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

Credit Ratings. California Water Service Company’s first mortgage bonds are rated by

Moody’s Investors Service (Moody’s) and Standard & Poor’s (S&P). The Company’s bank line of credit agree-
ment contains a provision that if the Company’s Moody’s or S&P’s senior debt ratings falls below investment
grade, the credit line may be terminated by the bank. At the end of the third quarter 2002, the Company met
separately with the two credit rating agencies at annual rating reviews. Following the review, Moody’s issued
a news release stating that it was placing the Company’s Aa3 senior secured debt rating on review for possible
downgrade and subsequently lowered the rating to A1. Moody’s indicated that the primary reason for the
action was delayed rate relief from the CPUC and the Company’s capital spending requirements for water
infrastructure and environmental compliance needs. In November 2002, S&P lowered the Company’s corpo-
rate credit rating from AA- to A+. In its news release, S&P stated that the change “has been caused principally
by deterioration in regulatory support from the California Public Utilities Commission,” noting that decisions
for recovery of reasonable expenses have been delayed as much as 18 months. In the news release, S&P classi-
fied the Company’s outlook as “stable,” saying, “Standard & Poor’s does not expect that Cal Water will
experience any funding anxiety beyond that associated with regulatory tardiness.” The Company believes the
credit rating agencies will maintain investment grade ratings for the Company’s first mortgage bonds.

Long-ter m Financing. Long-term financing, which includes common stock, preferred stock,
first mortgage bonds, senior notes and other debt securities, has been used to replace short-term borrowings
and fund construction. Internally-generated funds come from earnings not paid out as dividends, depreciation
and deferred income taxes. Additional information regarding the bank borrowings and long-term debt is pre-
sented in notes 8 and 9 to the financial statements. The Company believes that long-term financing is available
to it through debt and equity markets. In March 2002, the CPUC issued a decision granting Cal Water author-
ity to complete up to $250 million of equity and debt financing through 2005, subject to certain restrictions.
In addition to Company funds, construction projects are funded by developers’ contributions in aid of con-
struction which are not refundable and advances for construction which are refundable.

In both 2002 and 2001, long-term financing was provided by issuance of senior notes.

During 2002, Series E, 7.11% senior notes were issued in May and Series F, 5.90% senior notes were
issued in August. During 2001, Series D, 7.13% senior notes were issued in September. Each series,
which is an obligation of Cal Water, was issued for $20 million. These senior note issues do not require
sinking fund payments.

During 2002, the Company initiated a program to refinance a portion of Cal Water’s out-

standing first mortgage bonds. The refinancing is intended to take advantage of the available lower interest
rates. The Company estimates that the total program, which will be completed in two phases, will save
approximately $1.5 million in annual interest costs. The first phase of the program was completed in
2002 and included refinancing of Series S, BB and DD first mortgage bonds, and Series P that matured on
November 1, 2002. Including Series P, the total first mortgage bond principal balance refinanced for the
four series was $33,940,000. The refinancing was accomplished with funds from the issue of two new
series of lower interest cost, unsecured senior notes. Series G, $20 million senior notes were issued in
November 2002 and Series H, $20 million senior notes were issued in December 2002. The interest rate
on both series is 5.29% and both mature in 2022. Each series requires annual sinking fund payments of
$1.8 million commencing in 2012.

The second phase of the refinancing is expected to be completed in May 2003 when two $10
million senior notes are issued under Series I and J to redeem Series EE first mortgage bonds. Institutional
investors have committed to these two issues. The interest rate for Series I will be determined at closing, but
is expected be similar to the Series J interest rate which will be 5.54%. Depending on interest rates at the
time, Series FF and GG first mortgage bonds will be considered for possible refinancing during 2003.

In 2002 and 2000, $1.9 million and $3.6 million, respectively, of net income was reinvested

in the business after payment of dividends. Cash flow during 2001 was lower than expected because of lower
water usage by existing customers, regulatory lag in receiving rate relief and increased operating costs, espe-
cially for purchased power costs. As a result, funds required to pay 2001 dividends exceeded net income by
$2.1 million, resulting in a reduction of stockholders’ equity. The reduced cash flow also required the
Company to borrow additional funds under the bank line of credit agreement.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

The Company has a Dividend Reinvestment and Stock Purchase Plan (Plan). Under the Plan,

stockholders 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. During 2002 and 2001, shares were purchased on the open market. At this time, the Company
intends to continue purchasing shares required for the Plan on the open market. However, if new shares were
issued to satisfy future Plan requirements, the impact on earnings per share could be dilutive. Also, stockhold-
ers may experience dilution of their ownership percentage unless they participate in an offering at the same
level of current ownership.

2003 Financing Plan. The Company’s 2003 financing plan includes raising approximately $60
million of new capital. The plan includes issuance of $20 million in senior notes to institutional investors. The
senior note financing was completed on February 28, 2003, when Series K 4.58% and Series L 5.48% notes
were issued, each for $10 million. Additionally, a global shelf registration statement is being prepared. From
the global shelf registration, the Company expects to issue approximately $40 million of common stock. As
currently contemplated, the common stock issue will be accomplished with an initial issue during the second
quarter and a second issue late in the third quarter. However, the Company does not plan to issue common
stock until after the CPUC has issued a decision for the 2001 GRC applications. Therefore, if the CPUC deci-
sion is delayed, the common stock issues are also likely to be delayed. Beyond 2003, future issues from the
shelf registration could include common stock, preferred stock or debt instruments sold to individual investors.

Contractual Obligations. The Company’s contractual obligations are summarized in the
table below. Long-term debt payments include annual sinking fund payments on first mortgage bonds,
maturities of long-term debt and annual payments on other long-term obligations. Advances for Construction
represent annual contract refunds to developers for the cost of water systems paid for by the developers.
The contracts are non-interest bearing and refunds are generally on a straight-line basis over a 40-year
period. 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)

Total

Long-Term Debt
Advances for Construction
Operating leases

$251,365
115,459
21,000

Less Than
1 Year

$1,000
4,605
833

2-3 Years

4-5 Years

$ 1,896
15,243
1,834

$ 1,776
11,146
1,834

After
5 Years

$246,693
84,465
16,499

The Company has water supply contracts with wholesale suppliers in 16 of its operating dis-
tricts. For each contract, the cost of water is established by the wholesale supplier and is generally beyond
the Company’s control. 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 payments. 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 payments totaling $3,779,000 for 2003, a 27% increase
over 2002. The amount paid under this contract is fixed annually and generally does not vary with the quantity
of water delivered by the district during the year. Because of the fixed price arrangement, the Company oper-
ates 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 expendi-

tures for expanding and replacing the Company’s utility plant facilities and the acquisition of new water
properties. They also include refunds of advances for construction and retirement of first mortgage bonds.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

In 2002, utility plant expenditures totaled $88.4 million compared to $62.0 million in 2001.

The 2002 construction program included $71.6 million of Company-funded projects and $16.8 million of
projects funded by funds received from developers for non-refundable contributions in aid of construction
and refundable advances for construction. The Company’s 2002 projects were funded by internally-generated
funds, borrowings under bank credit lines, and issuance of long-term debt senior notes. The Company’s 2001
projects were funded by internally-generated funds, borrowings under bank credit lines, and issuance of $20
million in senior notes.

The 2003 Company-funded construction budget was authorized at $51.7 million. It includes
$4.5 million for the fifth year of a five-year program to construct a water treatment plant to accommodate
growth and meet water quality standards in the Bakersfield district. Construction of the plant is proceeding
on-time and on-budget. Over the five-year period, the plant and related pumping and pipeline facilities are
estimated to cost $49.0 million. Also in the 2003 budget is $10.7 million for new and replacement water
mains and $12.1 million for new wells, pumping equipment and storage facilities. The budget will be funded
by funds from operations, bank borrowings and long-term debt and equity financing. New subdivision con-
struction will be financed by developers’ non-refundable contributions-in-aid-of-construction and refundable
advances for construction.

Company-funded construction budgets over the next five years are projected to be about
$330 million. Included in the estimated amount is $61 million for compliance with arsenic water quality
regulations, completion of the Bakersfield treatment plant and expansion and replacement of water plant
infrastructure including the start of a program to replace certain wells that are nearing the end of their
service life.

Capital Str ucture. In 2002, common stockholders’ equity increased $1.9 million and in 2000

increased $3.6 million by net income not paid out as dividends. In 2001, common stockholders equity was
reduced by the $2.1 million that dividends paid exceeded net income. 36,180 shares of common stock were
issued in 2001 for the acquisition of the Nish water systems. The long-term debt portion of the capital struc-
ture increased in 2002, 2001 and 2000 primarily due to the issuance of new senior notes. It was reduced by
first mortgage bond sinking fund payments.

The Company’s total capitalization at December 31, 2002, was $453.1 million and at the end

of 2001 was $402.7 million. Because of the decline in 2001 net income and issuance of additional senior
notes, the debt component of capitalization has increased and the equity component has decreased. The
Company expects that its planned issuance of common equity, and receipt of regulatory relief will add to the
common equity portion of capitalization in 2003 and future years. At December 31 capitalization ratios were:

Common equity
Preferred stock
Long-term debt

2002

44.0%
0.7%
55.3%

2001

48.8%
0.9%
50.3%

The return on average common equity was 9.7% in 2002 compared to 7.6% in 2001. The low

return on average common equity in 2001 was directly related to the decline in net income.

Acquisitions. R I O G R A N D E U T I L I T Y C O R P O R AT I O N. On July 1, 2002, after receiving state reg-

ulatory commission approval, the Company acquired certain assets of Rio Grande Utility Corporation (Rio
Grande) through New Mexico Water. The purchase included the water and wastewater assets of Rio Grande,
which serves 2,400 water and 1,700 wastewater customers about 30 miles south of Albuquerque. The pur-
chase price was $2,300,000 in cash, plus assumption of $3,100,000 in outstanding debt. Rate base for the
system is approximately $5,400,000.

The Rio Grande purchase price was allocated to the fair value of net assets acquired, including
utility plant, water rights and assumed liabilities. The results of operations include the operating results of Rio
Grande since the acquisition date. The allocation of fair value is based on management’s estimate of the fair
value for purchase accounting purposes at the date of acquisition. The purchase price allocations are subject
to revision if management obtains additional information.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

For 2001, Rio Grande had gross revenue of $1,485,000. Its gross utility plant in service at

December 31, 2001, was $12,458,000 and net utility plant in service was $9,153,000. The regulatory deci-
sion authorizing the purchase included an authorization to increase annual water rates by $115,000.

N AT I O N A L U T I L I T I E S C O R P O R AT I O N. In June 2002, New Mexico Water signed an agreement
to purchase National Utilities Corporation for approximately $700,000. National Utilities serves 700 water
customers located adjacent to the Rio Grande water system and another 1,000 water customers located 150
miles south of Albuquerque, New Mexico. The purchase will entitle New Mexico Water to purchase up to
2,000 acre-feet of water annually as required for its operations. The purchase is subject to the approval of the
New Mexico Public Regulation Commission. Regulatory approval is expected in the third quarter of 2003.
National Utilities had 2002 revenue of $554,000 and total assets of $1,410,000. Its net utility plant in service
at December 31, 2001, was $1,178,000.

K A A N A PA L I WAT E R C O R P O R AT I O N. In August 2002, the Company agreed to acquire the Kaanapali
Water Corporation for $7.7 million in cash. Kaanapali Water provides water utility services to 500 customers
on the island of Maui in Hawaii, including 10 resorts and eight condominium projects. It posted 2001 revenues
of $3.3 million, and has net plant of approximately $7.3 million and current assets of $0.4 million. The trans-
action is subject to approval of the Hawaii Public Utilities Commission, and an application requesting approval
was filed in October 2002. A decision is expected by mid-2003.

N I S H WAT E R S Y S T E M S. 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 $0.2
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.

WA S H I N G T O N WAT E R . In 2002, Washington Water purchased the assets of eight water compa-
nies that serve 181 customers and generate $0.1 million in annual revenue. The combined purchase price
was $0.1 million. During 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.

Real Estate Prog ram. The Company’s subsidiaries own more than 900 real estate parcels.

Certain parcels are not necessary for or used in water utility operations. Most surplus properties have a low
cost basis. A program has been developed to realize the value of certain surplus properties through sale or
lease of those properties. The program will be ongoing for a period of several years. During the next four
years, the Company estimates that gross property transactions totaling over $10 million could be completed.
During 2002, the Company completed four sales totaling $3.0 million in pretax proceeds. In 2001, $4.0 mil-
lion in pretax sales were completed through two sales.

Stockholder Rights Plan. As explained in Note 7 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, production or contractual commitments. The Company operates only in the United States,
and therefore, is not subject to foreign currency exchange rate risks.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

Ter ror ism Risk. Since the September 11, 2001, terrorist attacks, to safeguard its water supply
and facilities, the Company has heightened security at its facilities and taken added precautions for the safety
of our employees and the water we deliver to our customers. While the Company does not make public com-
ments on its security programs, it has been in contact with federal, state and local law enforcement agencies
to coordinate and improve water delivery systems’ security. The Company has also assigned a high priority to
completing work necessary to comply with new EPA requirements concerning security of water facilities.
This effort encompasses all of the Company’s operations.

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. If interest rates increase, the Company’s
future long-term financing may be done at higher rates, resulting in a need to recover higher cost in cus-
tomers’ future rates. Cal Water’s long-term obligations are first mortgage bonds and senior note obligations
that are generally placed with insurance companies at fixed interest rates. Washington Water’s long-term obli-
gations are for periods of up to 10 years and are placed with two banks. New Mexico Water’s long-term debt
obligations are with a bank with maturities of 16 months. During 2002, the Company issued four series of
$20 million senior notes with interest rates ranging from 5.29% to 7.11%. The range of interest rates is an
example of changing market conditions. To expand access to capital debt markets, the Company will investi-
gate the use of private and public markets for future debt issues. It may also consider financing on a parent
company basis, rather than on a subsidiary-by-subsidiary basis.

The Company’s short-term financing is provided by bank lines of credit that are discussed

under the “Liquidity and Capital Resources” section of this report. Short-term borrowings that are not repaid
from operating cash or funded by retained earnings are generally converted to long-term debt issues. The
Company plans to continue the financing of its construction program with a combination of debt and equity
issues. Financing of acquisitions have been done using Company common stock or through the debt financing
vehicles available to the subsidiary companies.

Value Risk. Because the Company operates primarily in a regulated industry, its value risk
is somewhat lessened; however, regulated parameters also can be recognized as limitations to operations
and earnings, and the ability to respond to certain business conditions changes. During 2002 and 2001, the
Company experienced value risk because of the impact on earnings of CPUC decisions or the lack of decision
on earnings. 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.

Stock Market Perfor mance Risk. While the Company’s stock price has not been significantly
affected by poor performance of the general stock market over the past two years, the Company’s perform-
ance could be affected in other areas. The Company provides its employees a defined benefit pension plan
and postretirement medical benefit plan. The Company is responsible for funding both of these plans and a
portion of the plans’ assets are invested in stock market equities, other than Company stock. Poor perform-
ance of the equity investments could result in a need for additional future funding and cost to make up for a
loss of value in the equity investments. The Company expects to recover its costs associated with the benefit
plans in customer rates.

Equity Risk. The Company does not have equity investments and, therefore, it does not have

equity risks.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

R E C E N T A C C O U N T I N G P R O N O U N C E M E N T S
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143,

“Accounting for Asset Retirement Obligations,” which applies to legal obligations associated with the retire-
ment of long-lived assets and the associated asset retirement costs. The Statement is effective for the Company
in the first quarter of 2003. The Company does not expect the adoption of SFAS No. 143 to have a significant
impact on its financial position or results of operations.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or

Disposal Activities.” This Statement addresses financial accounting and reporting for costs associated with exit
or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring).” This Statement requires that a liability for costs associated with an exit or disposal activ-
ity be recognized and measured initially at fair value only when the liability is incurred. The provisions of this
Statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company
does not expect the impact of adopting SFAS No. 146 to have a significant impact on the Company’s financial
position, results of operations, or cash flows.

In November 2002, the FASB issued Interpretation No. 45, “Guarantors Accounting and

Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.”
Interpretation No. 45 requires a liability to be recognized at the time a company issues a guarantee for the
fair value of the obligations assumed under certain guarantee agreements. Additional disclosures about guar-
antee agreements are also required in the interim and annual financial statements. The Company does not
believe adoption of Interpretation No. 45 will have a material impact on the Company’s results of operations
or financial position. The recognition and measurement provision of FIN 45 are effective for the years begin-
ning after December 31, 2002. The disclosure requirements are effective for December 31, 2002, financial
statements; however, the Company is not a party to any guarantees at this time.

In December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based

Compensation, Transition and Disclosure.” This statement provides alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based employee compensation.
It also requires that disclosure of the pro forma effect of using the fair-value method of accounting for
stock-based employee compensation be displayed more prominently and in a table in annual financial
statements. Additionally, the statement requires disclosure of the pro forma effect in interim financial
statements. The transition and annual disclosure requirements of Statement No. 148 are effective for the
Company for 2002. The interim disclosure requirements are effective for the Company’s first quarter of
2003. The Company does not expect Statement No. 148 to have a material effect on its results of opera-
tions or financial condition.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

C o n s o l i d a t e d B a l a n c e S h e e t

In thousands, except per share data

December 31, 2002 and 2001

ASSETS

Utility plant:

Land
Depreciable plant and equipment
Construction work in progress
Intangible assets

Total utility plant

Less accumulated depreciation and amortization

Net utility plant

Current assets:

Cash and cash equivalents
Receivables:

Customers
Other

Unbilled revenue
Materials and supplies at average cost
Taxes and other prepaid expenses

Total current assets

Other assets:

Regulatory assets
Unamortized debt premium and expense
Other

Total other assets

2002

2001

$ 11,513
927,244
48,624
13,929
1,001,310
304,322
696,988

$ 10,709
859,846
26,826
12,277
909,658
285,316
624,342

1,063

14,831
9,130
7,969
2,760
7,234
42,987

953

14,572
8,228
7,291
2,147
7,224
40,415

46,089
6,798
7,720
60,607
$800,582

38,893
3,800
2,764
45,457
$710,214

C A L I F O R N I A WA T E R S E RV I C E G R O U P

CAPITALIZATION AND LIABILITIES

Capitalization:

Common stock, $0.01 par value; 25,000 shares authorized, 15,182

$ 152

2002

2001

outstanding in 2002 and 2001

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 and contingencies

See accompanying Notes to Consolidated Financial Statements.

49,984
149,215
(134)
199,217

3,475
250,365
453,057

1,000
36,379
23,706
3,742
2,873
23,841
91,541

2,774
31,371
28,804
115,459
77,576

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

$800,582

$710,214

C A L I F O R N I A WA T E R S E RV I C E G R O U P

C o n s o l i d a t e d S t a t e m e n t o f I n c o m e

In thousands, except per share data

For the years ended December 31, 2002, 2001 and 2000

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

Net operating income

Other income and expenses:
Non-regulated income, net
Gain on the sale of non-utility property
Total other income and expenses

2002

2001

2000

$263,151

$246,820

$244,806

76,672
22,897
6,344
37,646
34,073
11,587
21,238
12,568
9,829
232,854

73,174
21,130
5,910
36,521
34,109
12,131
19,226
9,728
9,740
221,669

73,768
15,136
6,275
32,974
32,308
11,592
18,368
11,571
9,618
211,610

30,297

25,151

33,196

2,637
2,980
5,617

1,979
3,864
5,843

1,413
–
1,413

Income before interest expense

35,914

30,994

34,609

Interest expense:

Long-term debt interest
Other interest

Total interest expense

Net income

Earnings per share:

Basic
Diluted

Weighted average number of common shares outstanding:

Basic
Diluted

See accompanying Notes to Consolidated Financial Statements.

15,554
1,287
16,841

14,187
1,842
16,029

12,901
1,745
14,646

$ 19,073

$ 14,965

$ 19,963

$ 1.25
$ 1.25

$ 0.98
$ 0.97

$ 1.31
$ 1.31

15,182
15,185

15,182
15,186

15,126
15,129

C A L I F O R N I A WA T E R S E RV I C E G R O U P

7302_18_56_3 3/7/03 2:55 PM Page 39

C o n s o l i d a t e d S t a t e m e n t o f C o m m o n S t o ck h o l d e r s ’ E q u i t y
a n d C o m p r e h e n s i ve I n c o m e

In thousands

For the years ended December 31, 2002, 2001 and 2000

Common
Stock

Additional
Paid-in
Capital

Retained
Earnings

Accumulated
Other
Comprehensive
Loss

Total
Stockholders’
Equity

Balance at December 31, 1999

$151

$49,340

$145,610

$(517)

$194,584

Net income
Other comprehensive income
Comprehensive income

Issuance of common stock
Dividends paid:

Preferred stock
Common stock

Total dividends paid

Balance at December 31, 2000

Net income
Other comprehensive loss
Comprehensive income

Acquisition
Dividends paid:

Preferred stock
Common stock

Total dividends paid

Balance at December 31, 2001

Net income
Other comprehensive income
Comprehensive income

Dividends paid:

Preferred stock
Common stock

Total dividends paid

Balance at December 31, 2002

–
–
–

–

–
–
–
151

–
–
–

–
–
–
152

–
–
–

–
–
–
$152

–
–
–

644

–
–
–
49,984

–
–
–

–

–
–
–
49,984

–
–
–

–
–
–
$49,984

19,963
–
–

–

153
16,235
16,388
149,185

14,965
–
–

220

153
16,918
17,071
147,299

19,073
–
–

–
31
–

–

–
–
–
(486)

–
(330)
–

–

–
–
–
(816)

–
682
–

19,963
31
19,994

644

153
16,235
16,388
198,834

14,965
(330)
14,635

221

153
16,918
17,071
196,619

19,073
682
19,755

153
17,004
17,157
$149,215

–
–
–
$(134)

153
17,004
17,157
$199,217

See accompanying Notes to Consolidated Financial Statements.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

C o n s o l i d a t e d S t a t e m e n t o f C a s h F l ow s

In thousands

For the years ended December 31, 2002, 2001 and 2000

2002

2001

2000

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

Gain on sale of non-utility property
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

Proceeds from sale of non-utility assets
Acquisitions

Net cash used in investing activities

Financing activities:

Net short-term borrowings
Issuance of common stock
Issuance of long-term debt
Advances for construction
Refunds of advances for construction
Contributions in aid of construction
Retirement of long-term debt
Dividends paid

Net cash provided 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.

$19,073

$14,965

$19,963

21,238

19,226

18,368

786
(2,980)

(1,088)
(561)
(431)
1,287
(3,909)
14,342
33,415

(71,553)
(16,808)
3,006
(2,300)
(87,655)

12,435
–
80,324
12,545
(4,597)
7,740
(36,940)
(17,157)
54,350
110
953
$ 1,063

2,919
(3,864)

(2,186)
673
(2,461)
6,642
(625)
20,324
35,289

(53,379)
(8,670)
3,999
(701)
(58,751)

7,402
–
20,524
6,498
(4,166)
10,868
(2,881)
(17,071)
21,174
(2,288)
3,241
$ 953

(3,203)
–

(1,503)
235
(255)
1,093
638
15,373
35,336

(33,540)
(3,621)
–
(709)
(37,870)

599
644
20,326
3,846
(3,870)
1,883
(2,920)
(16,388)
4,120
1,586
1,655
$ 3,241

$16,527
10,205
–

$14,785
11,775
899

$14,785
11,775
–

C A L I F O R N I A WA T E R S E RV I C E G R O U P

N o t e s t o C o n s o l i d a t e d F i n a n c i a l S t a t e m e n t s

December 31, 2002, 2001, and 2000

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
California Water Service Group (Company) is a holding company 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), Washington Water Service Company (Washington
Water) and New Mexico Water Service Company (New Mexico Water) provide regulated utility services
under the rules and regulations of their respective state’s regulatory commissions (jointly referred to as
Commissions). CWS Utility Services provides non-regulated water utility and utility-related services.

The Company operates primarily in one business segment, providing water and related

utility services.

S U M M A RY 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
Pr inciples of Consolidation The consolidated financial statements include the accounts of the

Company and its wholly-owned subsidiaries. Intercompany transactions and balances have been eliminated.
Reclassifications 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.

Use of Estimates The preparation of consolidated financial statements in conformity with

accounting principles generally accepted in the United States of America requires management to make esti-
mates 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.

R e ve n u e Revenue consists of monthly cycle customer billings for regulated water and waste

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.

Expense balancing and memorandum 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 and memorandum accounts until the Commission 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 accumu-
lated depreciation. Maintenance of utility plant is charged primarily to operation expenses. Interest is
capitalized on plant expenditures during the construction period and amounted to $1,473,000 in 2002,
$858,000 in 2001, and $703,000 in 2000.

Intangible assets acquired as part of water systems purchased are stated at amounts as pre-

scribed by the Commissions. All other intangibles have been recorded at cost and are amortized over their
useful life. Included in intangible assets is $6,515,000 paid to the City of Hawthorne in 1996 to lease the
city’s water system and associated water rights. The asset is being amortized on a straight-line basis over the
15-year life of the lease.

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

C A L I F O R N I A WA T E R S E RV I C E G R O U P

65 years. The provision for depreciation expressed as a percentage of the aggregate depreciable asset balances
was 2.4% in 2002, 2001 and 2000. 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, with original maturities of three months or less.

Restr icted Cash Restricted cash primarily represents proceeds collected through a surcharge

on certain customers’ bills plus interest earned on the proceeds and is used to service California Safe
Drinking Water Bond obligations. In addition, there are compensating balances at a bank in support of bor-
rowings. All restricted cash is classified in other prepaid expenses. At December 31, 2002 and 2001, the
amounts restricted were $1,131,000 and $887,000, 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 differences 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 ratemak-
ing purposes. The regulatory 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.

In addition, regulatory assets include items that are recognized as liabilities for financial state-
ment purposes, which will be recovered in future customer rates. The liabilities relate to postretirement
benefits, vacation and self-insured workers’ compensation accruals.

Long-lived Assets The Company regularly reviews its long-lived assets for impairment, annually
or when events or changes in business circumstances have occurred, which indicate the carrying amount of such
assets may not be fully realizable. Potential impairment of assets held for use is determined by comparing the
carrying amount of an asset to the future undiscounted cash flows expected to be generated by that asset. If
assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the
carrying value of the assets exceeds the fair value of the assets. There have been no such impairments as of
December 31, 2002.

Long-ter m 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.

A c c u m u l at e d O t h e r C o m p re h e n s i ve L o s s The Company has an unfunded Supplemental

Executive Retirement Plan. The unfunded accumulated benefit obligation of the plan, less the accrued benefit,
exceeds the unrecognized prior service cost. Accumulated other comprehensive loss has been recorded as a
separate component of Stockholders’ Equity.

Advances for Constr uction 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, 2002 and 2001, the amounts
refundable under the 20-year contracts were $3,248,000 and $4,320,000, respectively, and under 40-year
contracts were $111,136,000 and $102,337,000, respectively. In addition, other Advances for Construction
totaling $1,075,000 at December 31, 2002, are refundable based upon customer connections. Estimated
refunds for 2003 for all water main extension contracts are $4,600,000.

Contr ibutions in Aid of Constr uction Contributions in Aid of Construction represent pay-
ments 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

C A L I F O R N I A WA T E R S E RV I C E G R O U P

7302_18_56_3 3/7/03 2:55 PM Page 43

bases. Measurement of the deferred tax assets and liabilities is at enacted tax rates expected to apply to tax-
able income in the years in which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes
the enactment date.

It is anticipated that future rate action by the Commissions will reflect revenue requirements
for the tax effects of temporary differences recognized, which have previously been flowed through to cus-
tomers. The Commissions have granted the Company customer rate increases to reflect the normalization
of the tax benefits of the federal accelerated methods and available Investment Tax Credits (ITC) for all
assets placed in service after 1980. ITC are deferred and amortized over the lives of the related properties
for book purposes.

Advances for Construction and Contributions in Aid of Construction received from developers

subsequent to 1986 were taxable for federal income tax purposes and subsequent to 1991 were subject to
California income tax. In 1996 the federal tax law, and in 1997 the California tax law, changed and only
deposits for new services were taxable. In late 2000, federal regulations were further modified to exclude
fire services from tax.

Ear nings Per Share Basic earnings per share (EPS) is calculated by dividing income available
to common stockholders (net income less preferred stock dividend of $153,000) by the weighted average
shares outstanding during the year. Diluted EPS is calculated by dividing income available to common stock-
holders by the weighted average shares outstanding including potentially dilutive shares as determined by
application of the treasury stock method. The difference between basic and diluted weighted average number
of common stock outstanding is the effect of dilutive common stock options outstanding.

Stock-based Compensation The Company has a stockholder-approved Long-Term Incentive

Plan that allows granting of nonqualified stock options. The Company has adopted the disclosure require-
ments of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based
Compensation,” and as permitted by the statement, applies Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees,” for its plan. All of the Company’s outstanding options have
an exercise price equal to the market price on the date they were granted. No compensation expense was
recorded for the years ended December 31, 2002, 2001 or 2000.

The table below illustrates the effect on net income and earnings per share as if the Company

had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based
Compensation,” to stock-based employee compensation.

In thousands, except per share amounts

Net income, as reported
Deduct: Total stock-based employee compensation

expense determined under fair value based method
for all awards, net of related tax effects

Pro forma net income

Earnings per share:

Basic – as reported
Basic – pro forma

Diluted – as reported
Diluted – pro forma

2002

2001

2000

$19,073

$14,965

$19,963

86
$18,987

57
$14,908

24
$19,939

$ 1.25
$ 1.25

$ 1.25
$ 1.24

$ 0.98
$ 0.98

$ 0.97
$ 0.97

$ 1.31
$ 1.31

$ 1.31
$ 1.30

Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board

(FASB) issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which applies to legal obliga-
tions associated with the retirement of long-lived assets and the associated asset retirement costs. The
Statement is effective for the Company in the first quarter of 2003. The Company does not expect the adop-
tion of SFAS No. 143 to have a significant impact on its financial position or results of operations.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or

Disposal Activities.” This Statement addresses financial accounting and reporting for costs associated with exit
or disposal activities and supersedes Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition

C A L I F O R N I A WA T E R S E RV I C E G R O U P

for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring).” This Statement requires that a liability for costs associated with an exit or dis-
posal activity be recognized and measured initially at fair value only when the liability is incurred. The
provisions of this Statement are effective for exit or disposal activities that are initiated after December 31,
2002.The Company does not expect the impact of adopting SFAS No. 146 to be significant to the Company’s
financial position, results of operations, or cash flows.

In December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based

Compensation, Transition and Disclosure.” This statement provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based employee compensation. It
also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-
based employee compensation be displayed more prominently and in a table. Additionally, the statement
requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclo-
sure requirements of Statement No. 148 are effective for the Company in 2002. The interim disclosure
requirements are effective for the Company’s first quarter of 2003. The Company does not expect
Statement No. 148 to have a material effect on its results of operations or financial condition.

M E R G E R W I T H D O M I N G U E Z S E RV 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 com-
mon stock. The Company issued 2,210,254 new common shares in exchange for the 1,601,679 outstanding
Dominguez shares. Dominguez provided water service in 21 California communities. The former Dominguez
operations became districts within Cal Water. The Merger was accounted for as a pooling of interests. There
were no intercompany transactions as a result of the Merger. Certain reclassifications were made to the his-
torical financial statements of the companies to conform presentation. 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.

O T H E R A C Q U I S I T I O N S
During 2002, after receiving regulatory approval, the Company acquired the assets of Rio
Grande Utility Corporation (Rio Grande) through its wholly-owned subsidiary, New Mexico Water. The
purchase includes the water and wastewater assets of Rio Grande, which serves water and wastewater cus-
tomers in unincorporated areas of Valencia County, New Mexico. The purchase price was $2,300,000 in cash,
plus assumption of $3,100,000 in outstanding debt. Rate base for the system is $5,400,000, including intan-
gible water rights valued at $732,000.

In 2001, the Company acquired four companies operating in Cal Water’s Visalia district. 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 of accounting; 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, Washington Water
purchased the assets of eight water companies for cash of $701,000.

During 2000, Washington Water purchased the assets of Mirrormount Water Services and

Lacamas Farmsteads Water Company for $639,000 in cash and assumed debt. To provide in-house engineering,
Washington Water also purchased the assets of Robischon Engineers, Inc. in April 2000 for $70,000 in cash.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

7302_18_56_3 3/7/03 2:56 PM Page 45

Condensed balance sheets and pro forma results of operations for these acquisitions have not

been presented since the effect of these purchases are not material. Acquisitions that involved purchase of
assets were accounted for under the purchase method of accounting.

I N TA N G I B L E A S S E T S
As of December 31, 2002 and 2001, intangible assets that will continue to be amortized and

those not amortized were:

Amounts in thousands

AMORTIZED INTANGIBLE ASSETS:
Hawthorne lease
Water pumping rights
Water planning studies
Leasehold improvements and other

Total

UNAMORTIZED INTANGIBLE ASSETS:
Perpetual water rights

Gross
Carrying
Value

$ 6,515
1,046
1,783
2,160
$11,504

2002
Accumulated
Amortization

$2,968
2
238
1,027
$4,235

Net
Carrying
Value

$3,547
1,044
1,545
1,133
$7,269

Gross
Carrying
Value

$ 6,515
1,046
1,054
1,969
$10,584

2001

Accumulated
Amortization

$2,534
–
109
920
$3,563

Net
Carrying
Value

$3,981
1,046
945
1,049
$7,021

$ 2,425

–

$2,425

$ 1,693

–

$1,693

For the years ending December 31, 2002, 2001 and 2000, amortization of intangible assets was
$670,000, $630,000 and $507,000. Estimated future amortization expense related to intangible assets for the
succeeding five years is $671,000 per year for 2003 to 2007 and $3,243,000 beyond 2007.

P R E F E R R E D S T O C K
As of December 31, 2002 and 2001, 380,000 shares of preferred stock were authorized.
Dividends on outstanding shares are payable quarterly at a fixed rate before any dividends can be paid on
common stock.

The outstanding 139,000 shares of $25 par value cumulative, 4.4% Series C preferred shares
are not convertible to common stock. A premium of $243,250 would be due upon voluntary liquidation of
Series C. There is no premium in the event of an involuntary liquidation. Each Series C preferred share is
entitled to sixteen votes, with the right to cumulative votes at any election of directors.

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 $0.01 par value common stock.

As of December 31, 2002 and 2001, 15,182,046 shares of common stock were issued and outstanding.

Dividend Reinvestment and Stock Repurchase Plan The Company has a Dividend

Reinvestment and Stock Purchase Plan (Plan), which allows stockholders to reinvest dividends to purchase
additional Company common stock. The Plan also allows stockholders and other 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. During 2002 and 2001, shares were purchased
on the open market.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

7302_18_56_3 3/7/03 2:56 PM Page 46

Stockholder Rights Plan The Company’s Stockholder Rights Plan (Plan) is designed to pro-

vide stockholders protection and to maximize stockholder value by encouraging a prospective acquirer to
negotiate with the Board. The Plan was adopted in 1998 and authorized a dividend distribution of one right
(Right) to purchase 1/100th share of Series D Preferred Stock for each outstanding share of Common Stock
in certain circumstances. The Rights are for a ten-year period that expires in February 2008.

Each Right represents a right to purchase 1/100th share of Series D Preferred Stock at the
price of $120, subject to adjustment (Purchase Price). Each share of Series D Preferred Stock is entitled
to receive a dividend equal to 100 times any dividend paid on common stock and 100 votes per share in any
stockholder election. The Rights become exercisable upon occurrence of a Distribution Date. A Distribution
Date event occurs if (a) any person accumulates 15% of the then outstanding Common Stock, (b) any person
presents a tender offer which would cause the person’s ownership level to exceed 15% and the Board deter-
mines the tender offer not to be fair to the Company’s stockholders, or (c) the Board determines that a
stockholder maintaining a 10% interest in the Common Stock could have an adverse impact on the Company
or could attempt to pressure the Company to repurchase the holder’s shares at a premium.

Until the occurrence of a Distribution Date, each Right trades with the Common Stock and
is not separately transferable. When a Distribution Date occurs: (a) the Company would distribute separate
Rights Certificates to Common Stockholders and the Rights would subsequently trade separate from the
Common Stock; and (b) each holder of a Right, other than the acquiring person (whose Rights would there-
after be void), would have the right to receive upon exercise at its then current Purchase Price that number
of shares of Common Stock having a market value of two times the Purchase Price of the Right. If the
Company merges into the acquiring person or enters into any transaction that unfairly favors the acquiring
person or disfavors the Company’s other stockholders, the Right becomes a right to purchase Common
Stock of the acquiring person having a market value of two times the Purchase Price.

The Board may determine that in certain circumstances a proposal that would cause a

Distribution Date is in the Company stockholders’ best interest. Therefore, the Board may, at its option,
redeem the Rights at a redemption price of $0.001 per Right.

S H O R T- T E R M B O R R O W I N G S
At December 31, 2002, 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. Cal
Water maintained a separate bank line of credit for an additional $50,000,000 on the same terms as the
Company’s line of credit. The agreements require a 30-day out-of-debt period for borrowings under the
agreements in calendar year 2002. However, on September 23, 2002, the agreements were amended to
extend the out-of-debt compliance period to between January 1, 2002, and April 30, 2003. As explained
in Note 16 Subsequent Events, the lines of credit, which were scheduled to expire on April 30, 2003,
were renegotiated on February 28, 2003. At December 31, 2002, $34,000,000 was outstanding.

Washington Water has a loan commitment for $100,000 from a bank to meet its operating

and capital equipment purchase requirements at interest rates negotiated with the bank. At December 31,
2002, nothing was outstanding under the short-term commitment.

New Mexico Water has a $2.9 million credit agreement with a New Mexico bank that was

renewed in January 2003 for a 16-month period. The interest rate for the agreement is based on prime rate
plus 75 basis points. At December 31, 2002, the amount borrowed was $2,379,000.

The following table represents borrowings under the bank lines of credit:

Dollars in thousands

Maximum short-term borrowings
Average amount outstanding
Weighted average interest rate
Interest rate at December 31

2002

$52,285
$25,495

3.44%
3.61%

2001

2000

$36,800
$24,453

5.29%
3.16%

$26,750
$16,810

7.77%
7.88%

C A L I F O R N I A WA T E R S E RV I C E G R O U P

L O N G - T E R M D E B T
As of December 31, 2002 and 2001, long-term debt outstanding was:

In thousands

First Mortgage Bonds:

Senior Notes:

Series

J
K
P
S
BB
CC
DD
EE
FF
GG

A
B
C
D
E
F
G
H

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%
7.11%
5.90%
5.29%
5.29%

Maturity
Date

2023
2012
2002
2003
2008
2020
2022
2023
2023
2023

2025
2028
2030
2031
2032
2017
2022
2022

3.0% to
7.4%

2003-33

California Department of
Water Resources loans

Other long-term debt

Total long-term debt
Less current maturities

Long-term debt excluding current maturities

2002

$ 4,000
5,000
–
–
–
18,400
–
19,100
19,100
19,100
84,700

20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
160,000

2,797

3,868

2001

$ 4,000
5,000
2,565
2,580
11,520
18,500
19,100
19,200
19,200
19,200
120,865

20,000
20,000
20,000
20,000
–
–
–
–
80,000

2,886

4,230

251,365
1,000

207,981
5,381

$250,365

$202,600

The first mortgage bonds and unsecured senior notes are obligations of Cal Water. All bonds

are held by institutional investors and secured by substantially all of Cal Water’s utility plant. The senior notes
are held by institutional investors and require interest-only payments until maturity, except series G and H
which have an annual sinking fund requirement of $1.8 million starting in 2012. The Department of Water
Resources (DWR) loans were financed under the California Safe Drinking Water Bond Act. Repayment of
principal and interest on the DWR loans is through a surcharge on customer bills. Other long-term debt is
primarily equipment and system acquisition financing arrangements with financial institutions. Compensating
balances of $227,000 as of December 31, 2002, are required by these institutions. Aggregate maturities and
sinking fund requirements for each of the succeeding five years (2003 through 2007) are $1,000,000,
$932,000, $909,000, $928,000 and $918,000.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

In thousands

O T H E R A C C R U E D L I A B I L I T I E S
As of December 31, 2001 and 2002, other accrued liabilities were:

Accrued pension and postretirement benefits
Accrued and deferred compensation
Accrued insurance
Other

2002

$ 9,635
6,041
2,914
5,251
$23,841

2001

$ 9,777
4,926
1,317
5,208
$21,228

In thousands

2002

2001

2000

I N C O M E TA X E S
Income tax expense consists of the following:

Current
Deferred
Total

Federal

$8,797
1,039
$9,836

$6,472
1,456
$7,928

$7,961
1,554
$9,515

State

$2,406
326
$2,732

$2,136
(336)
$1,800

$2,519
(463)
$2,056

Total

$11,203
1,365
$12,568

$ 8,608
1,120
$ 9,728

$10,480
1,091
$11,571

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

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

2002

$11,074

1,818
(191)
(133)
$12,568

The components of deferred income tax expense were:

In thousands

Depreciation
Developer advances and contributions
Bond redemption premiums
Investment tax credits
Other
Total deferred income tax expense

2002

$2,405
(789)
806
(95)
(962)
$1,365

2001

2000

$8,643

$11,037

1,170
(156)
71
$9,728

1,336
(155)
(647)
$11,571

2001

2000

$2,337
(783)
(42)
(94)
(298)
$1,120

$2,031
(814)
(61)
(61)
(4)
$1,091

C A L I F O R N I A WA T E R S E RV I C E G R O U P

The tax effects of differences that give rise to significant portions of the deferred tax assets and

deferred tax liabilities at December 31, 2002 and 2001 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

2002

2001

$37,923
6,325
1,639
876
1,136
4,703
52,602

82,130
1,843
83,973
$31,371

$41,531
5,744
1,703
537
938
868
51,321

79,348
789
80,137
$28,816

A valuation allowance was not required at December 31, 2002 and 2001. Based on historical taxable
income and future taxable income projections over the period in which the deferred assets are deductible, manage-
ment believes it is more likely than not that the Company will realize the benefits of the deductible differences.

E M P L OY 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 substantially 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, pooled equity, bonds and short-term investment accounts. The data in the tables below
includes the unfunded, non-qualified, supplemental executive retirement plan. In addition, the tables reflect
a plan amendment effective January 1, 2003, that increased the annual minimum benefit, which is recognized
over the working life of the employees.

Benefits earned by Dominguez employees under the Dominguez pension plan were frozen as of
the merger date and future pension benefits to those employees will be provided under the Company pension
plan. The Dominguez plan was curtailed. The Dominguez plan was fully funded and additional contributions
to the plan could not be funded, although plan annual expense was recorded. As a result of the curtailment,
accrued 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 participants to contribute up to 18% of pre-tax compensation. The Company matches fifty cents for
each dollar contributed by the employee up to a maximum Company match of 4.0%. Company contributions
were $1,422,000, $1,425,000, and $1,298,000, for the years 2002, 2001 and 2000, respectively.

Other Postretirement Plans The Company provides substantially all active, permanent employees
with medical, dental and vision benefits through a self-insured plan. Employees retiring at or after age 58 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. Plan assets are invested in mutual funds, short-term money market instruments
and commercial paper. Retired employees are also provided with a $5,000 life insurance benefit.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

7302_18_56_3 3/7/03 2:57 PM Page 50

The Company records the costs of postretirement benefits during the employees’ years of

active service. The Commissions have issued decisions that authorize rate recovery of tax deductible funding
of postretirement 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, 2002 and 2001:

In thousands

Change in benefit obligation:
Beginning of year
Service cost
Interest cost
Assumption change
Plan amendment
Experience loss
Benefits paid
End of year

Change in plan assets:
Fair value of plan assets at beginning of year
Actual return on plan assets
Employer contributions
Retiree contributions
Benefits paid
Fair value of plan assets at end of year

Funded status
Unrecognized actuarial (gain) or loss
Unrecognized prior service cost
Unrecognized transition obligation
Unrecognized net initial asset
Net amount recognized

Pension Benefits

Other Benefits

2002

2001

2002

2001

$ 60,359
2,968
4,404
30
15,424
660
(4,276)
$ 79,569

$ 57,340
(2,377)
5,616
–
(4,276)
$ 56,303

$(23,266)
1,281
18,875
–
–
$ (3,110)

$59,098
2,786
4,333
1,326
11
2,289
(9,484)
$60,359

$63,648
1,356
1,820
–
(9,484)
$57,340

$ (3,019)
(6,191)
4,525
–
–
$ (4,685)

$ 14,708
815
1,037
699
40
845
(641)

$ 17,503

$ 2,300
(79)
885
470
(1,111)
$ 2,465

$(15,038)
5,025
786
3,045
(276)
$ (6,458)

$ 12,052
625
858
1,943
–
15
(785)
$ 14,708

$ 2,067
237
781
415
(1,200)
$ 2,300

$(12,408)
3,339
817
3,321
(276)
$ (5,207)

Amounts recognized on the balance sheet consist of:

In thousands

Accrued benefit costs
Additional minimum liability
Intangible asset
Accumulated other comprehensive loss
Net amount recognized

Pension Benefits

Other Benefits

2002

$(3,110)
(4,784)
4,650
134
$(3,110)

2001

$(4,685)
(1,396)
580
816
$(4,685)

2002

$(6,458)
–
–
–
$(6,458)

2001

$(5,207)
–
–
–
$(5,207)

Pension Benefits

Other Benefits

2002

2001

2002

2001

Weighted average assumptions as of December 31:

Discount rate
Long-term rate of return on plan assets
Rate of compensation increases

6.70%
8.00%
1.00 to 4.25%

7.00%
8.00%
4.25%

6.70%
8.00%
–

7.00%
8.00%
–

C A L I F O R N I A WA T E R S E RV I C E G R O U P

7302_18_56_3 3/7/03 2:57 PM Page 51

Net periodic benefit costs for the pension and other postretirement plans for the years ending

December 31, 2002, 2001 and 2000 included the following components:

In thousands

Service cost
Interest cost
Expected return on plan assets
Net amortization and deferral
Net periodic benefit cost

Pension Plan

Other Benefits

2002

$ 2,968
4,404
(4,497)
1,166
$ 4,041

2001

2000

$ 2,786
4,333
(4,946)
855
$ 3,028

$ 2,846
4,079
(4,498)
486
$ 2,913

2002

$ 815
1,037
(216)
500
$2,136

2001

2000

$ 625
858
(212)
363
$1,634

$ 544
790
(152)
357
$1,539

Postretirement benefit expense recorded in 2002, 2001, and 2000 was $1,157,000, $885,000,
and $781,000, respectively. $5,165,000, which is recoverable through future customer rates, is recorded as a
regulatory asset. The Company intends to make annual contributions to the plan up to the amount deductible
for tax purposes.

For 2002 measurement purposes, the Company assumed a 7% 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 two 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

1-percentage
Point Increase

1-percentage
Point Decrease

$ 354
$2,742

$ (279)
$(2,216)

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
The Company has a stockholder-approved Long-Term Incentive Plan that allows granting of

nonqualified stock options, performance shares and dividend units. Under the plan, a total of 1,500,000 com-
mon 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, 2002, 36,750
options were exercisable at a weighted average price of $24.08.

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 subsequently converted to 52,357 shares of Company common stock.

The fair value of stock options used to compute pro forma net income and earnings per share

disclosures is the estimated fair value at grant date using the Black-Scholes option-pricing model with the fol-
lowing assumptions:

Expected dividend
Expected volatility
Risk-free interest rate
Expected holding period in years

2002

2001

2000

4.5%
27.7%
3.25%
5.0

4.3%
30.4%
4.6%
5.0

4.3%
22.0%
4.9%
5.0

C A L I F O R N I A WA T E R S E RV I C E G R O U P

The following table summarizes the activity for the stock option plans:

Outstanding at December 31, 1999
Granted
Exercised
Outstanding at December 31, 2000
Granted
Cancelled
Outstanding at December 31, 2001
Granted
Outstanding at December 31, 2002

52,357
53,500
(52,357)
53,500
58,000
(12,000)
99,500
55,000
154,500

Weighted
Average
Exercise
Price

$23.45
23.06
23.45
23.06
25.94
24.50
24.57
25.15
24.77

Weighted
Average
Remaining
Contractual Life

Options
Exercisable

–

19,092

9.5

8.8

8.2

–

11,875

36,750

Weighted
Average
Fair
Value

–
$3.74

–
5.65

–
4.41
–

F A 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 is
estimated at $306,140,000 as of December 31, 2002, and $214,046,000 as of December 31, 2001, using a
discounted cash flow analysis, based on the current rates available to the Company for debt of similar maturi-
ties. The fair value of advances for construction contracts is estimated at $34,000,000 as of December 31,
2002 and $32,000,000 as of December 31, 2001, based on data provided by brokers.

C O M M I T M E N T S A N D C O N T I N G E N C I E S
Commitments The Company leases office facilities in many of its operating districts. The total
paid and charged to operations for such leases was $800,000 in 2002, $720,000 in 2001 and $760,000 in
2000. Payments under the lease commitments over the succeeding five years 2003 through 2007 are esti-
mated to be $833,000, $893,000, $941,000, $943,000 and $891,000. Over the 20-year period through
2023, 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 $6,816,000 in 2002, $6,208,000 in
2001 and $5,400,000 in 2000. The estimated payments under the contracts for the five years 2003 through
2007 are $8,000,000, $8,300,000, $8,600,000, $9,000,000 and $9,300,000.

The water supply contract with Stockton East Water District (SEWD) requires a fixed, annual
payment and does not vary during the year with the quantity of water delivered by the district. Because of the
fixed price arrangement, the Company operates to receive as much water as possible from SEWD in order to
minimize the cost of operating Company-owned wells used to supplement SEWD deliveries. The total paid
under the contract was $2,967,000 in 2002, $3,496,000 in 2001 and $3,269,000 in 2000. Pricing under the
contract varies annually. For 2003, the estimated payment is $3,779,000.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

During 2001 and 2002, the Company committed up to $7.6 million of the its bank line of

credit to a contractor for construction of a customer and operation center. The tax-free exchange of seven
surplus Company properties to the contractor for the new customer and operations center was completed
on September 30, 2002. Because the transaction was structured as a property exchange, acquiring the new
facility did not require a significant expenditure of cash. Under terms of the exchange agreement, during the
construction period the Company had guaranteed the contractor’s bank loan. The new facility, which is valued
at over $7 million, served as security to the Company for the guarantee. When the property exchange was
completed, the contractor paid off the bank loan, and the Company was released from its guarantee.

In 2002, the Company agreed to acquire the Kaanapali Water Corporation for $7,700,000

in cash. The acquisition is subject to approval of the Hawaii Public Utilities Commission, which is expected
in mid-2003. Also in 2002, the New Mexico Water signed an agreement to purchase National Utilities
Corporation for approximately $700,000 in cash.The purchase of National Utilities is subject to the approval
of the New Mexico Public Regulation Commission, which is expected in the third quarter of 2003.

Contingencies In 1995, the State of California’s Department of Toxic Substances Control

(DTSC) named the Company as a potential responsible party for cleanup of a toxic contamination plume in
the Chico groundwater. The toxic spill occurred when cleaning solvents, which were discharged into the city’s
sewer system by local dry cleaners, leaked into the underground water supply due to breaks in the city’s
sewer pipes. The DTSC contends that the Company’s responsibility stems from its operation of wells in the
surrounding vicinity that caused the contamination plume to spread. While the Company intends to cooperate
with the cleanup effort, it denies any responsibility for the contamination or the resulting cleanup and intends
to vigorously resist any action that may be brought against it. The Company has negotiated with DTSC regard-
ing dismissal of the Company from the claim in exchange for the Company’s cooperation in the cleanup
effort. However, no agreement was reached with DTSC regarding dismissal of the Company from the DTSC
action. In December 2002, the Company was named along with eight other defendants in a lawsuit filed by
DTSC for the cleanup of the plume. The suit asserts that the defendants are jointly and severally liable for the
estimated cleanup of $8.7 million. The Company believes that it has insurance coverage for this claim and that
if it were ultimately held responsible for a portion of the cleanup costs, there would not be a material adverse
effect on the Company’s financial position or results of operations.

In July 2002, the Company was served with a lawsuit in state court naming it as one of several

defendants for damages alleged to have resulted from waste oil contamination in the Company’s drinking
water. The suit did not specify a dollar amount. The Company does not believe that the complaint alleges
any facts under which it may be held liable. The Company has filed a motion to dismiss the suit on various
grounds. The Court has not ruled on the Company’s motion. If necessary, the Company intends to vigorously
defend the suit. In 2000, the plaintiff in this action brought a suit against the Company in federal court with
similar allegations concerning drinking water contamination. That suit was dismissed; however, the Court did
not bar the plaintiff from filing an amended complaint. The Company’s insurance carrier is paying for legal
defense costs and the Company believes that its insurance policy will cover all costs related to this matter.

In December 2001, the Company and several other defendants were served with a lawsuit by
the estate and immediate family members of a deceased employee of a pipeline construction contractor. The
contractor’s employee had worked on various Company projects over a number of years. The plaintiffs allege
that the Company and other defendants are responsible for an asbestos-related disease that is claimed to have
caused the death of the contractor’s employee. The complaint seeks damages in excess of $50,000, in addition
to unspecified punitive damages. The Company denies responsibility in the case and intends to vigorously
defend itself. Pursuant to an indemnity provision in the contracts between the contractor and the Company,
the contractor has accepted liability for the claim against the Company and is reimbursing the Company for
its defense costs.

The Company and City of Stockton (City) purchase water from Stockton East Water District
(SEWD). The City has discussed with SEWD its belief that SEWD’s meter, which recorded water deliveries
to the City’s system, malfunctioned for some period of time, and as a result the City overpaid for water

C A L I F O R N I A WA T E R S E RV I C E G R O U P

deliveries from SEWD. The City has told SEWD that it believes it was overcharged between $800,000
and $2,300,000. If the City’s assertion is correct, it could mean that the Company was undercharged. The
Company cannot determine whether SEWD agrees with the City’s assertion or whether and in what amount
SEWD will make a refund to the City. If SEWD were to make a refund to the City, it could have a future
operating fund shortfall, which might result in higher future purchased water costs for the Company’s
Stockton district. However, the Company believes that if purchased water costs increased, the increase would
be recovered in customers’ future billings.

The Company is involved in other proceedings or litigation arising in the ordinary course of

operations. The Company believes the ultimate resolution of such matters will not materially affect its finan-
cial position, results of operations or cash flows.

16 S U B S E Q U E N T E V E N T S

Negotiations to renew separate bank credit agreements for the Company and Cal Water that

were scheduled to expire on April 30, 2003, have been completed. The new agreements, which replace a com-
bined $60 million credit line, became effective on February 28, 2003, and expire on April 30, 2005. Under the
new agreements the Company will have available a total of $65 million. Of the total, $55 million is designated
for Cal Water and $10 million for the Company including funding of its subsidiaries’ operations. Cal Water’s
$55 million portion can be used solely for purposes of the regulated California utility. On July 1, 2003, the
credit facility available to Cal Water will be reduced to $45 million. The reduction will lower the commitment
fee paid by Cal Water on the unused portion of the credit line. Like the prior agreements, the new agreements
also have a 30-day out-of-debt requirement that must be met by December 31, 2003.

On February 28, 2003, the Company issued two series of senior notes to institutional investors,
each for $10 million. The 5.48% Series L notes mature in February 2018. The 4.58% Series K notes mature in
December 2010. Proceeds from the notes were used to repay outstanding short-term bank borrowings.

In February 2003, the Commission staff recommended that the Company be fined up to
$9,600,000 and refund $470,000 in revenue for failing to report two acquisitions as required by the
Commission. One acquisition was completed prior to adoption of the reporting requirement by the
Commission; the other was inadvertently not reported.The Company acquired the two water systems, which
serve 283 customers, for approximately $140,000.The Company is preparing its response to the staff report.
The Company does not believe that the staff’s recommendation will be upheld when this matter is considered
by the Commission; accordingly, no liability has been accrued.

C A L I F O R N I A WA T E R S E RV I C E G R O U P

Q U A R T E R LY F I N A N C I A L D A TA ( U N A U D I T E D )
The Company’s common stock is traded on the New York Stock Exchange under the symbol
“CWT.” Through 2002, quarterly dividends have been paid on common stock for 232 consecutive quarters
and the quarterly rate has been increased each year since 1968.

2002 – in thousands except per share amounts

Operating revenue
Net operating income
Net income
Diluted earnings per share
Common stock market price range:

High
Low

Dividends paid

2001 – in thousands except per share amounts

Operating revenue
Net operating income
Net income
Diluted earnings per share
Common stock market price range:

High
Low

Dividends paid

I n d e p e n d e n t A u d i t o r s ’ R e p o r t

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 RV I C E G R O U P :

First

$51,611
5,281
1,928
0.12

26.25
23.20
.2800

$47,008
3,792
221
0.01

28.60
23.38
.27875

Second

$69,183
8,300
6,619
0.43

26.69
23.40
.2800

$66,958
8,050
5,764
0.37

27.70
24.10
.27875

Third

Fourth

$81,440
11,515
7,675
0.50

26.45
21.60
.2800

$76,310
9,517
5,920
0.39

27.00
23.77
.27875

$60,917
5,201
2,852
0.19

25.95
23.65
.2800

$56,544
3,792
3,060
0.20

27.50
24.00
.27875

We have audited the accompanying consolidated balance sheet of California Water Service Group
and subsidiaries as of December 31, 2002 and 2001, 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, 2002. 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.

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 assess-
ing the accounting principles used and significant estimates made by management, as well as evaluating the
overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the financial position of California Water Service Group and subsidiaries as of December 31, 2002 and
2001, and the results of their operations and their cash flows for each of the years in the three-year period ended
December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

Mountain View, California
January 29, 2003, except as to Note 16, which is as of February 28,2003

C A L I F O R N I A WA T E R S E RV I C E G R O U P

C o r p o ra t e I n fo r m a t i o n

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

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 mem-
bership in approved signature medallion programs) pursuant
to SEC Rule 17Ad-15. A notary’s acknowledgement is not
acceptable. 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

O f f i c e r s

A N N U A L M E E T I N G

The Annual Meeting of Stockholders will be held on
Wednesday, April 23, 2003, 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 transacted during
the meeting will be contained in the proxy material, which
will be mailed to stockholders on or about March 26, 2003.

D I V I D E N D D A T E S F O R 2 0 0 3

Quarter

First
Second
Third
Fourth

Declaration

Record Date

Payment Date

January 29
April 23
July 23
October 22

February 7
May 2
August 1

February 21
May 16
August 15
October 31 November 14

A N N U A L R E P O R T F O R 2 0 0 2 O N F O R M 1 0 - K
A copy of the Company’s report for 2002 filed with the
Securities and Exchange Commission (SEC) on Form 10-K
will be available in April 2003 and can be obtained by any
stockholder at no charge upon written request to the
address below. The Company’s filings with the SEC can
viewed via the link to the SEC’s EDGAR system on the
Company’s web site.

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

C A L I F O R N I A WA T E R S E RV I C E C O M PA N Y

Robert W. Foy 1,2,3 Chairman of the Board

Christine L. McFarlane Vice President, Human Resources

Peter C. Nelson 1,2,3 President and Chief Executive Officer

Raymond H. Taylor Vice President, Operations

Paul G. Ekstrom 4 Vice President, Customer Service, and
Corporate Secretary

Richard D. Nye 1,2,3 Vice President, Chief Financial Officer
and Treasurer

Francis S. Ferraro 2,5 Vice President, Regulatory Matters and
Corporate Development

Dan L. Stockton Vice President, Chief Information Officer

Calvin L. Breed 1 Controller, Assistant Secretary and
Assistant Treasurer

WA S H I N G T O N WA T E R S E RV I C E C O M PA N Y

Michael P. Ireland President

Robert R. Guzzetta 2 Vice President, Engineering and
Water Quality

N E W M E X I C O WA T E R S E RV I C E C O M PA N Y

Robert J. Davey President

1 Holds the same position with California Water Service Group
2 Also an officer of 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

B o a r d o f D i r e c t o r s

Peter C. Nelson*
President and
Chief Executive Officer

Robert W. Foy*
Chairman of the Board

C. H. Stump
Director Emeritus
Former Chairman of the Board and
former 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

George A. Vera†
Vice President and Chief
Financial Officer, the David &
Lucile Packard Foundation

Richard P. Magnuson†‡§
Private Venture Capital Investor

Edward D. Harris, Jr., M.D.‡*§
Professor of Medicine, Emeritus,
Stanford University Medical Center

Douglas M. Brown†‡§
President and Chief Executive
Officer of Tuition Plan
Consortium

Linda R. Meier†‡§
Member, National Advisory Board, Haas Public Service
Center; Member of the Board of Directors, Greater Bay
Bancorp; Chair of the Western Regional Advisory Board of
International Education; Member of the National Board of
the Institute of International Education; and Member of the
Board of Directors, Stanford Alumni Association

† Member of the Audit Committee
‡ Member of the Compensation Committee
* Member of the Executive Committee
§ Member of the Nominating/Corporate Governance Committee

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