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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 10-K
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2008
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission file No. 1-13883
 
CALIFORNIA WATER SERVICE GROUP
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
  77-0448994
(I.R.S. Employer
Identification No.)
1720 North First Street,
San Jose, California
(Address of Principal Executive Offices)
  95112
(Zip Code)
 
(408) 367-8200
(Registrant’s Telephone Number, including Area Code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class:
 
Name of Each Exchange on Which Registered:
 
Common Stock, $0.01 par value per share
  New York Stock Exchange
Preferred Share Purchase Rights
  New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
þ Large accelerated filer o Accelerated filer  o Non-accelerated filer o Smaller reporting company
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ
 
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant was $678.9 million on June 30, 2008, the last business day of the registrant’s most recently completed second fiscal quarter. The valuation is based on the closing price of the registrant’s common stock as traded on the New York Stock Exchange.
 
Common stock outstanding at February 23, 2009, — 20,723,952 shares.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the definitive proxy statement for the California Water Service Group 2009 Annual Meeting are incorporated by reference into Part III hereof.
 


 

 
TABLE OF CONTENTS
 
             
        Page
 
  Business     1  
    Forward-Looking Statement     1  
    Overview     2  
    Regulated Business     2  
    Non-Regulated Business     4  
    Operating Segment     4  
    Growth     5  
    Geographical Service Areas and Number of Customers at Year-end Rates and Regulation     5  
    Rates and Regulations     6  
    Seasonal Fluctuations     7  
    Water Supply     8  
    Utility Plant Construction     10  
    Sale of Surplus Properties     11  
    California Energy Situation     11  
    Security at Company Facilities     11  
    Quality of Water Supplies     11  
    Competition and Condemnation     12  
    Environmental Matters     12  
    Employees     12  
    Executive Officers of the Registrant     13  
  Risk Factors     13  
  Unresolved Staff Comments     25  
  Properties     25  
  Legal Proceedings     26  
  Submission of Matters to a Vote of Security Holders     27  
 
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     28  
  Selected Financial Data     30  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     31  
    Overview     31  
    Critical Accounting Policies and Estimates     31  
    Results of Operations     34  
    Rates and Regulation     38  
    Water Supply     43  
    Liquidity and Capital Resources     43  
  Quantitative and Qualitative Disclosures About Market Risk     49  
  Financial Statements and Supplementary Data     50  
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     79  
  Controls and Procedures     79  
  Other Information     79  
 
  Directors and Executive Officers and Corporate Governance     79  
  Executive Compensation     80  
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     80  
  Certain Relationships and Related Transactions and Director Independence     80  
  Principal Accountant Fees and Services     80  
 
  Exhibits, Financial Statement Schedules     81  
    Signatures     82  
    Exhibit Index     83  
 EX-21
 EX-23.1
 EX-23.2
 EX-31.1
 EX-31.2
 EX-32


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PART I
 
Item 1.   Business.
 
Forward-Looking Statements
 
This annual report, including all documents incorporated by reference, contains forward-looking statements within the meaning established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements in this annual report are based on currently available information, expectations, estimates, assumptions and projections, and our management’s beliefs, assumptions, judgments and expectations about us, the water utility industry and general economic conditions. These statements are not statements of historical fact. When used in our documents, statements that are not historical in nature, including words like “expects,” “intends,” “plans,” “believes,” “may,” “estimates,” “assumes,” “anticipates,” “projects,” “predicts,” “forecasts,” “should,” “seeks,” or variations of these words or similar expressions are intended to identify forward-looking statements. The forward-looking statements are not guarantees of future performance. They are based on numerous assumptions that we believe are reasonable, but they are open to a wide range of uncertainties and business risks. Consequently, actual results may vary materially from what is contained in a forward-looking statement.
 
Factors which may cause actual results to be different than those expected or anticipated include, but are not limited to:
 
  •  governmental and regulatory commissions’ decisions, including decisions on proper disposition of property;
 
  •  changes in regulatory commissions’ policies and procedures;
 
  •  the timeliness of regulatory commissions’ actions concerning rate relief;
 
  •  changes in the capital markets and access to sufficient capital on satisfactory terms;
 
  •  new legislation;
 
  •  changes in accounting valuations and estimates;
 
  •  changes in accounting treatment for regulated companies, including adoption of International Financial Reporting Standards, if required;
 
  •  electric power interruptions;
 
  •  increases in suppliers’ prices and the availability of supplies including water and power;
 
  •  fluctuations in interest rates;
 
  •  changes in environmental compliance and water quality requirements;
 
  •  acquisitions and the ability to successfully integrate acquired companies;
 
  •  the ability to successfully implement business plans;
 
  •  civil disturbances or terrorist threats or acts, or apprehension about the possible future occurrences of acts of this type;
 
  •  the involvement of the United States in war or other hostilities;
 
  •  our ability to attract and retain qualified employees;
 
  •  labor relations matters as we negotiate with the unions;
 
  •  implementation of new information technology systems;
 
  •  restrictive covenants in or changes to the credit ratings on current or future debt that could increase financing costs or affect the ability to borrow, make payments on debt, or pay dividends;
 
  •  general economic conditions, including changes in customer growth patterns and our ability to collect billed revenue from customers;


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  •  changes in customer water use patterns and the effects of conservation;
 
  •  the impact of weather on water sales and operating results;
 
  •  the ability to satisfy requirements related to the Sarbanes-Oxley Act and other regulations on internal controls; and
 
  •  the risks set forth in “Risk Factors” included elsewhere in this annual report.
 
In light of these risks, uncertainties and assumptions, investors are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this annual report or as of the date of any document incorporated by reference in this report, as applicable. When considering forward-looking statements, investors should keep in mind the cautionary statements in this annual report and the documents incorporated by reference. We are not under any obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.
 
Overview
 
California Water Service Group is a holding company incorporated in Delaware with six operating subsidiaries: California Water Service Company (Cal Water), New Mexico Water Service Company (New Mexico Water), Washington Water Service Company (Washington Water), Hawaii Water Service Company, Inc. (Hawaii Water), and CWS Utility Services and HWS Utility Services LLC (CWS Utility Services and HWS Utility Services LLC being referred to collectively in this annual report as Utility Services). Cal Water, New Mexico Water, Washington Water, and Hawaii Water are regulated public utilities. The regulated utility entities also provide some non-regulated services. Utility Services provides non-regulated services to private companies and municipalities. Cal Water was the original operating company and began operations in 1926.
 
Our business is conducted through our operating subsidiaries. The bulk of the business consists of the production, purchase, storage, treatment, testing, distribution and sale of water for domestic, industrial, public and irrigation uses, and for fire protection. We also provide non-regulated water-related services under agreements with municipalities and other private companies. The non-regulated services include full water system operation, billing and meter reading services. Non-regulated operations also include the lease of communication antenna sites, lab services, and promotion of other non-regulated services. Earnings may be significantly affected by the sale of surplus real properties if and when they occur.
 
During the year ended December 31, 2008, there were no significant changes in the kind of products produced or services rendered or those provided by our operating subsidiaries, or in the markets or methods of distribution.
 
Our mailing address and contact information is:
 
California Water Service Group
1720 North First Street
San Jose, California 95112-4598
telephone number: 408-367-8200
www.calwatergroup.com
 
Annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports are available free of charge through our website. The reports are available on our website on the same day they appear on the SEC’s website.
 
Regulated Business
 
California water operations are conducted by the Cal Water and CWS Utility Services entities, which provide service to approximately 463,400 customers in 83 California communities through 26 separate districts. Of these 26 districts, 24 districts are regulated water systems, which are subject to regulation by the California Public Utilities Commission (CPUC). The other 2 districts, the City of Hawthorne and the City of Commerce, are governed through their respective city councils and are outside of the CPUC’s jurisdiction. California water operations account for approximately 94% of our total customers and approximately 95% of our total consolidated operating revenue.


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Washington Water provides domestic water service to approximately 15,800 customers in the Tacoma and Olympia areas. Washington Water’s utility operations are regulated by the Washington Utilities and Transportation Commission. Washington Water accounts for approximately 3% of our total customers and approximately 2% of our total consolidated operating revenue.
 
New Mexico Water provides service to approximately 7,600 water and wastewater customers in the Belen, Los Lunas and Elephant Butte areas in New Mexico. New Mexico’s regulated operations are subject to the jurisdiction of the New Mexico Public Regulation Commission. New Mexico Water accounts for approximately 2% of our total customers and approximately 1% of our total consolidated operating revenue.
 
Hawaii Water provides service to approximately 3,700 water and wastewater customers on the islands of Maui and Hawaii, including several large resorts and condominium complexes. Hawaii’s regulated operations are subject to the jurisdiction of the Hawaii Public Utilities Commission. Hawaii Water accounts for less than 1% of our total customers and approximately 2% of our total operating revenue. HWS Utility Services LLC was organized in 2007 and began non-regulated operations in January 2008.
 
The state regulatory bodies governing our regulated operations are referred to as the Commissions in this report. Rates and operations for regulated customers are subject to the jurisdiction of the respective state’s regulatory commission. The Commissions require that water and wastewater rates for each regulated district be independently determined. The Commissions are expected to authorize rates sufficient to recover normal operating expenses and allow the utility to earn a fair and reasonable return on invested capital.
 
We distribute water in accordance with accepted water utility methods. Where applicable, we hold franchises and permits in the cities and communities where we operate. The franchises and permits allow us to operate and maintain facilities in public streets and right- of-ways as necessary.
 
We operate the City of Hawthorne and the City of Commerce water systems under lease agreements. In accordance with the lease agreements, we receive all revenues from operating the systems and are responsible for paying the operating costs. Rates for the City of Hawthorne and City of Commerce water systems are established in accordance with operating agreements and are subject to ratification by the respective city councils. The City of Hawthorne lease is a 15-year lease and expires in 2011. The City of Commerce lease is a 15-year lease and expires in 2018. The terms of other operating agreements range from one-year to three-year periods with provisions for renewals.
 
In February 1996, we entered into an agreement to operate the City of Hawthorne water system. The system, which is located near the Hermosa-Redondo district, serves about half of Hawthorne’s population. The agreement required us to make an up-front $6.5 million lease payment to the city that is being amortized over the lease term. Additionally, annual lease payments of $0.1 million are made to the city and indexed to changes in water rates. Under the lease we are responsible for all aspects of system operation and capital improvements, although title to the system and system improvements reside with the city. At the end of the lease, the city is required to reimburse us for the unamortized value of capital improvements made during the term of the lease. In exchange, we receive all revenue from the water system, which was $5.2 million, $5.4 million and $5.4 million in 2008, 2007, and 2006, respectively.
 
In July 2003, an agreement was negotiated with the City of Commerce to lease and operate its water system. The lease requires us to pay $0.8 million per year in monthly installments and pay $200 per acre-foot for water usage exceeding 2,000 acre-feet per year plus a percentage of certain operational savings that may be realized. Under the lease agreement, we are responsible for all aspects of the system’s operations. The city is responsible for capital expenditures, and title to the system and system improvements resides with the city. We bear the risks of operation and collection of amounts billed to customers. The agreement includes a procedure to request rate changes for costs changes outside of our control and other cost changes. In exchange, we receive all revenue from the system, which totaled $2.0 million in 2008 and $1.7 million in 2007 and 2006.
 
The City of Hawthorne and the City of Commerce are governed through their respective city councils and are considered non-regulated because they are outside of the CPUC’s jurisdiction. We report revenue and expenses for the City of Hawthorne and City of Commerce leases in operating revenue and operating expenses because we are entitled to retain all customer billings and are generally responsible for all operating expenses.


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Non-Regulated Businesses
 
Fees for non-regulated activities are based on contracts negotiated between the parties. Under other contract arrangements, we operate municipally owned water systems, privately owned water systems, and recycled water distribution systems, but are not responsible for all operating costs. Non-regulated revenue received from water system operations is generally determined on a fee-per-customer basis.
 
Non-regulated activities consist primarily of:
 
  •  operating water systems, which are owned by other entities;
 
  •  providing meter reading and billing services;
 
  •  leasing communication antenna sites on our properties;
 
  •  operating recycled water systems;
 
  •  providing lab services for water quality testing;
 
  •  marketing and billing of optional third party insurance program to our residential customers;
 
  •  selling surplus property, and
 
  •  other services as requested by the client.
 
The revenue from these activities is not included in operations revenue, and therefore is reported below operating profit on the income statement. Due to the variety of services provided and activities being outside of our core business, the number of customers is not tracked for these non-regulated activities, except customers for the City of Hawthorne and the City of Commerce.
 
In the first quarter of 2008, the Company’s wholly-owned subsidiary HWS Utility Services, LLC, acquired contracts to operate and maintain water and wastewater systems in Hawaii. The purchase price of $1.3 million was paid with the issuance of the Company’s common stock. The purchase price is being amortized over the remaining life of the contracts.
 
We provide meter reading and customer billing services for several municipalities in California. We also provide sewer and refuse billing services to several municipalities.
 
We lease antenna sites to telecommunication companies, which place equipment at various Company-owned sites. Lease income totaled $2.0 million in 2008 and 2007 and $1.7 million in 2006. The antennas are used in cellular phone and personal communication applications. We continue to negotiate new leases for similar uses.
 
We provide laboratory services to San Jose Water Company, a 5% stockholder of Cal Water, and Great Oaks Water Company and for the systems under operation and maintenance agreements.
 
In 2006, we started an Extended Service Protection program (ESP) in California covering certain repairs to residential customer’s water line between the meter and the home. The non-regulated program was operated by CWS Utility Services. Typically the utility is responsible for servicing and maintaining the water line up to and including the meter. The home owner is responsible for the water line from the meter to the house. In late 2007, we contracted with Home Service USA to replace the ESP program with an insurance product. Home Service USA now provides water line protection insurance, sewer line protection insurance, and internal plumbing protection insurance to Cal Water’s customers. Cal Water includes charges for these optional non-tariffed services on its bills and CWS Utility Services facilitates marketing these products to its customers.
 
Operating Segment
 
We operate primarily in one business segment, the supply and distribution of water and providing water-related utility services.


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Growth
 
We intend to continue exploring opportunities to expand our regulated and non-regulated water and wastewater businesses in the western United States. The opportunities could include system acquisitions, lease arrangements similar to the City of Hawthorne and City of Commerce contracts, full service system operation and maintenance agreements, meter reading, billing contracts and other utility-related services. Management believes that a holding company structure facilitates providing non-regulated utility services, which are not subject to any Commission’s jurisdiction.
 
Geographical Service Areas and Number of Customers at Year-end
 
Our principal markets are users of water within our service areas. Most of the geographical service areas that we service are regulated. In addition, the City of Hawthorne and City of Commerce are included due to similarities in structure and risk of operations. The approximate number of customers served in each district is as follows:
 
Regulated Customers, City of Hawthorne and City of Commerce Customers at December 31, (rounded to the nearest hundred)
 
                 
    2008     2007  
 
SAN FRANCISCO BAY AREA
               
Mid-Peninsula (serving San Mateo and San Carlos)
    36,200       36,100  
South San Francisco (including Colma and Broadmoor)
    16,800       16,800  
Bear Gulch (serving portions of Menlo Park, Atherton, Woodside and Portola Valley)
    18,100       18,000  
Los Altos (including portions of Cupertino, Los Altos Hills, Mountain View and Sunnyvale)
    18,600       18,600  
Livermore
    18,200       18,200  
                 
      107,900       107,700  
                 
SACRAMENTO VALLEY
               
Chico (including Hamilton City)
    27,400       27,300  
Oroville
    3,600       3,600  
Marysville
    3,700       3,800  
Dixon
    2,800       2,900  
Willows
    2,400       2,400  
Redwood Valley (Lucerne, Duncans Mills, Guerneville, Dillon Beach, Noel Heights & portions of Santa Rosa)
    1,900       2,000  
                 
      41,800       42,000  
                 
SALINAS VALLEY
               
Salinas
    27,800       28,000  
King City
    2,500       2,500  
                 
      30,300       30,500  
                 


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    2008     2007  
 
SAN JOAQUIN VALLEY
               
Bakersfield
    65,500       65,400  
Stockton
    41,500       42,200  
Visalia
    39,200       38,900  
Selma
    6,100       6,100  
Kern River Valley
    4,300       4,300  
Antelope Valley (Fremont Valley, Lake Hughes, Lancaster & Leona Valley)
    1,400       1,400  
                 
      158,000       158,300  
                 
LOS ANGELES AREA
               
East Los Angeles (including portions of the City of Commerce)
    26,700       26,600  
Hermosa-Redondo (serving Hermosa Beach, Redondo Beach and a portion of Torrance)
    26,500       26,300  
Dominguez (Carson and portions of Compton, Harbor City, Long Beach, Los Angeles and Torrance)
    33,700       33,700  
Palos Verdes (including Palos Verdes Estates, Rancho Palos Verdes, Rolling Hills Estates and Rolling Hills)
    24,000       24,000  
Westlake (a portion of Thousand Oaks)
    7,100       7,100  
Hawthorne and Commerce (leased municipal systems)
    7,400       7,400  
                 
      125,400       125,100  
                 
CALIFORNIA TOTAL
    463,400       463,600  
HAWAII
    3,700       700  
NEW MEXICO
    7,600       7,500  
WASHINGTON
    15,800       15,800  
                 
COMPANY TOTAL
    490,500       487,600  
                 
 
Rates and Regulation
 
Our water utility rates and service for the regulated business are subject to the jurisdiction of the Commissions. The Commissions’ decisions and the timing of those decisions can have a significant impact on our operations and earnings.
 
Since our 24 California-regulated operating districts are not physically integrated, rates are set independently for each district as required by the California Public Utilities Commission (CPUC). General office (headquarters) expenses and capital expenditures are considered separately and allocated ratably to the operating districts.
 
General and Escalation Rate Increases
 
General rate case (GRC) applications in California address district and general office operating costs and capital requirements for a forward-looking three-year period. GRC decisions typically authorize an immediate rate increase and annual step rate increases for the three-year cycle. Under the CPUC’s 2004 rate case processing plan, step rate increases will generally be effective on July 1 of each calendar year through 2010, and are designed to maintain the return on equity (ROE) authorized in the initial decision in succeeding years. Cal Water is required to file a GRC for each operating district every three years. The CPUC adopted a new rate case plan (RCP) in May 2007. Under this plan, Cal Water is able to recover general office expenses, including employee benefit costs, as well as insurance and other corporate items, for its 24 regulated operating districts in 2008 as determined by the CPUC in the 2007 GRC. The next California GRC will be filed in July 2009 covering all 24 California districts and general office expenses. Rate increases resulting from the 2009 GRC are scheduled to be effective January 1, 2011.

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The CPUC’s processing schedule sets an expected effective date of July 1 for Cal Water filings including the 2007 GRC (12 month processing schedule) and a January 1, 2011 effective date for the 2009 GRC (18 month schedule). While we expect future filings to receive decisions on the CPUC’s published processing time line, if decisions are delayed, legislation enacted in 2003 gives us protection by establishing an effective date when the decision should have been made. This allows interim rates to be charged typically based upon inflation and surcharge or surcredit, if necessary, once the CPUC renders a decision.
 
In December 2005, the CPUC approved the California Water Action Plan (the Plan). The Plan identifies and lays out 28 best practices associated with water infrastructure management and rate making that California would like to adopt over time. Among other things, the Plan calls for streamlining the GRC process, development and adoption of a Water Rate Adjustment Mechanism (WRAM), and creating incentives for large water systems to acquire smaller systems. As part of the streamlining process, the CPUC issued its new RCP in May 2007. Cal Water’s request for a WRAM and a Modified Cost Balancing Account (MCBA) was approved and implemented in 2008. See Rates and Regulations Section in Item 7 of this report.
 
Water rates for Washington Water and New Mexico Water regulated operations are set based on historic 12-month data. Applications are filed on an “as needed” basis and can be submitted annually. Water rates for the regulated operations of Hawaii Water are set based on a combination of historical base and forward-looking methodology and are allowed to be filed annually. In these states, regulatory procedures do not provide for step rate increases or offset increases (see “Expense-Balancing and Memorandum Accounts” below), except for Hawaii, which allows immediate rate adjustments to reflect changes in purchased power rates.
 
Expense-Balancing and Memorandum Accounts
 
Cal Water uses expense-balancing accounts (also referred to as Incremental Cost Balancing Accounts (ICBA)) and memorandum accounts to track suppliers’ rate changes for purchased water, purchased power, and pump taxes, and other costs that are not included in customer water rates. The cost changes are referred to as “offsetable expenses,” because under certain circumstances, they are collectible from customers (or refunded to customers) in future rates designed to offset cost changes from suppliers. We do not record the ICBA and memorandum accounts until the CPUC has authorized a change in customer rates and the customer has been billed. The cumulative net amount in the expense balancing accounts and memorandum accounts as of December 31, 2008, was approximately $1.5 million. This amount includes certain amounts that have been authorized for recovery through customer surcharges but which have not yet been collected and amounts that have not yet been filed for recovery. Effective July 1, 2008, the ICBA was replaced with the MCBA. With the MCBA, the suppliers’ rate changes for purchased water, purchased power, and pump taxes are immediately reflected in the financial statements. (See “Rates and Regulation” section in Item 7 of this report).
 
Washington Water, New Mexico Water, and Hawaii Water did not have material amounts in expense balancing or memorandum accounts.
 
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Rates and Regulation” for more information on rates and regulation.
 
Seasonal Fluctuations
 
Our water business is seasonal in nature and weather conditions can have a material effect on customer usage. Customer demand for water generally is lower during the cooler and rainy, winter months. Demand increases in the spring when warmer weather returns and the rains end, and customers use more water for outdoor purposes, such as landscape irrigation. Warm temperatures during the generally dry summer months result in increased demand. Water usage declines during the fall as temperatures decrease and the rainy season begins.
 
During years in which precipitation is especially heavy or extends beyond the spring into the early summer, customer demand can decrease from historic normal levels, generally due to reduced outdoor water usage. Likewise, an early start to the rainy season during the fall can cause a decline in customer usage. When summer temperatures are cooler than normal, water usage is generally lower. A warmer than normal summer can result in higher customer usage. In the past, the seasonality of water usage had a significant impact on operating revenues


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and net income. In addition, the promotion of water conservation could also affect our operating revenues and net income. During 2008, Cal Water, after receiving California Public Utilities Commission approval, changed its method of recognizing revenue and production costs with the adoption of the WRAM and MCBA. As a result, customer water usage does not have the same impact as in prior years. This is discussed further in Management’s Discussion and Analysis.
 
Drought can have an impact on the business. When rainfall is below average for consecutive years, drought conditions can develop and certain customers may be required to reduce consumption to preserve available supply. As an example, from 1987 to 1993, California experienced a six-year period when rainfall was below historic average. During that period, some districts issued water-rationing requirements to their customers. In certain districts, penalties were assessed on customers who exceeded monthly allotments, which was approved by the CPUC after local governments enacted ordinances for drought. During 2008, the governor of California declared a drought emergency in the state and Cal Water’s water wholesalers requested voluntary reduction in water usage. On January 29, 2009, the California Department of Water Resources indicated that the second snow survey of the winter season indicated that the snow content was 61 percent of normal to date, statewide. The financial impact of a drought, or of water rationing, has been minimized with the adoption of the WRAM and MCBA. Water rationing will present us with challenges including changing our billing system to accommodate any penalty program, responding to customer requirements, and certain operational issues. We are in the process of increasing our water conservation programs to promote water savings.
 
Water Supply
 
In California, we obtain our water supply from wells, surface runoff or diversion, and by purchase from public agencies and other wholesale suppliers. Our water supply has been adequate to meet customer demand; however, during periods of drought, some districts have experienced mandatory water rationing. California’s rainy season usually begins in November and continues through March with the most rain typically falling in December, January and February. During winter months, reservoirs and underground aquifers are replenished by rainfall. Snow accumulated in the mountains provides an additional water source when spring and summer temperatures melt the snowpack, producing runoff into streams and reservoirs, and also replenishing underground aquifers.
 
Washington and Hawaii receive rain in all seasons with the majority falling during winter months. Washington Water and Hawaii Water draw all their water supply by pumping from wells. Historically, approximately half of Cal Water’s water supply is purchased from wholesale suppliers with the balance pumped from wells. During 2008, approximately 49 percent of the Cal Water supply was obtained from wells, 47 percent was purchased from wholesale suppliers and 4 percent was obtained from surface supplies. Well water is generally less expensive and Cal Water strives to maximize the use of its well sources in districts where there is an option between well or purchased supply sources.
 
New Mexico Water’s rainfall normally occurs in all seasons, but is heaviest in the summer monsoon season. New Mexico Water pumps all of its water supply from wells based on its water rights.
 
We have six California water treatment plants in the Bakersfield, Bear Gulch, Kernville, Oroville and Redwood Valley districts. Water for operation of the Bakersfield plants, with a combined capacity of 28 million gallons per day, is drawn from the Kern River under a long-term contract with the City of Bakersfield. The other four plants have a capacity of 14 million gallons per day.
 
During 2008, we produced an estimated 138 billion gallons of water for our customers, down 2% from the estimated 141 billion gallons produced in 2007. The 2008 average daily water production was approximately 377 million gallons. By comparison, in 2007, the average daily water production was approximately 387 million gallons.


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The following table shows the estimated quantity of water purchased and the percentage of purchased water to total water production in each California operating district that purchased water in 2008. Other than noted below, all other districts receive 100% of their water supply from wells.
 
                     
    (MG)
           
    Water
           
    Production
    Percentage
     
District
  Purchased     Purchased    
Source of Purchased Supply
 
SAN FRANCISCO BAY AREA
                   
Mid-Peninsula
    5,917       100 %   San Francisco Water Public Utilities Commission
South San Francisco
    2,961       98 %   San Francisco Water Public Utilities Commission
Bear Gulch
    4,882       97 %   San Francisco Water Public Utilities Commission
Los Altos
    3,692       73 %   Santa Clara Valley Water District
Livermore
    2,993       75 %   Alameda County Flood Control and Water Conservation District
SACRAMENTO VALLEY
                   
Oroville
    989       74 %   Pacific Gas and Electric Co. and County of Butte
Redwood Valley
    115       75 %   County of Lake
SAN JOAQUIN VALLEY
                   
Antelope/Kern
    61       16 %   Antelope Valley-East Kern Water Agency and City of Bakersfield
Bakersfield
    4,581       17 %   Kern County Water Agency and City of Bakersfield
Stockton
    7,424       71 %   Stockton East Water District
LOS ANGELES AREA
                   
East Los Angeles
    4,525       73 %   Central Basin Municipal Water District
Dominguez
    9,938       76 %   West Basin Municipal Water District and City of Torrance
City of Commerce
    50       7 %   Central Basin Municipal Water District
Hawthorne
    1,524       100 %   West Basin Municipal Water District
Hermosa-Redondo
    4,237       93 %   West Basin Municipal Water District
Palos Verdes
    7,438       100 %   West Basin Municipal Water District
Westlake
    3,319       100 %   Calleguas Municipal Water District
 
 
MG = million gallons
 
The Bear Gulch district obtains a portion of its water supply from surface runoff from the local watershed. In the Oroville and Redwood Valley districts, the water purchased is from a surface supply. The surface sources are processed through our water treatment plants before being delivered to the distribution system. In the Bakersfield and Kern River Valley districts, we purchase surface supply then process the water through our treatment plants. In addition, the Bakersfield district purchases treated water as a component of its water supply.
 
The Chico, Marysville, Dixon, and Willows districts in the Sacramento Valley, the Salinas and King City districts in the Salinas Valley, and the Selma and Visalia districts in the San Joaquin Valley obtain their entire supply from wells.
 
In the Salinas district, which solely depends upon ground water, several wells were taken out of service in the last three years, primarily due to poor water quality. We have installed treatment systems on some of these wells to


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meet customer demand. Management believes that water supply issues in the Salinas district will be adequately resolved in the future by seeking additional sources or additional treatment.
 
Purchases for the Los Altos, Livermore, Oroville, Redwood Valley, Stockton, and Bakersfield districts are pursuant to long-term contracts expiring on various dates after 2011.
 
The water supplies purchased for the Dominguez, East Los Angeles, Hermosa-Redondo, Palos Verdes, and Westlake districts, and the Hawthorne and Commerce systems are provided by public agencies pursuant to a statutory obligation of continued non-preferential service to purveyors within the agencies’ boundaries.
 
Purchases for the South San Francisco, Mid-Peninsula, and Bear Gulch districts are in accordance with long-term contracts with the San Francisco Public Utilities Commission (SFPUC) expiring on June 30, 2009, which are in the process of renegotiation.
 
Management anticipates that we will be able to renew each of the water supply contracts as they expire. The price of wholesale water purchases is subject to pricing changes imposed by the various wholesalers.
 
Shown below are wholesaler price rates and increases that became effective in 2008 and estimated wholesaler price rates and percent changes for 2009.
 
                                         
              2008
              2009
 
    Effective
        Percent
    Effective
        Percent
 
District
  Month   Unit Cost     Change     Month   Unit Cost     Change  
 
Antelope
  January   $ 290/af       9.4 %   January   $ 315/af       8.6 %
Bakersfield*
  July     140/af       2.9 %   July     154/af       10.0 %
Bear Gulch
  July     1.43/ccf       10.0 %   July     1.66/ccf       16.1 %
Commerce
  July     635/af       20.5 %   July     768/af       20.9 %
Dominguez
  January     606/af       5.9 %   January     740/af       22.2 %
East Los Angeles
  July     635/af       20.5 %   July     768/af       20.9 %
Hawthorne
  January     606/af       5.9 %   January     740/af       22.2 %
Hermosa-Redondo
  January     606/af       5.9 %   January     740/af       22.2 %
Livermore
  January     1.575/ccf       8.0 %   January     1.84/ccf       16.8 %
Los Altos
  July     620/af       7.8 %   July     670/af       8.1 %
Oroville
  January     75,000/yr       2.8 %   January     75,000/yr       0.0 %
Palos Verdes
  January     606/af       5.9 %   January     740/af       22.2 %
Mid-Peninsula
  July     1.43/ccf       10.0 %   July     1.66/ccf       16.1 %
Redwood Valley
  May     50/af       4.9 %   May     53/af       6.0 %
So. San Francisco
  July     1.43/ccf       10.0 %   July     1.66/ccf       16.1 %
Stockton
  April     476,350/mo       (2.8 %)   April     505,075/mo       6.0 %
Westlake
  January     657/af       10.1 %   January     769/af       17.1 %
 
 
af = acre foot; ccf = hundred cubic feet; yr = fixed annual cost; mo = fixed monthly cost
 
* untreated water
 
We work with all local suppliers and agencies responsible for water supply to insure adequate, long-term supply for each system.
 
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Water Supply” concerning more information on adequacy of supplies.
 
Utility Plant Construction
 
We have continually extended, enlarged, and replaced our facilities as required to meet increasing demands and to maintain the water systems. We obtain construction financing using funds from operations, short-term bank borrowings, long-term financing, advances for construction and contributions in aid of construction that are funded


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by developers. Advances for construction are cash deposits from developers for construction of water facilities or water facilities deeded from developers. These advances are generally refundable without interest over a period of 40 years by equal annual payments. Contributions in aid of construction consist of nonrefundable cash deposits or facilities transferred from developers, primarily for fire protection and relocation projects. We cannot control the amount received from developers. This amount fluctuates from year-to-year as the level of construction activity carried on by developers varies. This activity is impacted by the demand for housing, commercial development, and general business conditions, including interest rates.
 
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” for additional information.
 
Sale of Surplus Real Properties
 
When properties are no longer used and useful for public utility purposes, we are no longer allowed to earn a return on our investment in the property in the regulated business. The surplus property is transferred out of the regulated operations. From time to time, some properties have been sold or offered for sale. As these sales are subject to local real estate market conditions and can take several months or years to close, income from the sale of surplus properties may or may not be consistent from year-to-year.
 
California Energy Situation
 
The California energy crisis was well publicized. There is still uncertainty about the state’s ability to avoid future rolling electric blackouts, although we did not experience any major electric blackouts during 2008 or 2007. We continue to use power efficiently to minimize the power expenses passed on to our customers, and maintain backup power systems to continue water service to our customers if the power companies’ supplies are interrupted. Many of our well sites are equipped with emergency electric generators designed to produce electricity to keep the wells operating during power outages. Storage tanks also provide customers with water during blackout periods.
 
Security at Company Facilities
 
Due to terrorist and other risks, we have heightened security at our facilities and have taken added precautions to protect our employees and the water delivered to customers. In 2002, federal legislation was enacted that resulted in new regulations concerning security of water facilities, including submitting vulnerability assessment studies to the federal government. We have complied with regulations issued by the Environmental Protection Agency (EPA) pursuant to our federal legislation concerning vulnerability assessments and have made filings to the EPA as required. In addition, communication plans have been developed as a component of our procedures. While we do not make public comments on our security programs, we have been in contact with federal, state, and local law enforcement agencies to coordinate and improve our water delivery systems’ security.
 
Quality of Water Supplies
 
Our operating practices are designed to produce potable water in accordance with accepted water utility practices. Water entering the distribution systems from surface sources is treated in compliance with federal and state Safe Drinking Water Acts (SDWA) standards. Most well supplies are chlorinated or chloraminated for disinfection. Water samples from each water system are analyzed on a regular, scheduled basis in compliance with regulatory requirements. We operate a state-certified water quality laboratory at the San Jose General Office that provides testing for most of our California operations. Certain tests in California are contracted with independent certified labs qualified under the Environmental Laboratory Accreditation Program. Local independent state certified labs provide water sample testing for the Washington, New Mexico and Hawaii operations.
 
In recent years, federal and state water quality regulations have continued to increase water testing requirements. The SDWA continues to be amended to reflect new public health concerns. We monitor water quality standard changes and upgrade our treatment capabilities to maintain compliance with the various regulations.


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Competition and Condemnation
 
Our principal operations are regulated by the Commission of each state. Under state laws, no privately owned public utility may compete within any service territory that we already serve without first obtaining a certificate of public convenience and necessity from the applicable Commission. Issuance of such a certificate would only be made upon finding that our service is deficient. To management’s knowledge, no application to provide service to an area served by us has been made.
 
State law provides that whenever a public agency constructs facilities to extend a utility system into the service area of a privately owned public utility, such an act constitutes the taking of property and requires reimbursement to the utility for its loss. State statutes allow municipalities, water districts and other public agencies to own and operate water systems. These agencies are empowered to condemn properties already operated by privately owned public utilities. The agencies are also authorized to issue bonds, including revenue bonds, for the purpose of acquiring or constructing water systems. However, if a public agency were to acquire utility property by eminent domain action, the utility would be entitled to just compensation for its loss. In Washington, annexation was approved in February 2008 for property served by us on Orcas Island; however, we continue to serve the customers in the annexed area and do not expect the annexation to impact our operations. To management’s knowledge, other than the Orcas Island property, no municipality, water district, or other public agency is contemplating or has any action pending to acquire or condemn any of our systems.
 
In recent years, consolidation within the water industry has accelerated. A number of publicly traded water companies have been acquired or merged into larger domestic companies. Several acquisitions of publicly traded companies have also been completed by much larger foreign companies. We intend to continue the pursuit of opportunities to expand our business in the western United States, which may include expansion through acquisitions or mergers with other companies.
 
Environmental Matters
 
Our operations are subject to environmental regulation by various governmental authorities. Environmental affairs programs have been designed to provide compliance with water discharge regulations, underground and aboveground fuel storage tank regulations, hazardous materials management plans, hazardous waste regulations, air quality permitting requirements, wastewater discharge limitations and employee safety issues related to hazardous materials. Also, we actively investigate alternative technologies for meeting environmental regulations and continue the traditional practices of meeting environment regulations.
 
For a description of the material effects that compliance with environmental regulations may have on us, see Item 1A. “Risk Factors — Risks Related to Our Regulatory Environment.” We expect environmental regulation to increase, resulting in higher operating costs in the future, which may have a material adverse effect on earnings.
 
Employees
 
At year-end 2008, we had 929 employees, including 58 at Washington Water, 16 at New Mexico Water and 44 at Hawaii Water. In California, most non-supervisory employees are represented by the Utility Workers Union of America, AFL-CIO, except certain engineering and laboratory employees who are represented by the International Federation of Professional and Technical Engineers, AFL-CIO.
 
At December 31, 2008, there were 595 union employees. In November 2008, we negotiated 2009 wage increases with both of our unions of 3.0%. The current agreement with the unions is effective through 2009. Management believes that it maintains good relationships with the unions.
 
Employees at Washington Water, New Mexico Water, and Hawaii Water are not represented by unions.


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Executive Officers of the Registrant
 
             
Name
 
Positions and Offices with California Water Service Group
 
Age
 
Peter C. Nelson(1)
  President and Chief Executive Officer since February 1, 1996. Formerly Vice President, Division Operations (1994-1995) and Region Vice President (1989-1994), Pacific Gas & Electric Company, a gas and electric public utility     61  
Martin A. Kropelnicki(2)
  Chief Financial Officer and Treasurer since March 13, 2006. Previously Chief Financial Officer of Power Light Corporation (2005-2006), Chief Financial Officer and Executive Vice President of Corporate Services of Hall Kinion and Associates (1997-2004), Deloitte & Touche Consulting (1996-1997), various positions with Pacific Gas & Electric (1989-1996)     42  
Lynne P. McGhee(2)
  Corporate Secretary since July 25, 2007; Associate Corporate Counsel since May 2003; previously served as a Commissioner legal advisor and staff counsel at the California Public Utilities Commission     44  
Calvin L. Breed(3)
  Controller, Assistant Secretary and Assistant Treasurer since November 1, 1994; previously Treasurer of TCI International, Inc. (1984-1994); a certified public accountant with Arthur Andersen & Co. (1980-1983)     53  
 
 
(1) Holds the same position with California Water Service Company, CWS Utility Services, and Hawaii Water Service Co.; Chief Executive Officer of New Mexico Water Service Company and Washington Water Service Company;
 
(2) Holds the same position with California Water Service Company New Mexico Water Service Company, Washington Water Service Company, Hawaii Water Service Company, Inc., and CWS Utility Services;
 
(3) Holds the same position with California Water Service Company, Washington Water Service Company, and Hawaii Water Service Company; Assistant Secretary and Assistant Treasurer of New Mexico Water Service Company
 
Item 1A.   Risk Factors.
 
The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected.
 
Risks Related to Our Regulatory Environment
 
Our business is heavily regulated by state and federal regulatory agencies and our financial viability depends upon our ability to recover costs from our customers through rates that must be approved by state public utility commissions.
 
California Water Service Company, New Mexico Water Service Company, Washington Water Service Company and Hawaii Water Service Company, Inc., are regulated public utilities which provide water service to our customers. The rates that we charge our water customers are subject to the jurisdiction of the regulatory commissions in the states in which we operate. These commissions set water rates for each operating district independently because the systems are not interconnected. The commissions authorize us to charge rates which they consider to be sufficient to recover normal operating expenses, to provide funds for adding new or replacing water infrastructure, and to allow us to earn what the commissions consider to be a fair and reasonable return on invested capital.
 
Our revenues and consequently our ability to meet our financial objectives are dependent upon the rates we are authorized to charge our customers by the commissions and our ability to recover our costs in these rates. Our management uses forecasts, models and estimates in order to set rates that will provide a fair and reasonable return


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on our invested capital. While our rates must be approved by the commissions, no assurance can be given that our forecasts, models and estimates will be correct or that the commissions will agree with our forecasts, models and estimates. If our rates are set too low, our revenues may be insufficient to cover our operating expenses, capital expenditure requirements and desired dividend levels.
 
We periodically file rate increase applications with the commissions. The ensuing administrative and hearing process may be lengthy and costly. The decisions of the commissions are beyond our control and we can provide no assurances that our rate increase requests will be granted by the commissions. Even if approved, there is no guarantee that approval will be given in a timely manner or at a sufficient level to cover our expenses and provide a reasonable return on our investment. If the rate increase decisions are delayed, our earnings may be adversely affected.
 
Our evaluation of the probability of recovery of regulatory assets is subject to adjustment by regulatory agencies and any such adjustment could adversely affect our results of operations.
 
Regulatory decisions may also impact prospective revenues and earnings, affect the timing of the recognition of revenues and expenses and may overturn past decisions used in determining our revenues and expenses. Our management continually evaluates the anticipated recovery of regulatory assets, liabilities, and revenues subject to refund and provides for allowances and/or reserves as deemed necessary. Under Financial Accounting Standard SFAS No. 71 (Accounting for the Effects of Certain Types of Regulation), we can defer certain costs if we believe it is probable that we will be allowed to recover those costs by future rate increases. If a commission determined that a portion of our assets were not recoverable in customer rates, we may suffer an asset impairment which would require a write down in such asset’s valuation which would be recorded through operations.
 
If our assessment as to the probability of recovery through the ratemaking process is incorrect, the associated regulatory asset or liability would be adjusted to reflect the change in our assessment or any regulatory disallowances. A change in our evaluation of the probability of recovery of regulatory assets or a regulatory disallowance of all or a portion of our cost could have a material adverse effect on our financial results.
 
Regulatory agencies may disagree with our valuation and characterization of certain of our assets.
 
If we determine that assets are no longer used or useful for utility operations, we may remove them from our rate base and subsequently sell those assets. If the commission disagrees with our characterization, we could be subjected to penalties. Furthermore, there is a risk that the commission could determine that appreciation in property value should be awarded to the ratepayers rather than our stockholders.
 
Changes in laws, rules and policies of regulatory agencies can significantly affect our business.
 
Regulatory agencies may change their rules and policies for various reasons, including as a result of changes in the local political environment. In some states, regulators are elected by popular vote or are appointed by elected officials, and the results of elections may change the rules and policies of an agency. As a result of the political process, long-established rules and policies of an agency can change dramatically. For example, in 2001 regulation regarding recovery of increases in electrical rates changed in California. For over 20 years prior to 2001, the California Public Utilities Commission allowed recovery of electric rate increases under its operating rules. However, in 2003, the commission reinstated its policy to allow utilities to adjust their rates for rate changes by the power companies. The original decision by the commission to change its policy, as well as its subsequent decision to reinstate that policy, affected our business.
 
We rely on policies and regulations promulgated by the various state commissions in order to recover capital expenditures, maintain favorable treatment on gains from the sale of real property, offset certain production and operating costs, recover the cost of debt, maintain an optimal equity structure without over-leveraging, and have financial and operational flexibility to engage in non-regulated operations. If any of the commissions with jurisdiction over us implement policies and regulations that do not allow us to accomplish some or all of the items listed above, our future operating results may be adversely affected.


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In addition, legislatures may repeal, relax or tighten existing laws, or enact new laws that impact the regulatory agencies with jurisdiction over our business or affect our business directly. If changes in existing laws or the implementation of new laws limit our ability to accomplish some or all of our business objectives, our future operating results may be adversely affected.
 
We expect environmental regulation to increase, resulting in higher operating costs in the future.
 
Our water and wastewater services are governed by various federal and state environmental protection and health and safety laws and regulations. These provisions establish criteria for drinking water and for discharges of water, wastewater and airborne substances. The Environmental Protection Agency promulgates numerous nationally applicable standards, including maximum contaminant levels (MCLs) for drinking water. We believe we are currently in compliance with all of the MCLs promulgated to date but we can give no assurance that we will continue to comply with all water quality requirements. If we violate any federal or state regulations or laws governing health and safety, we could be subject to substantial fines or otherwise sanctioned.
 
Environmental laws are complex and change frequently. They have tended to become more stringent over time. As new or stricter standards are introduced, they could increase our operating costs. Although we would likely seek permission to recover these costs through rate increases, we can give no assurance that the commissions would approve rate increases to enable us to recover these additional compliance costs.
 
We are required to test our water quality for certain chemicals and potential contaminants on a regular basis. If the test results indicate that we exceed allowable limits, we may be required either to commence treatment to remove the contaminant or to develop an alternate water source. Either of these results may be costly, and there can be no assurance that the commissions would approve rate increases to enable us to recover these additional compliance costs.
 
We are party to a toxic contamination lawsuit which could result in our paying damages not covered by insurance.
 
In 1995, the State of California’s Department of Toxic Substances Control (DTSC) named us as a potential responsible party for cleanup of a toxic contamination plume in the Chico groundwater. In December 2002, we were named along with other defendants in two lawsuits filed by DTSC for the cleanup of the plumes. The toxic spill occurred when cleaning solvents, which were discharged into the city’s sewer system by local dry cleaners, leaked into the underground water supply. The DTSC contends that our responsibility stems from our operation of wells in the surrounding vicinity that caused the contamination plumes to spread. While we are cooperating with the clean up, we deny any responsibility for the contamination or the resulting cleanup.
 
In 2007, the Company entered into Court approved consent decrees (Consent Decrees). The Consent Decrees conditioned the Company’s performance upon many factors, including, but not limited to, water pumped and treated by the Company must meet regulatory standards so the Company may distribute to its customers. Pursuant to the terms of the Consent Decrees, the Company will incur capital costs of $1.5 million and future operating costs with a present value of approximately $2.6 million. In its 2007 general rate case (GRC) settlement negotiations, Division of Ratepayer Advocates have tentatively agreed to track all costs associated with the Consent Decrees including legal costs to pursue insurance coverage for potential future recovery in rates.
 
In connection with these suits, our insurance carrier has filed a separate lawsuit against us for reimbursement of past defense costs which approximate $1.5 million. We believe that the insurance carrier has a duty to defend and is not entitled to any defense cost reimbursement. Furthermore, we believe that insurance coverage exists for the Company’s claims. However, if our claim is ultimately found to be excludable under insurance policies, we may have to pay damages. Although we consider it probable that we will be able to recover amounts paid for damages through rate increases, we can give no assurance that we will be able to make such a recovery.
 
The number of environmental and product-related lawsuits against other water utilities have increased in frequency in recent years. If we are subject to additional environmental or product-related lawsuits, we might incur significant legal costs and it is uncertain whether we would be able to recover the legal costs from ratepayers or other third parties. In addition, if current California law regarding California Public Utilities Commission’s


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preemptive jurisdiction over regulated public utilities for claims about compliance with California Department of Health Services and United States Environmental Protection Agency water quality standards changes, our legal exposure may be significantly increased.
 
Risks Related to Our Business Operations
 
Wastewater operations entail significant risks.
 
While wastewater collection and treatment is not presently a major component of our revenues, wastewater collection and treatment involve many risks associated with damage to the surrounding environment. If collection or treatment systems fail or do not operate properly, untreated or partially treated wastewater could discharge onto property or into nearby streams and rivers, causing property damage or injury to aquatic life, or even human life. Liabilities resulting from such damage could materially and adversely affect our results of operations and financial condition.
 
Demand for our water is subject to various factors and is affected by seasonal fluctuations.
 
Demand for our water during the warmer, dry months is generally greater than during cooler or rainy months due primarily to additional requirements for water in connection with irrigation systems, swimming pools, cooling systems and other outside water use. Throughout the year, and particularly during typically warmer months, demand will vary with temperature and rainfall levels. If temperatures during the typically warmer months are cooler than normal, or if there is more rainfall than normal, the demand for our water may decrease.
 
In addition, governmental restrictions on water usage during drought conditions may result in a decreased demand for our water, even if our water reserves are sufficient to serve our customers during these drought conditions. However, during the drought of the late 1980’s and early 1990’s the California Public Utilities Commission beginning in 1992 allowed us to surcharge our customers to collect lost revenues caused by customers’ conservation during the drought. Regardless of whether we may surcharge our customers during a conservation period, they may use less water even after a drought has passed because of conservation patterns developed during the drought. Furthermore, our customers may wish to use recycled water as a substitute for potable water. If rights are granted to others to serve our customers recycled water, there will likely be a decrease in demand for our water.
 
The adequacy of our water supplies depends upon a variety of factors beyond our control. Interruption in the water supply may adversely affect our earnings.
 
We depend on an adequate water supply to meet the present and future needs of our customers. Whether we have an adequate supply varies depending upon a variety of factors, many of which are partially or completely beyond our control, including:
 
  •  the amount of rainfall;
 
  •  the amount of water stored in reservoirs;
 
  •  underground water supply from which well water is pumped;
 
  •  changes in the amount of water used by our customers;
 
  •  water quality;
 
  •  legal limitations on water use such as rationing restrictions during a drought; and
 
  •  population growth.
 
We purchase our water supply from various governmental agencies and others. Water supply availability may be affected by weather conditions, funding and other political and environmental considerations. In addition, our ability to use surface water is subject to regulations regarding water quality and volume limitations. If new regulations are imposed or existing regulations are changed or given new interpretations, the availability of surface water may be materially reduced. A reduction in surface water could result in the need to procure more costly water from other sources, thereby increasing our water production costs and adversely affecting our operating results.


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We have entered into long-term agreements, which commit us to payments whether or not we purchase any water. Therefore, if demand is insufficient to use our required purchases we would have to pay for water we did not receive.
 
From time to time, we enter into water supply contracts with third parties and our business is dependent upon such agreements in order to meet regional demand. For example, we have entered into a water supply contract with the San Francisco Public Utilities Commission which we rely upon. We can give no assurance that the San Francisco Public Utilities Commission, or any of the other parties from whom we purchase water, will renew our contracts upon expiration, or that we will not be subject to significant price increases under any such renewed contracts.
 
The parties from whom we purchase water maintain significant infrastructure and systems to deliver water to us. Maintenance of these facilities is beyond our control. If these facilities are not adequately maintained or if these parties otherwise default on their obligations to supply water to us, we may not have adequate water supplies to meet our customers’ needs.
 
If we are unable to access adequate water supplies we may be unable to satisfy all customer demand which could result in rationing. Rationing may have an adverse effect on cash flow from operations. We can make no guarantee that we will always have access to an adequate supply of water that will meet all required quality standards. Water shortages may affect us in a variety of ways. For example, shortages could:
 
  •  adversely affect our supply mix by causing us to rely on more expensive purchased water;
 
  •  adversely affect operating costs;
 
  •  increase the risk of contamination to our systems due to our inability to maintain sufficient pressure; and
 
  •  increase capital expenditures for building pipelines to connect to alternative sources of supply, new wells to replace those that are no longer in service or are otherwise inadequate to meet the needs of our customers and reservoirs and other facilities to conserve or reclaim water.
 
We may or may not be able to recover increased operating and construction costs on a timely basis, or at all, for our regulated systems through the ratemaking process. Although we can give no assurance, we may also be able to recover certain of these costs from third parties that may be responsible, or potentially responsible, for groundwater contamination.
 
Changes in water supply costs impacts our operations
 
The cost to obtain water for delivery to our customers varies depending on the sources of supply, wholesale suppliers’ prices and the quantity of water produced to supply customer water usage. Our source of supply varies by operating district. 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 portion of the supply is from surface sources and processed through company-owned water treatment plants. On average, slightly more than half of the water we deliver to our customers is pumped from wells or received from a surface supply with the remainder purchased from wholesale suppliers. Water purchased from suppliers usually costs us more than surface supplied or well pumped water. During 2008, the cost of purchased water for delivery to customers represented 31.7% of our total operating costs and in 2007 it represented 33.1% of our total operating costs.
 
Wholesale water suppliers may increase their prices for water delivered to us based on factors that affect their operating costs. Purchased water rate increases are beyond our control. In California, effective July 1, 2008, our ability to recover increases in the cost of purchased water changed with the adoption of the MCBA. With this change, any price increase will be recorded as an expense but also as revenue. The balance in the MCBA will be collected in the future. There may be a short-term impact to our cash flow from operations, but the impact to earnings has been minimized.
 
Depending on the degree of heat and lack of rain and other factors that affect the adequacy of our water supply, we may have to purchase higher-cost water to meet customer demand.


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We depend upon an adequate supply of electricity and certain chemicals for the delivery of our water. An interruption in the supply of these inputs or increases in their prices could adversely affect our results of operations.
 
We rely on purchased electrical power in order to operate the wells and pumps which are needed to supply water to our customers. We have back-up power generators to operate a number of our wells and pumps in emergencies, but an extended interruption in power supply could impact our ability to continue to supply water. In the past, California has been subjected to rolling power blackouts due to insufficient power supplies. We can give no assurance that we will not be subject to power blackouts in the future. In addition, we require sufficient supplies of certain chemicals in order to treat the water which we supply. There are multiple suppliers of these chemicals, but if we were to suffer an interruption of supply we might not be able to adequately treat our water.
 
Purchased power expense represents electricity purchased to operate the wells and pumps. Purchased power is a significant operating expense. During 2008 and 2007, purchased power expense represented 7.4% of our total operating costs. These costs, which are beyond our control, can and do increase unpredictably. These costs can also increase in substantial amounts, as occurred in California during 2001 when rates we paid for electricity increased 48%. Cash flows between rate filings may be adversely affected until the commission authorizes a rate change. We track the expense differences caused by the rate change as part of our MCBA. Cost of chemicals used in the delivery of water is not an element of the MCBA and therefore any variances in quantity or cost could impact our results of operations.
 
Our ability to generate new operating contracts is affected by local politics.
 
Our revenue growth depends upon our ability to generate new as well as to renew operating contracts with cities, other agencies and municipal utility districts. Because we are selling our services in a political environment, we are subject to changing trends and municipal preferences. Recent terrorist acts have affected some political viewpoints relative to outsourcing of water or wastewater utility services. Municipalities own and municipal employees operate the majority of water and wastewater systems. A significant portion of our marketing and sales efforts is spent demonstrating the benefits of contract operations to elected officials and municipal authorities. The existing political environment means that decisions are based on many factors, not just economic factors.
 
Our business requires significant capital expenditures that are dependent on our ability to secure appropriate funding. If we are unable to obtain sufficient capital or if the rates at which we borrow increase, there would be a negative impact on our results of operations.
 
The water utility business is capital-intensive. We invest significant funds to add or replace property, plant and equipment. In addition, water shortages may adversely affect us by causing us to rely on more purchased water. This could cause increases in capital expenditures needed to build pipelines to secure alternative water sources. In addition, we require capital to grow our business through acquisitions. We fund our short-term capital requirements from cash received from operations and funds received from developers. We also borrow funds from banks under short-term bank lending arrangements. We seek to meet our long-term capital needs by raising equity through common or preferred stock issues or issuing debt obligations. We cannot give any assurance that these sources will continue to be adequate or that the cost of funds will remain at levels permitting us to earn a reasonable rate of return. In the event we are unable to obtain sufficient capital, our expansion efforts could be curtailed, which may affect our growth and may affect our future results of operations.
 
Our ability to access the capital markets is affected by the ratings of certain of our debt securities. Standard & Poor’s Rating Agency issues a rating on California Water Service Company’s ability to repay certain debt obligations. The credit rating agency could downgrade our credit rating based on reviews of our financial performance and projections or upon the occurrence of other events that could impact our business outlook. Standard & Poor’s rating is A+ with a stable outlook. Lower ratings by the agency could restrict our ability to access equity and debt capital. We can give no assurance that the rating agency will maintain ratings which allow us to borrow under advantageous conditions and at reasonable interest rates. A future downgrade by the agency could also increase our cost of capital by causing potential investors to require a higher interest rate due to a perceived risk related to our ability to repay outstanding debt obligations.


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While the majority of our debt is long term at fixed rates, we do have interest rate exposure in our short-term borrowings which have variable interest rates. We are also subject to interest rate risks on new financings. However, if interest rates were to increase on a long-term basis, our management believes that customer rates would increase accordingly, subject to approval by the appropriate commission. We can give no assurance that the commission would approve such an increase in customer rates.
 
We are obligated to comply with specified debt covenants under certain of our loan and debt agreements. Failure to maintain compliance with these covenants could limit future borrowing, and we could face increased borrowing costs, litigation, acceleration of maturity schedules, and cross default issues. Such actions by our creditors could have a material adverse effect on our financial condition and results of operations.
 
If the national and world-wide financial crisis intensifies, potential disruptions in the financial and real estate markets may adversely affect our business, including by adversely affecting the availability and cost of short-term funds for our liquidity requirements, our ability to meet long-term commitments and our customers’ ability to pay for water, which in turn could adversely affect our results of operations, cash flows and financial condition.
 
We rely on our current credit facilities to fund short-term liquidity needs if internal funds are not available from operations. Specifically, given the seasonal fluctuations in demand for our water we commonly draw on our credit facilities to meet our cash requirements at times in the year when demand is relatively low. We also may occasionally use letters of credit issued under our revolving credit facilities. Disruptions in the capital and credit markets or further deterioration in the strength of financial institutions could adversely affect our ability to draw on our credit facilities. Our access to funds under our credit facilities is dependent on the ability of our bank to meet its funding commitments. At present, our credit facilities are funded by a single bank. Our bank may not be able to meet its funding commitments to us if it experiences shortages of capital and liquidity or if it experiences excessive volumes of borrowing requests from other borrowers within a short period of time.
 
Longer-term disruptions in the financial markets as a result of uncertainty, changing or increased regulation, reduced capital-raising alternatives, or failures of significant financial institutions or other factors could adversely affect our access to liquidity. Any disruption could require us to take measures to conserve cash until the markets stabilize or until alternative credit arrangements or other funding for business needs can be arranged. Such measures could include deferring capital expenditures, dividend payments or other discretionary uses of cash.
 
Many of our customers and suppliers also have exposure to risks that their ability to meet their payment and supply commitments are adversely affected by the worldwide financial crisis and recession in the United States and resulting potential disruptions in the financial and real estate markets. We operate in geographic areas that may be particularly susceptible to declines in the price of real property and other consequences of the financial crisis, which could result in significant declines in demand for our products and services in certain of our districts. In the event that any of our significant customers or suppliers, or a significant number of smaller customers and suppliers, are adversely affected by these risks, we may face disruptions in supply, significant reductions in demand for our products and services, inability of customers to pay invoices when due, and other adverse effects that could negatively affect our financial condition, results of operations and/or cash flows.
 
Our operations and certain contracts for water distribution and treatment depend on the financial capability of state and local governments, and other municipal entities such as water districts. Major disruptions in the financial strength or operations of such entities, such as liquidity limitations, bankruptcy or insolvency, could have an adverse effect on our ability to conduct our business and/or enforce our rights under contracts to which such entities are a party.
 
We are a holding company that depends on cash flow from our subsidiaries to meet our obligations and to pay dividends on our common stock.
 
As a holding company, we conduct substantially all of our operations through our subsidiaries and our only significant assets are investments in those subsidiaries. 95% of our revenues are derived from the operations of California Water Service Company. As a result, we are dependent on cash flow from our subsidiaries, and California Water Service Company in particular, to meet our obligations and to pay dividends on our common stock.


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We can make dividend payments only from our surplus (the excess, if any, of our net assets over total paid-in capital) or if there is no surplus, the net profits for the current fiscal year or the fiscal year before which the dividend is declared. In addition, we can pay cash dividends only if after paying those dividends we would be able to pay our liabilities as they become due. Owners of our capital stock cannot force us to pay dividends and dividends will only be paid if and when declared by our board of directors. Our board of directors can elect at any time, and for an indefinite duration, not to declare dividends on our capital stock.
 
Our subsidiaries are separate and distinct legal entities and generally have no obligation to pay any amounts due on California Water Service Group’s debt or to provide California Water Service Group with funds for dividends. Although there are no contractual or regulatory restrictions on the ability of our subsidiaries to transfer funds to us, the reasonableness of our capital structure is one of the factors considered by state and local regulatory agencies in their ratemaking determinations. Therefore, transfer of funds from our subsidiaries to us for the payment of our obligations or dividends may have an adverse effect on ratemaking determinations. Furthermore, our right to receive cash or other assets upon the liquidation or reorganization of a subsidiary is generally subject to the prior claims of creditors of that subsidiary. If we are unable to obtain funds from our subsidiaries in a timely manner we may be unable to meet our obligations or pay dividends.
 
An important element of our growth strategy is the acquisition of water and wastewater systems, including pursuant to operating agreements. Risks associated with potential acquisitions, divestitures or restructurings may adversely affect us.
 
We may seek to acquire or invest in other companies, technologies, services or products that complement our business. The execution of our growth strategy may expose us to different risks than those associated with our utility operations. We can give no assurance that we will succeed in finding attractive acquisition candidates or investments, or that we would be able to reach mutually agreeable terms with such parties. In addition, as consolidation becomes more prevalent in the water and wastewater industries, the prices for suitable acquisition candidates may increase to unacceptable levels and limit our ability to grow through acquisitions. If we are unable to find acquisition candidates or investments, our ability to grow may be limited.
 
Acquisition and investment transactions may result in the issuance of our equity securities that could be dilutive if the acquisition or business opportunity does not develop in accordance with our business plan. They may also result in significant write-offs and an increase in our debt. The occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.
 
Any of these transactions could involve numerous additional risks. For example, we may incur one or more of the following:
 
  •  problems integrating the acquired operations, personnel, technologies or products with our existing businesses and products;
 
  •  diversion of management time and attention from our core business to the acquired business;
 
  •  failure to retain key technical, management, sales and other personnel of the acquired business;
 
  •  difficulty in retaining relationships with suppliers and customers of the acquired business; and
 
  •  difficulty in getting required regulatory approvals.
 
In addition, the businesses and other assets we acquire may not achieve the sales and profitability expected. The occurrence of one or more of these events may have a material adverse effect on our business. There can be no assurance that we will be successful in overcoming these or any other significant risks encountered.


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We may not be able to increase or sustain our recent growth rate, and we may not be able to manage our future growth effectively.
 
We may be unable to continue to expand our business or manage future growth. To successfully manage our growth and handle the responsibilities of being a public company, we believe we must effectively:
 
  •  hire, train, integrate and manage additional qualified engineers for research and development activities, sales and marketing personnel, and financial and information technology personnel;
 
  •  retain key management and augment our management team;
 
  •  implement and improve additional and existing administrative, financial and operations systems, procedures and controls;
 
  •  expand and upgrade our technological capabilities; and
 
  •  manage multiple relationships with our customers, regulators, suppliers and other third parties.
 
If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities, satisfy customer requirements, execute our business plan or respond to competitive pressures.
 
We have a number of large-volume commercial and industrial customers and a significant decrease in consumption by one or more of these customers could have an adverse effect on our operating results and cash flows.
 
Our revenues will decrease, and such decrease may be material, if a significant business or industrial customer terminates or materially reduces its use of our water. Approximately $94.6 million, or 23% of our 2008 water utility revenues was derived from business and industrial customers. If any of our large business or industrial customers reduces or ceases its consumption of our water, we may seek commission approval to increase the rates of our remaining customers to offset decreased revenues. There can be no assurance, however, that the commission would approve such a rate relief request, and even if it did approve such a request, it would not apply retroactively to the date of the reduction in consumption. The delay between such date and the effective date of the rate relief may be significant and could adversely affect our operating results and cash flows.
 
Our operating cost and costs of providing services may rise faster than our revenues.
 
Our ability to increase rates over time is dependent upon approval of such rate increases by state commissions, which may be inclined, for political or other reasons, to limit rate increases. However, our costs are subject to market conditions and other factors, which may increase significantly. The second largest component of our operating costs after water production is made up of salaries and wages. These costs are affected by the local supply and demand for qualified labor. Other large components of our costs are general insurance, workers compensation insurance, employee benefits and health insurance costs. These costs may increase disproportionately to rate increases authorized by state commissions and may have a material adverse effect on our future results of operations.
 
Our non-regulated business operates in a competitive market.
 
While a majority of our business is regulated, our non-regulated business participates in a competitive market. We compete with several larger companies whose size, financial resources, customer base and technical expertise may restrict our ability to compete successfully for certain operations and maintenance contracts. Due to the nature of our contract operations business, and to the very competitive nature of the market, we must accurately estimate the cost and profitability of each project while, at the same time, maintaining prices at a level low enough to compete with other companies. Our inability to achieve this balance could adversely impact our results of operations.
 
Demand for our stock may fluctuate due to circumstances beyond our control.
 
We believe that stockholders invest in public utility stocks, in part, because they seek reliable dividend payments. If there is an over-supply of stock of public utilities in the market relative to demand by such investors,


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the trading price of our securities could decrease. Additionally, if interest rates rise above the dividend yield offered by our equity securities, demand for our stock, and consequently its market price, may also decrease.
 
The price of our common stock may be volatile and may be affected by market conditions beyond our control.
 
The trading price of our common stock may fluctuate in the future because of the volatility of the stock market and a variety of other factors, many of which are beyond our control. Factors that could cause fluctuations in the trading price of our common stock include: regulatory developments; general economic conditions and trends; price and volume fluctuations in the overall stock market from time to time; actual or anticipated changes or fluctuations in our results of operations; actual or anticipated changes in the expectations of investors or securities analysts; actual or anticipated developments in our competitors’ businesses or the competitive landscape generally; litigation involving us or our industry; major catastrophic events or sales of large blocks of our stock.
 
Equity markets in general have recently experienced extreme price and volume fluctuations and the market prices of many companies have decreased substantially. Such price and volume fluctuations may continue to adversely affect the market price of our common stock for reasons unrelated to our business or operating results.
 
Adverse investment returns and other factors may increase our pension liability and pension funding requirements.
 
A substantial number of our employees are covered by a defined benefit pension plan. At present, the pension plan is underfunded because our projected pension benefit obligation exceeds the aggregate fair value of plan assets. Under applicable law, we are required to make cash contributions to the extent necessary to comply with minimum funding levels imposed by regulatory requirements. The amount of such required cash contribution is based on an actuarial valuation of the plan. The funded status of the plan can be affected by investment returns on plan assets, discount rates, mortality rates of plan participants, pension reform legislation and a number of other factors. There can be no assurance that the value of our pension plan assets will be sufficient to cover future liabilities. Although we have made contributions to our pension plan in recent years, it is possible that we could incur a pension liability adjustment, or could be required to make additional cash contributions to our pension plan, which would reduce the cash available for business and other needs.
 
Work stoppages and other labor relations matters could adversely affect our operating results.
 
At December 31, 2008, 595 of our 929 total employees were union employees. Most of our unionized employees are represented by the Utility Workers Union of America, AFL-CIO, except certain engineering and laboratory employees who are represented by the International Federation of Professional and Technical Engineers, AFL-CIO. In November 2008 we negotiated 2009 wage increases with both unions of 3.0%.
 
We believe our labor relations are good, but in light of rising costs for healthcare and pensions, contract negotiations in the future may be difficult. Furthermore, changes in applicable law or regulations could have an adverse effect on management’s negotiating position with respect to our currently unionized employees and/or employees that decide to unionize in the future. We are subject to a risk of work stoppages and other labor relations matters as we negotiate with the unions to address these issues, which could affect our results of operations and financial condition. We can give no assurance that issues with our labor forces will be resolved favorably to us in the future or that we will not experience work stoppages.
 
We depend significantly on the services of the members of our management team, and the departure of any of those persons could cause our operating results to suffer.
 
Our success depends significantly on the continued individual and collective contributions of our management team. The loss of the services of any member of our management team could have a material adverse effect on our business as our management team has knowledge of our industry and customers and would be difficult to replace.


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Our operations are geographically concentrated in California and this lack of diversification may negatively impact our operations.
 
Although we own facilities in a number of states, over 95% of our operations are located in California. As a result, we are largely subject to weather, political, water supply, labor, utility cost, regulatory and economic risks affecting California.
 
We are also affected by the real property market in California. In order to grow our business, we may need to acquire additional real estate or rights to use real property owned by third parties, the cost of which tends to be higher and more volatile in California relative to other states. The value of our assets in California may decline if there is a decline in the California real estate market which results in a significant decrease in real property values.
 
In 2007 and 2008 we experienced an increases in uncollectible accounts, which, we believe, were attributable in part to the significant decline in real estate values, experienced by our customers in a number of our districts in California.
 
The effects of natural disasters, terrorist activity, pandemics, or poor water quality or contamination to our water supply may result in disruption in our services and litigation which could adversely affect our business, operating results and financial condition.
 
We operate in areas that are prone to earthquakes, fires, mudslides and other natural disasters. A significant seismic event in California, where our operations are concentrated, or other natural disaster in California could adversely impact our ability to deliver water and adversely affect our costs of operations. A major disaster could damage or destroy substantial capital assets. The California Public Utilities Commission has historically allowed utilities to establish a catastrophic event memorandum account as another possible mechanism to recover costs. However, we can give no assurance that the CPUC or any other commission would allow any such cost recovery mechanism in the future.
 
Our water supplies are subject to contamination, including contamination from the development of naturally-occurring compounds, chemicals in groundwater systems, pollution resulting from man-made sources, such as MTBE, sea water incursion and possible terrorist attacks. If our water supply is contaminated, we may have to interrupt the use of that water supply until we are able to substitute the flow of water from an uncontaminated water source. In addition, we may incur significant costs in order to treat the contaminated source through expansion of our current treatment facilities, or development of new treatment methods. If we are unable to substitute water supply from an uncontaminated water source, or to adequately treat the contaminated water source in a cost-effective manner, there may be an adverse effect on our revenues, operating results and financial condition. The costs we incur to decontaminate a water source or an underground water system could be significant and could adversely affect our business, operating results and financial condition and may not be recoverable in rates. We could also be held liable for consequences arising out of human exposure to hazardous substances in our water supplies or other environmental damage. For example, private plaintiffs have the right to bring personal injury or other toxic tort claims arising from the presence of hazardous substances in our drinking water supplies. Our insurance policies may not be sufficient to cover the costs of these claims.
 
We operate a dam. If the dam were to fail for any reason, we would lose a water supply and flooding likely would occur. Whether or not we were responsible for the dam’s failure, we could be sued. We can give no assurance that we would be able to successfully defend such a suit.
 
In light of the threats to the nation’s health and security ensuing in the wake of the September 11, 2001 terrorist attacks, we have taken steps to increase security measures at our facilities and heighten employee awareness of threats to our water supply. We have also tightened our security measures regarding the delivery and handling of certain chemicals used in our business. We have and will continue to bear increased costs for security precautions to protect our facilities, operations and supplies. These costs may be significant. Despite these tightened security measures, we may not be in a position to control the outcome of terrorist events should they occur.
 
We depend upon our skilled and trained workforce to ensure water delivery. Were a pandemic to occur, we can give no assurance that we would be able to maintain sufficient manpower to ensure uninterrupted service in all of the districts that we serve.


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We retain certain risks not covered by our insurance policies.
 
We evaluate our risks and insurance coverage annually. Our evaluation considers the costs, risks and benefits of retaining versus insuring various risks as well as the availability of certain types of insurance coverage. In addition, portions of our business are difficult or impracticable to insure. Furthermore, we are also affected by increases in prices for insurance coverage; in particular, we have been, and will continue to be, affected by rising health insurance costs. Retained risks are associated with deductible limits, partial self-insurance programs and insurance policy coverage ceilings. If we suffer an uninsured loss, we may be unable to pass all, or any portion, of the loss on to customers because our rates are regulated by regulatory commissions. Consequently, uninsured losses may negatively affect our financial condition, liquidity and results of operations. There can be no assurance that we will not face uninsured losses pertaining to the risks we have retained.
 
We rely on our information technology and a number of complex business systems that could malfunction and result in negative impacts on our profitability and cash flow.
 
Our business is dependent on several complex business systems, certain of which are owned by third parties. The business systems must function reliably in order for us to operate effectively. Among other things, system malfunctions and security breaches could prevent us from operating or monitoring our facilities, billing accurately and timely analysis of financial results. Our profitability and cash flow could be affected negatively in the event these systems do not operate effectively or are circumvented.
 
The accuracy of our judgments and estimates about financial and accounting matters will impact our operating results and financial condition.
 
We make certain estimates and judgments in preparing our financial statements regarding, among others:
 
  •  the useful life of intangible rights;
 
  •  the number of years to depreciate certain assets;
 
  •  amounts to set aside for uncollectible accounts receivable, inventory obsolesces and uninsured losses;
 
  •  our legal exposure and the appropriate accrual for claims, including medical claims and workers’ compensation claims;
 
  •  future costs for pensions and other post-retirement benefits; and
 
  •  possible tax allowances.
 
The quality and accuracy of those estimates and judgments will have an impact on our operating results and financial condition.
 
In addition, we must estimate unbilled revenues and costs as of the end of each accounting period. If our estimates are not accurate, we will be required to make an adjustment in a future period. Accounting rules permit us to use expense balancing accounts and memorandum accounts that include input cost changes to us that are different from amounts incorporated into the rates approved by the commissions. These accounts result in expenses and revenues being recognized in periods other than in which they occurred.
 
Our controls and procedures may fail or be circumvented.
 
Management regularly reviews and updates our internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could result in lack of compliance with contractual agreements, misstatements in our financial statements in amounts that could be material or could cause investors to lose confidence in our reported financial information, either of which could have a negative effect on the trading price of our stock and may negatively affect our ability to raise future capital.


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Further, if we or our independent registered public accounting firm discover a material weakness in our internal control over financial reporting, the disclosure of that fact, even if quickly remedied, could reduce the market’s confidence in our financial statements and harm our stock price. In addition, non-compliance with Section 404 of the Sarbanes-Oxley Act of 2002 could subject us to a variety of administrative sanctions, including the suspension or delisting of our common stock from the New York Stock Exchange and the inability of registered broker-dealers to make a market in our common stock, which would further reduce our stock price.
 
We may be required to adopt International Financial Reporting Standards (IFRS), or other accounting or financial reporting standards, the ultimate adoption of which could negatively impact our business, financial condition or results of operations.
 
We could be required to adopt IFRS or other accounting or financial reporting standards different from GAAP, which is currently applicable to our accounting and financial reporting. In 2008 the SEC released a timetable for the adoption of IFRS according to which we could be required to adopt IFRS by 2016. Under GAAP we are subject to the provisions of SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation,” which, among other things, allows us to defer certain costs if we believe it is probable that we will be allowed to recover those costs by future rate increases. Currently, IFRS does not contain provisions equivalent to SFAS No. 71. The implementation and adoption of new accounting or financial reporting standards could affect our reported performance, which in turn could favorably or unfavorably impact our business, financial condition or results of operations. Furthermore, the transition to and application of new accounting or financial reporting standards could result in increased administrative costs.
 
Municipalities, water districts and other public agencies may condemn our property by eminent domain action.
 
State statutes allow municipalities, water districts and other public agencies to own and operate water systems. These agencies are empowered to condemn properties already operated by privately owned public utilities. However, whenever a public agency constructs facilities to extend a utility system into the service area of a privately owned public utility, such an act constitutes the taking of property and requires reimbursement to the utility for its loss. If a public agency were to acquire our utility property by eminent domain action, we would be entitled to just compensation for our loss, but we would no longer have access to the condemned property nor would we be entitled to any portion of revenue generated from the use of such asset going forward.
 
Item 1B.   Unresolved Staff Comments.
 
None
 
Item 2.   Properties.
 
Our physical properties consist of offices and water facilities to accomplish the production, storage, treatment, and distribution of water. These properties are located in or near the geographic service areas listed above in Item 1 “Business — Geographical Service Areas and Number of Customers at Year-end.” Our headquarters, which houses accounting, engineering, information systems, human resources, purchasing, regulatory, water quality, and executive staff, is located in San Jose, California.
 
The real properties owned are held in fee simple title. Properties owned by Cal Water are subject to the indenture securing first mortgage bonds of which $23.7 million remained outstanding at December 31, 2008. Washington Water has long-term bank loans that are secured primarily by utility plant owned by Washington Water. New Mexico Water has a long-term loan which is secured by utility plant owned by New Mexico Water.
 
Cal Water owns 655 wells and operates 9 leased wells. There are 415 owned storage tanks with a capacity of 487 million gallons, 43 managed storage tanks with a capacity of 35 million gallons, and 3 reservoirs with a capacity of 220 million gallons. Cal Water owns and operates 6 surface water treatment plants with a combined capacity of 42 million gallons per day. There are 5,547 miles of supply and distribution mains in the various systems.


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Washington Water owns 332 wells and manages 85 wells. There are 135 owned storage tanks and 39 managed storage tanks with a storage capacity of 9 million gallons. There are 326 miles of supply and distribution lines.
 
New Mexico Water owns 17 wells. There are 12 storage tanks with a storage capacity of 4 million gallons. There are 134 miles of supply and distribution lines. New Mexico operates two waste water treatment facilities with a combined capacity to process 358,000 gallons per day. There are 29 miles of sewer collection mains.
 
Hawaii Water owns 17 wells. There are 6 storage tanks with a storage capacity of 5 million gallons. There are 35 miles of supply and distribution lines. Hawaii Water operates five wastewater treatment facilities with a combined capacity to process approximately 1.2 million gallons per day. There are 29 miles of sewer collection mains.
 
In the leased City of Hawthorne and City of Commerce systems or in systems that are operated under contract for municipalities or private companies, title to the various properties is held exclusively by the municipality or private company.
 
Item 3.   Legal Proceedings.
 
Chico Groundwater/Wausau Insurance Matter
 
In 1995, the State of California’s Department of Toxic Substances Control (DTSC) named us as a potential responsible party for cleanup of toxic contamination plumes, which contain perchloroethylene, also know as tetrachloroethylene (PCE) in the Chico groundwater. In December 2002, we were named along with other defendants in two lawsuits filed by DTSC for the cleanup of the plumes. In 2007, we entered into Court approved consent decrees (Consent Decrees). The Consent Decrees conditioned our performance upon many factors, including, but not limited to, water pumped and treated by us must meet regulatory standards so we may distribute to its customers. Pursuant to the terms of the Consent Decrees, we will incur capital costs of $1.5 million and future operating costs with a present value of approximately $2.6 million. In our 2007 general rate case (GRC) settlement negotiations, Division of Ratepayer Advocates have tentatively agreed to track all costs associated with the Consent Decrees, including legal costs to pursue insurance coverage, for potential future recovery in rates.
 
In connection with these suits, our insurance carrier, Employers Insurance of Wausau (Wausau) filed a separate lawsuit against us for reimbursement of past defense costs which approximate $1.5 million and a declaratory determination of coverage. On January 23, 2008, the Court heard various parties’ motions and on September 25, 2008 issued its rulings that Wausau had a duty to defend; therefore, the Company will not have to reimburse Wausau for previously incurred defense costs. The Court did not find Wausau’s actions were intended to harm the Company, so punitive damages will not be recoverable by the Company. However, the Court also found that the issue of policy coverage will be determined at trial. A trial date has been set for May 26, 2009. Based on the Court’s rulings, the Company has not recorded any liability associated with reimbursement of costs to defend and expensing the related costs as incurred. We continue to believe that the claims are covered under the insurance policies. However, if our claim is ultimately found to be excludable under the insurance policies, the Company believes that recovery of costs associated with the Consent Decrees are probable from either its equitable indemnity lawsuit against manufacturers and distributors of perchloroethylene, also know as tetrachloroethylene, (PCE) in California; or through rate increases in the future. Therefore, no accrual or contingency has been recorded for this matter.
 
Other Groundwater Contamination
 
The Company has been and is involved in litigation against third parties to recover past and future costs related to ground water contamination in our service areas. The cost of litigation is expensed as incurred and any settlement is first offset against such costs. Any settlement in excess of the cost to litigate is accounted for on a case by case basis based upon the nature of the settlement. It is anticipated that the majority of the settlement will be reflected as a benefit to the rate payers by offsetting future operating or capital costs.
 
The Company is involved in a lawsuit against major oil refineries regarding the contamination of the ground water as a result of the gas additive MTBE. The Company entered into a partial settlement with the defendants in April of 2008 that represent approximately 70% of the responsible parties (as determined by the Superior Court). Based on the allocation matrix, on October 22, 2008, the Company received $34.2 million after deducting attorneys’


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fees and litigation expenses. The Company is aggressively pursuing legal action against the remaining responsible parties. The Company is in the process of determining with the Commission the appropriate regulatory treatment of the proceeds. It is anticipated that the proceeds will be used by the Company on infrastructure improvements. The Company is in the process of filing with the Internal Revenue Service a request for a private letter ruling regarding the taxability of the proceeds.
 
As of December 31, 2008, the Company believes the proceeds are non-taxable based upon its intent to reinvest them in qualifying assets. In 2009, when an agreement is reached with the Commission regarding the regulatory treatment, or when the taxability is determined based upon proceedings with the Internal Revenue Service, the Company will adjust the accounting of the settlement accordingly.
 
As previously reported, Cal Water has filed with the City of Bakersfield, in the Superior Court of California, a lawsuit that names potentially responsible parties, who manufactured and distributed products containing 1,2,3 trichloropropane (TCP) in California. TCP has been detected in the ground water. The lawsuit seeks to recover treatment costs necessary to remove TCP. The Court has now coordinated our action with other water purveyor cases (TCP Cases JCCP 4435) in San Bernardino County. No trial date has yet been set.
 
The Company has filed in San Mateo County Superior Court a complaint (California Water Service Company v. The Dow Chemical Company, et al. CIV 473093) against potentially responsible parties that manufactured and distributed products, which contained perchloroethylene, also know as tetrachloroethylene (PCE) in California, to recover the past, present, and future treatment costs. No trial date has yet been set.
 
Other Legal Matters
 
In the past few years, the Company has been named as a co-defendant in several asbestos related lawsuits. The company has been dismissed without prejudice in two of these cases. In Case No. BC360406, reported in our prior year annual report, the Court has approved a confidential settlement between the Company, the plaintiff and his heirs. The settlement was paid for by our contractor’s and our insurance policy carriers. There was no effect on our financial statements. On February 6, 2009, plaintiffs filed in Alameda County William and Barbara Church vs. Asbestos Corporation, LTD et al., Case No. RG09434913, against the Company and numerous other defendants. Plaintiffs’ complaint alleges personal injury from his exposure to asbestos. The complaint states negligence, false representations, strict liability, premise/owner liability and loss of consortium causes of actions. The Complaint does not state any amount of damages. The Company does not believe that the plaintiffs’ have any valid causes of actions against the Company. The Company will vigorously defend itself in this matter. Accordingly, the Company has not recorded an accrual for this matter.
 
From time to time, the Company is involved in various disputes and litigation matters that arise in the ordinary course of business. We review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount of the range of loss can be estimated, we accrue a liability for the estimated loss in accordance with SFAS No 5, “Accounting of Contingencies.” Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based on the best information available at the time. While the outcome of these disputes and litigation matters cannot be predicted with any certainty, management does not believe that when taking into account existing reserves that the ultimate resolution of these matters will materially affect our financial position, results of operations, or cash flows.
 
Item 4.   Submission of Matters to a Vote of Security Holders.
 
No matters were submitted to a vote of security holders in the fourth quarter of 2008.


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PART II
 
Item 5.   Market for Registrant’s Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Our common stock is traded on the New York Stock exchange under the symbol “CWT.” At December 31, 2008, there were 20,723,202 common shares outstanding. There were 2,704 common stockholders of record as of February 11, 2009.
 
During 2008, we paid a cash dividend of $1.17 per common share, or $0.2925 per quarter. During 2007, we paid a cash dividend of $1.16 per common share, or $0.2900 per quarter. In January 2009, our Board of Directors declared a cash dividend of $0.2950 per common share payable on February 20, 2009, to stockholders of record on February 9, 2009. This represents our 42nd consecutive year of increasing the annual dividend and marks the 257th consecutive quarterly dividend.
 
During 2008 and 2007, the common stock market price range and dividends per share were as follows for each quarter
 
                                 
    First     Second     Third     Fourth  
 
2008
                               
Common stock market price range:
                               
High
  $ 40.68     $ 41.04     $ 40.22     $ 46.43  
Low
    33.58       31.69       31.16       29.73  
Dividends paid per common share
    0.2925       0.2925       0.2925       0.2925  
 
                                 
    First     Second     Third     Fourth  
 
2007
                               
Common stock market price range:
                               
High
  $ 44.54     $ 40.85     $ 43.96     $ 44.39  
Low
    36.75       34.46       35.39       35.85  
Dividends paid per common share
    0.2900       0.2900       0.2900       0.2900  


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Five Years Performance Graph
 
The following performance graph compares the changes in the cumulative shareholder return on California Water Service Group’s common stock with the cumulative total return on the Baird Water Utility Index and the Standard & Poor’s 500 Index during the last five years ended December 31, 2008. The comparison assumes $100 was invested on December 31, 2003, in California Water Service Group’s common stock and in each of the forgoing indices and assumes reinvestment of dividends.
 
(PERFORMANCE GRAPH)
 
Performance Graph Data
 
The following descriptive data is supplied in accordance with rule 304(d) of Regulations S-T:
 
                                                             
      2003     2004     2005     2006     2007     2008
California Water Service Group
      100         143         150         163         154         200  
S&P 500
      100         109         112         128         132         81  
Baird Water Utility Index
      100         114         156         157         151         136  
                                                             


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Item 6.   Selected Financial Data.
 
The following selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements and the Notes thereto and the information contained in Item 7, “Managements Discussion and Analysis of Financial Condition and Results of Operations.”
 
Historical results are not necessarily indicative of future results.
 
FIVE YEAR FINANCIAL REVIEW
 
                                         
    2008     2007     2006     2005     2004  
    (Dollars in thousands, except common share and customer data)  
 
Summary of Operations
                                       
Operating revenue
                                       
Residential
  $ 284,913     $ 253,745     $ 232,811     $ 222,634     $ 221,323  
Business
    75,620       65,457       60,366       56,962       55,803  
Industrial
    18,932       17,403       16,286       14,241       13,592  
Public authorities
    21,042       17,952       15,728       14,965       15,118  
Other
    9,805       12,525       9,526       11,926       9,731  
                                         
Total operating revenue
    410,312       367,082       334,717       320,728       315,567  
Operating expenses
    352,843       322,912       294,411       278,903       273,488  
Interest expense, other income and expenses, net
    17,664       13,011       14,726       14,602       16,053  
                                         
Net income
  $ 39,805     $ 31,159     $ 25,580     $ 27,223     $ 26,026  
                                         
Common Share Data
                                       
Earnings per share — diluted
  $ 1.90     $ 1.50     $ 1.34     $ 1.47     $ 1.46  
Dividend declared
    1.17       1.16       1.15       1.14       1.13  
Dividend payout ratio
    62 %     77 %     86 %     78 %     77 %
Book value per share
  $ 19.44     $ 18.66     $ 18.31     $ 15.98     $ 15.66  
Market price at year-end
    46.43       37.02       40.40       38.23       37.65  
Common shares outstanding at year-end (in thousands)
    20,723       20,666       20,657       18,390       18,367  
Return on average common stockholders’ equity
    10.2 %     8.1 %     8.2 %     9.3 %     9.8 %
Long-term debt interest coverage
    4.72       3.70       3.17       3.61       3.38  
Balance Sheet Data
                                       
Net utility plant
  $ 1,112,367     $ 1,010,196     $ 941,475     $ 862,731     $ 800,305  
Total assets
    1,418,107       1,184,499       1,165,019       996,945       942,853  
Long-term debt including current portion
    290,316       291,921       293,592       275,275       275,921  
Capitalization ratios:
                                       
Common stockholders’ equity
    58.1 %     56.9 %     56.0 %     51.4 %     50.8 %
Preferred stock
          0.5 %     0.5 %     0.6 %     0.6 %
Long-term debt
    41.9 %     42.6 %     43.5 %     48.0 %     48.6 %
Other Data
                                       
Estimated water production (million gallons) Wells and surface supply
    72,228       70,708       70,094       67,841       72,279  
Purchased
    65,529       70,530       62,320       61,612       66,760  
                                         
Total estimated water production
    137,757       141,238       132,414       129,453       139,039  
                                         
Metered customers
    417,208       412,432       407,762       402,191       395,286  
Flate-rate customers
    73,285       75,123       76,131       76,810       77,869  
                                         
Customers at year-end **
    490,493       487,555       483,893       479,001       473,155  
                                         
New customers added
    2,938       3,662       4,892       5,846       6,733  
Revenue per customer
  $ 837     $ 753     $ 692     $ 670     $ 667  
Utility plant per customer
    3,228       2,968       2,778       2,578       2,418  
Employees at year-end
    929       891       869       840       837  
 
 
** Includes customers of the City of Hawthorne and City of Commerce


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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Overview
 
For 2008, net income was $39.8 million compared to $31.2 million in 2007, or an increase of 27.7%. The increase in net income was primarily caused by an increase in revenues to $410.3 million, or an 11.8% increase from 2007. Net operating income increased $13.3 million to $57.5 million, or a 30.1% increase over 2007 levels. Net other income reflected a net decrease of $4.6 million due primarily to investment losses and no real estate sales in 2008. Diluted earnings per share for 2008 were $1.90 compared to $1.50 in 2007, or an increase of 26.7%.
 
As a result of the 2007 General Rate Case (2007 GRC) and corresponding approved rates which were effective the first of July 2008, we recognized a significant increase in net income. The rate increases authorized additional annual revenues of $47.1 million (see discussion in the Regulatory Matters section of this report). The 2007 GRC rates include recovery of certain costs that have not yet been incurred. These costs relate primarily to additional employees and their associated benefits. The new employees scheduled in the 2007 GRC were to implement new programs and for administrative positions required for a company our size, additional engineering staff to work on the design of capital projects, and additional field positions that have not kept up with the customer growth in some of our districts. The new programs include, among other things, a routine flushing program and a management training program and other programs needed to maintain and account for our operations.
 
All of the personnel positions in the 2007 GRC went through a rigorous justification process and we are in the process of hiring for those positions. Therefore we anticipate that once the employees are hired there will be an increase in operating expenses.
 
In addition the 2007 GRC includes recovery of certain conservation expenses. These costs have begun to be incurred and we anticipate the level of expense to increase to match what is included in rates.
 
We plan to continue to seek rate relief to recover our operating cost increases and receive reasonable returns on invested capital. We expect to fund our long-term capital needs through a combination of debt, common stock offerings, and cash flow from operations.
 
Critical Accounting Policies and Estimates
 
We maintain our accounting records in accordance with accounting principles generally accepted in the United States of America and as directed by the Commissions to which our operations are subject. The process of preparing financial statements requires the use of estimates on the part of management. The estimates used by management are based on historic experience and an understanding of current facts and circumstances. A summary of our significant accounting policies is listed in Note 2 of the Notes to Consolidated Financial Statements. The following sections describe those policies where the level of subjectivity, judgment, and variability of estimates could have a material impact on the financial condition, operating performance, and cash flows of the business.
 
Revenue Recognition
 
Revenue includes monthly cycle customer billings for regulated water and wastewater services at rates authorized by regulatory commissions and billings to certain non-regulated customers at rates authorized by contract with government agencies.
 
Revenue from metered customers includes billings to customers based on monthly meter readings plus an estimate for water used between the customer’s last meter reading and the end of the accounting period. As of December 31, 2008 and 2007, our unbilled revenue amount was $13.1 million and $12.9 million, respectively. The unbilled revenue amount is generally higher during the summer months when water sales are higher. 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, with the balance recorded as unearned revenue on the balance sheet and recognized as revenue when earned in the subsequent accounting period. Our unearned revenue liability was $2.7 million and $2.2 million as of December 31, 2008 and 2007, respectively. This liability is included in “other accrued liabilities” on our consolidated balance sheets.


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Effective July 1, 2008, Cal Water is operating under a Water Rate Adjustment Mechanism (WRAM) approved in February 2008 by the California Public Utilities Commission (CPUC). Under the WRAM, Cal Water records the adopted level of volumetric revenues as established by the CPUC for metered accounts (adopted volumetric revenues). In addition to volumetric-based revenues, the revenue requirements approved by the CPUC include service charges, flat rate charges, and other items not subject to the WRAM. The adopted volumetric revenue considers the seasonality of consumption of water based upon historical averages. The variance between adopted volumetric revenues and actual billed volumetric revenues for metered accounts is recorded as a component of revenue with an offsetting entry to a current asset or liability balancing account (tracked individually for each Cal Water district). The variance amount may be positive or negative and represents amounts that will be billed or refunded to customers in the future.
 
Also effective July 1, 2008, Cal Water is operating under a Modified Cost Balancing Account (MCBA). We track authorized expense levels for purchased water, purchased power and pump taxes, as established by the CPUC. Variances (which include the effects of changes in both rate and volume) between adopted and actual purchased water, purchased power, and pump taxes expenses will be recorded as a component of revenue, as the amount of such variances will be recovered from or refunded to our customers at a later date. Any recovery or refund of the MCBA would be netted against the WRAM revenue over- or under-recovery for the corresponding district. The monthly balances accrue interest (payable or receivable) based upon the 90 day commercial paper rate.
 
The balances in the WRAM and MCBA assets and liabilities will fluctuate on a monthly basis depending upon the level of variance between adopted and actual results. When the net amount for any district achieve a pre-determined level at the end of any calendar year (i.e., at least 2.5 percent over- or under-recovery of the approved revenue requirement), Cal Water will seek approval from the Commission to refund or collect the balance in the accounts. Account balances less than those levels may be refunded or collected in Cal Water’s general rate case proceedings or aggregated with future calendar year balances for comparison with the recovery level. As of December 31, 2008, the net aggregated asset is $4.6 million and the aggregate liability is $2.6 million and are included in other accounts receivable and accounts payable, respectively.
 
Expense-Balancing and Memorandum Accounts
 
The Company has historically used expense-balancing accounts (also referred as Incremental Cost Balancing Accounts (ICBA)) and memorandum accounts to track only suppliers’ rate changes for purchased water, purchased power, and pump taxes that are not included in customer water rates. The cost changes were referred to as “off-setable expenses” because under certain circumstances they were refundable from customers (or refunded to customers) in future rates designed to offset cost changes from suppliers. The balancing and memorandum accounts have not been recorded until the CPUC has authorized a change in customer rates and the customer has been billed. The cumulative net amount in the expense balancing accounts and memorandum accounts as of December 31, 2008, was approximately $1.5 million. This amount includes certain amounts that have been authorized for recovery through customer surcharges but which have not yet been collected and amounts that have not yet been filed for recovery. See “Rates and Regulations” below for descriptions of amounts included in this total that have been authorized for recovery.
 
Modified Cost Balancing Accounts
 
With the implementation of the WRAM, the existing ICBA expense balancing accounts will be replaced by Modified Cost Balancing Accounts (MCBA) described above. The MCBA will be recorded on the Company’s books.
 
The existing ICBA and the memorandum accounts will not be transferred to the WRAM/MCBA balances. Additions and other adjustments to these balances ended on July 1, 2008. However, interest will continue to accumulate on these balances until they are fully amortized through customer billings.
 
Washington Water, New Mexico Water, and Hawaii Water do not have any material amounts in expense balancing or memorandum accounts.


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Regulated Utility Accounting
 
Because we operate extensively in a regulated business, we are subject to the provisions of SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation.” Regulators establish rates that are designed to permit the recovery of the cost of service and a return on investment. Based upon past practices and decisions by the Commissions, we assess the probability of future recovery from rate payers of certain items, including the probability of return of amounts collected to rate payers. If it is probable that rates will recover an item in the future, a regulatory asset will be reported. If it is probable that rates will reflect a reduction in future rates for an item, a regulatory liability will be reported. We assess the probability of recovery of the regulatory assets and regulatory liabilities in each reporting period. In addition, if a regulatory commission determined that a portion of our assets used in utility operations were not recoverable in customer rates, we would be required to determine if we had suffered an asset impairment that would require a write-down in the assets’ valuation. There have been no such asset impairments as of December 31, 2008 or December 31, 2007.
 
Income Taxes
 
We account for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities at enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on the deferred tax assets and liabilities of a change in tax rate in the period that includes the enactment date. We must also assess the likelihood that deferred tax assets will be recovered in future taxable income and, to the extent recovery is unlikely, a valuation allowance would be recorded. If a valuation allowance were required, it could significantly increase income tax expense. In management’s view, a valuation allowance was not required at December 31, 2008 or December 31, 2007.
 
We anticipate that future rate action by the regulatory commissions will reflect revenue requirements for the tax effects of temporary differences recognized, which have previously been passed through to customers. The regulatory commissions have granted us rate increases to reflect the normalization of the tax benefits of the federal accelerated methods and available Investment Tax Credits (ITCs) for all assets placed in service after 1980. ITCs are deferred and amortized over the lives of the related properties for book purposes.
 
Pension Benefits
 
We incur costs associated with our pension and postretirement health care benefits plans. To measure the expense of these benefits, our 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 our management could result in significant variances in the cost recognized for pension benefit plans. The estimates used are based on historical experience, current facts, future expectations, and recommendations from independent advisors and actuaries. We use an investment advisor to provide advice in managing the plan’s investments. We anticipate any increase in funding for the pension and postretirement health care benefits plans will be recovered in future rate filings, thereby mitigating the financial impact.
 
In September 2006, the FASB issued SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans — An Amendment of FASB Statement Nos. 87, 88, 106 and 132(R).” We adopted SFAS No. 158 as of December 31, 2006 which required the full recognition of the projected benefit obligation over the fair value of plan assets, reflecting the funded status of the benefit plans, on the balance sheet. We believe it is probable that future costs will be recovered in future rates and therefore have recorded a regulatory asset in accordance with SFAS 71.
 
Workers’ Compensation, General Liability, and Other Claims
 
We are self-insured for a portion of workers’ compensation and general liability claims. Excess amounts are covered by insurance policies. For workers’ compensation, we work with an independent actuary firm to estimate the discounted liability associated with claims submitted and claims not yet submitted based on historical data. These estimates could vary significantly from actual claims paid, which could impact earnings and cash flows. For


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general liability claims and other claims, management estimates the cost incurred but not yet paid using historical information. Actual costs could vary from these estimates. Management believes actual costs incurred would be allowed in future rates, mitigating the financial impact.
 
Contingencies
 
We did not record any provisions relating to the contingencies reported in Note 15 of the Notes to Consolidated Financial Statements, as these did not qualify for recording under SFAS No. 5 or other accounting standards. If management’s assessment is incorrect, these items could have a material impact on our financial condition, results of operations, and cash flows.
 
Results of Operations
 
Earnings
 
Net income in 2008 was $39.8 million compared to $31.2 million in 2007 and $25.6 million in 2006. Diluted earnings per common share were $1.90 in 2008, $1.50 in 2007, and $1.34 in 2006. The weighted average number of common shares outstanding used in the diluted earnings per share calculation was 20,734,000 in 2008, 20,689,000 in 2007, and 18,925,000 in 2006. The increase in 2008 earnings per share resulted from increased operating income, largely driven by rate increases. Offsetting the increase in revenues were decline in other income as a result of a decline in value of investment assets, amortization of certain start up costs of our operations on the island of Hawaii not covered by rates and no significant property sales this year compared with the prior year.
 
Dividends
 
At the January 2009 meeting, the Board of Directors declared the quarterly dividend, increasing it for the 42nd consecutive year. The quarterly dividend was raised from $0.2925 to $0.2950 per common share, or an annual rate of $1.18 per common share. Dividends have been paid for 64 consecutive years. The annual dividends paid per common share in 2008, 2007, and 2006 were $1.17, $1.16, and $1.15, respectively. Earnings not paid as dividends are reinvested in the business for the benefit of stockholders. The dividend payout ratio was 62% in 2008, 77% in 2007, and 86% in 2006, for an average of 75% over the three-year period. Our long-term targeted dividend payout ratio is 60%
 
Operating Revenue
 
Operating revenue in 2008 was $410.3 million, an increase of $43.2 million, or 11.8%, over 2007. Operating revenue in 2007 was $367.1 million, an increase of $32.4 million, or 9.7%, above 2006. The estimated sources of changes in operating revenue were:
 
                 
    2008     2007  
    Dollars in millions  
 
Rate increases
  $ 42.1     $ 15.0  
Net revenue increases due to WRAM and MCBA
    2.0        
Usage by new customers
    4.0       2.7  
Change in presentation of Commission fees
    (2.7 )      
Usage by existing customers and other
    (2.2 )     14.7  
                 
Net change
  $ 43.2     $ 32.4  
                 
 
The usage by existing customers can materially change based upon current weather patterns, influenced both by temperature and rainfall. However, with the adoption of the WRAM and MCBA on July 1, 2008, the impact of weather on revenue has been minimized.
 
In 2008, rate relief increased revenues by $42.1 million. This was a record increase as a significant portion of our corporate costs received rate recovery from all districts effective July 2008, rather than a phased in approach of prior years regulatory treatment. See the “Rates and Regulation” section of this report for more information on regulatory activity occurring in 2007, 2008, and through February 13, 2009.


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The number of customers in 2008 increased by 2,938 or an increase of 0.6% over 2007 levels. This increase includes 153 customers in New Mexico, 3,025 customers in Hawaii, 46 customers in Washington, and a decline of 299 customers in California. The growth of our customer base resulted from organic growth in our existing service areas with the exception of approximately 3,000 customers who were added through acquisition of systems in Hawaii.
 
Water Production Expenses
 
Water production expenses, which consist of purchased water, purchased power, and pump taxes, comprise the largest segment of total operating expenses. Water production costs accounted for 41.5%, 43.0%, and 42.2% of total operating costs in 2008, 2007, and 2006, respectively. The rates charged for wholesale water supplies, electricity, and pump taxes are established by various public agencies. As such, these rates are beyond our control.
 
The table below provides the amount of increases (decreases), and percent changes in water production costs during the past two years:
 
                                                 
    2008     2007  
    Amount     Change     % Change     Amount     Change     % Change  
                Dollars in millions              
 
Purchased water
  $ 111.7     $ 5.0       5 %   $ 106.7     $ 13.3       14 %
Purchased power
    25.9       1.9       8 %     24.0       1.2       5 %
Pump taxes
    8.9       0.7       9 %     8.2       0.1       1 %
                                                 
Total water production expenses
  $ 146.5     $ 7.6       5 %   $ 138.9     $ 14.6       12 %
                                                 
 
Two of the principal factors affecting water production expenses are the amount of water produced and the source of the water. Generally, water from wells costs less than water purchased from wholesale suppliers.
 
The table below provides the amounts, percentage change, and source mix for the respective years:
 
                                                 
    2008     2007     2006  
    MG     % of Total     MG     % of Total     MG     % of Total  
    Millions of gallons (MG)  
 
Source:
                                               
Wells
    67,041       48.7 %     65,562       46.4 %     64,481       48.7 %
% change from prior year
    2 %             2 %             3 %        
Purchased
    65,529       47.5 %     70,530       49.9 %     62,320       47.1 %
% change from prior year
    (7 )%             13 %             1 %        
Surface
    5,187       3.8 %     5,146       3.7 %     5,613       4.2 %
% change from prior year
    1 %             (8 )%             11 %        
                                                 
Total
    137,757       100.0 %     141,238       100.0 %     132,414       100.0 %
                                                 
% change from prior year
    (2 )%             7 %             2 %        
 
Purchased water expenses are affected by changes in quantities purchased, supplier prices, and cost differences between wholesale suppliers. For 2008, the $5.0 million increase in purchased water is due to a 7% decrease in quantities offset by wholesaler water rate increases of between 2.8% and 20.5%. Purchased water was offset by lease of water rights of $1.6 million in 2008 versus $2.4 million in 2007. The impact of variation of actual water production expense from the adopted expense, effective July 1, 2008, is recorded as a component of revenue under the MCBA. (See “Water Supply” in Item 1 of this report). For 2007 the $13.3 million increase in purchased water is due to a 13% increase in quantities purchased and wholesale water rate increases of between 4.0% and 8.6%, For 2006, the $5.9 million increase in purchased water costs is due to a 2% increase in quantities purchased, magnified by overall higher wholesale water rates. On an overall blended basis, wholesale water rates increased 12.6% on a cost-per-million-gallon basis in 2008. Purchased power expenses are affected by the quantity of water pumped from wells and moved through the distribution system, rates charged by electric utility companies, and rate structures applied to usage during peak and non-peak times of the day or season. The purchased power expense increase of


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$1.9 million was primarily due to the combination of increased well production and higher energy costs. Pump taxes increased $0.7 million in 2008 over 2007.
 
Administrative and General Expenses
 
Administrative and general expenses include payroll related to administrative and general functions, all employee benefits charged to expense accounts, insurance expenses, legal fees, regulatory utility commissions’ expenses, expenses associated with being a public company, and general corporate expenses.
 
During 2008, administrative and general expenses increased $5.2 million, or 9.5%, compared to 2007. Pension expense increased $5.0 million over the prior year and legal expense increased $0.8 million. Increase in labor expense and other administrative costs were offset by a reduction in recording of expense of fees paid to the Commission of $2.7 million. (Fees paid to the Commission by our customers were previously recorded as a component of revenue and expense. Effective July 1, 2008, the revenues are recorded net of fees with the adoption of the WRAM). Other expense elements contributed to the balance of the change, but none were individually significant.
 
During 2007, administrative and general expenses increased $1.5 million, or 2.8%, compared to 2006. Outside services increased $0.6 million or 15.4%, due primarily to increased legal expense. Fees to the Commissions (calculated as a percentage of revenue) increased $0.5 million due to the increased revenue and a change in the rate charged by the Commissions. Liability insurance increased $0.5 million, or 33.2%, due to higher insurance premiums. Other expense elements contributed to the balance of the change, but none were individually significant.
 
Other Operations Expenses
 
The components of other operations expenses include payroll, material and supplies, and contract service costs of operating the regulated water systems, including the costs associated with water transmission and distribution, pumping, water quality, meter reading, billing, and operations of district offices.
 
For 2008, other operations expenses increased $4.9 million, or 10.6%, from 2007. The cost of operating the production and distribution systems increased $4.0 million, or 14.7% over the prior year. The largest increase in this category is the cost of labor. Outside services for water treatment and water quality testing and chemicals increased by $1.0 million, or 32%. The other major single increase was in conservation expense of $0.6 million, or an increase of 66% from 2007. Uncollectible accounts, which increased $0.2 million over the prior year. Other expense elements contributed to the balance of the change, but none were individually significant.
 
For 2007, other operations expenses increased $3.4 million, or 7.9%, from 2006. The cost of operating the production and distribution systems increased $1.6 million, or 6.6% over the prior year. The largest increase in this category is the cost of labor and outside services for water treatment and water quality testing, which increased by $1.0 million, or 13%. The other major increase is due to additional provision for uncollectible accounts, which increased $1.1 million, or 122% over the prior year. We believe that the slow down of the economy and the increase in foreclosures of homes is the most important cause of the increase in other operations expenses. Other causes elements contributed to the balance of the increase, but none were individually significant.
 
Maintenance
 
Maintenance expenses increased $0.6 million, or 3.5%, in 2008, compared to 2007 due to increased costs for maintenance of meters, services and pumping equipment. Repairs of mains declined from the prior year. For 2007, maintenance expenses increased $2.7 million, or 17.6%, compared to 2006, due to repairs of water mains and services.
 
Depreciation and Amortization
 
Depreciation and amortization increased due to the increased level of our capital expenditures and our use of a higher depreciation rate as authorized by the CPUC.


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Income Taxes
 
For 2008, income taxes increased $3.4 million as compared to 2007. For 2007, income taxes increased $3.9 million as compared to 2006. The increase in income tax for 2008, as compared to 2007, was due to higher pretax income. The effective tax rate was 37.7%, 39.9%, and 39.7% in 2008, 2007, and 2006, respectively. The effective tax rate was affected by the benefit from an additional tax deduction for the qualified production activity deduction for income attributed to the production of water. The tax rate is also affected by the flow through method of accounting for income taxes which resulted from differences between tax depreciation and book depreciation on both pre-1982 assets, as well as all California assets. The flow through method of accounting is described in the Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements. We anticipate the reversal of federal tax depreciation on pre-1982 assets to continue in future years; however, its effect on our tax provision is uncertain due to the offsetting flow-through of state tax depreciation, which continues to increase with capital additions and the impact of cost to remove of pre-1982 assets.
 
Property and Other Taxes
 
For 2008, expenses increased $1.2 million, or 8.5%, compared to 2007. For 2007, expenses increased $0.8 million, or 6.0% over 2006 levels. The increase in both years is due primarily to increased local franchise tax, which is based upon revenue and property taxes, which is based primarily upon our utility plant in service.
 
Non-Regulated Revenue and Expense, Net
 
The major components of non-regulated income are revenue and operating expenses related to the following activities:
 
  •  operating and maintenance services (O&M) and meter reading and billing services;
 
  •  antenna site leases;
 
  •  Extended Service Protection (ESP);
 
  •  design and construction services;
 
  •  interest income;
 
  •  change in cash surrender value of life insurance; and
 
  •  non-regulated expenses.
 
For 2008, we experienced a significant decline in the cash surrender value of life insurance contracts associated with our benefit plans. In 2008, the decline was of $3.8 million, while in 2007 we recognized a gain of $539. The cash surrender value is determined in part by the market of certain underlining funds, the value of which reflects the changes in the stock market. Due to the continued decline in the stock market during 2008, there was a corresponding impact on the cash surrender value of the life insurance contracts. In addition, we expensed certain acquisition costs associated with some non-regulated operations and maintenance contracts, which are recorded as intangible assets. For 2007, non-regulated income net of expenses increased $1.0 million, or 29%, compared to 2006. The increase was primarily due to increased non-regulated revenues from our ESP program, interest income, and antenna site leases. See Note 3 of the Notes to Consolidated Financial Statements for additional information.
 
Gain on Sale of Non-Utility Property
 
For 2008, there were no significant non-utility property sales compared to pretax gains of $2.5 million in 2007 and $0.3 million for 2006. Earnings and cash flow from these transactions are sporadic and may or may not continue in future periods, depending upon market conditions. The Company has other non-utility properties that may be marketed in the future based on real estate market conditions.


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Interest Expenses
 
In 2008 interest expenses increased $0.9 million due to borrowing on our line of credit. In 2007, interest expenses remained flat compared to 2006. Capitalized interest in 2008, 2007, and 2006 was $3.4 million, $2.6 million, and $2.7 million, respectively. See the “Liquidity and Capital Resources” section for more information.
 
Rates and Regulation
 
The state regulatory commissions have plenary powers setting rates and operating standards. As such, state commission decisions significantly impact our revenues, earnings, and cash flows. The amounts discussed herein are generally annual amounts, unless specifically stated, and the financial impact to recorded revenue is expected to occur over a 12-month period from the effective date of the decision. In California, water utilities are required to make several different types of filings. Most filings result in rate changes that remain in place until the next General Rate Case (GRC). As explained below, surcharges and surcredits to recover balancing and memorandum accounts as well as general rate case interim rate catch-up surcharges are temporary rate changes, which have specific time frames for recovery.
 
GRCs, escalation rate increase filings, and offset filings change rates to amounts that will remain in effect until the next GRC. The CPUC follows a rate case plan, which requires Cal Water to file a GRC for each of its 24 regulated operating districts every three years. In a GRC proceeding, the CPUC not only considers the utility’s rate setting requests, but may also consider other issues that affect the utility’s rates and operations. Effective in 2004, Cal Water’s GRC schedule was shifted from a calendar year to a fiscal year with test years commencing on July 1st of each year. The CPUC is generally required to issue its GRC decision prior to the first day of the test year or authorize interim rates. As such, Cal Water’s GRC decisions, prior to 2005, were generally issued in the fourth quarter, and from 2005 through 2009 were generally issued in the third quarter. In accordance with the rate case plan, the Commission would issue a decision on Cal Water’s 2009 general rate case filing in the fourth quarter of 2010 with rates effective on January 1, 2011. A decision on the eight GRCs filed in July of 2006 was delayed beyond July 1, 2007. As required by state law, the CPUC authorized interim rates incorporating the last twelve months change in CPI. A final decision on the 2007 GRC was made on July 10, 2008 with final rates billed effective on July 10, 2008. A provision in the final decision allows recovery of the revenue lost due to the delay over a twelve-month period beginning in the fourth quarter of 2008.
 
Between GRC filings utilities may file escalation rate increases, which allow the utility to recover cost increases, primarily from inflation and incremental investment, during the second and third years of the rate case cycle. However, escalation rate increases are subject to a weather-normalized earnings test. Under the earnings test, the CPUC may reduce the escalation rate increase if, in the most recent twelve month period, this earnings test reflects earnings in excess of authorized for that district.
 
In addition, utilities are entitled to file offset filings. Offset filings may be filed to adjust revenues for construction projects authorized in GRCs when the plant is placed in service or for rate changes charged to the Company for purchased water, purchased power, and pump taxes (referred to as “offsettable expenses”). Such rate changes approved in offset filings remain in effect until a GRC is approved.
 
Surcharges and surcredits to amortize balances in the WRAM and MCBA accounts, which are interest bearing, will be made in March of each year based on the district balances for the last calendar year. Surcharges will be for twelve months. In the event the combined WRAM and MCBA balance for a district is less than 2.5% of revenue, the amount will not be amortized at that time. The WRAM and MCBA amounts are cumulative, so if they are not amortized in a given calendar year, the balance will be rolled forward and reviewed with the following year balance.


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The following is a summary of rate filings and the anticipated annual impact on revenues. California decisions and resolutions may be found on the CPUC website at www.cpuc.ca.gov.
 
                     
            Increase
    CA District/
Type of Filing
  Decision/Resolution   Approval Date   Annual Revenue    
Subsidiary
 
GRC, Step Rate and Offset Filings
                   
City of Hawthorne
  Res. 1233(1)   January 2009   $ 3.0 million     City of Hawthorne
Offset
  Various(2)   February 2009   $ 9.0 million     7 districts
Offset
  AL 1878, 1879   August, 2008   $ 1.8 million     2 districts
Step Rate
  Various(3)   August, 2008   $ 0.6 million     5 districts
GRC 2007 — General Office Offset
  D.08-07-008   July, 2008   $ 13.7 million     15 districts
GRC 2007 — Final Rates
  D.08-07-008(4)   July, 2008   $ 28.2 million     8 districts
Offset
  R. W-4703   September, 2008   $ 1.0 million     Kern River Valley
GRC 2007 — Interim Rates
  AL 1861   July, 2008   $ 5.2 million     8 districts
Step Rate
  Various(5)   July, 2008   $ 1.1 million     4 districts
Offset
  AL 1849, 1850, 1851   January, 2008   $ 1.9 million     3 districts
GRC 2006
  D.07-12-055(6)   January, 2008   $ 5.8 million     8 districts
Offset
  Various(7)   January, 2008   $ 2.0 million     3 districts
Offset
  AL 1838   November, 2007   $ 0.8 million     Los Altos
Offset
  AL 1828, 1829, 1830   September, 2007   $ 1.5 million     3 districts
GRC 2006 — Interim rates
  D.07-06-028   July, 2007   $ 2.0 million     8 districts
Step Rate
  Various(8)   July, 2007   $ 4.6 million     14 districts
Offset
  AL 1805   May, 2007   $ 1.7 million     Stockton
Offset
  AL 1801 and 1804   Feb, 2007   $ 0.9 million     2 districts
Offset
  Various(9)   Jan, 2007   $ 2.5 million     4 districts
Step Rate
  Various(10)   Jan, 2007   $ 1.8 million     7 districts
Surcharges and Surcredits
                   
GRC 2007- Lost Revenue Recovery
  AL 1887   November, 2008   $ 0.7 million     8 districts
PBOP Surcharge
  D. 08-03-021(11)   April 2008   $ 0.7 million     24 districts
GRC 2006- Lost Revenue Recovery
  AL 1852   February 2008   $ 2.7 million     8 districts
Balancing
  AL 1835, 1836, 1837(12)   October, 2007   $ 2.4 million     3 districts
GRC 2005-Lost Revenue Recovery
  AL 1833   September, 2007   $ 0.5 million     8 districts
 
 
(1) City of Hawthorne Resolution 1233 allows increases of $0.8 million in February 2009, $1.0 million in July 2009, and $1.2 million in January 2010.
 
(2) Increases result from advice letters 1893, 1894, 1895, 1896, 1899, 1901, and 1902.
 
(3) Increases result from advice letters 1867, 1868, 1869, 1870, and 1871.
 
(4) The CPUC authorized a $33.4 million increase, which was inclusive of the $5.2 million granted in interim rates in July 2008.
 
(5) Increases result from advice letters 1857, 1858, 1859, and 1860.
 
(6) The CPUC authorized a $7.8 million increase, which was inclusive of the $2.0 million granted in interim rates in July 2007.
 
(7) Increases result from advice letters 1844, 1845, and 1846.
 
(8) Increases were authorized in D.05-07-022 and D.06-08-011.
 
(9) Increases result from advice letters 1791, 1797, 1798, and 1799.
 
(10) Increases were authorized in D.03-09-021, D.04-04-041, and D.04-09-038.
 
(11) The PBOP surcharge, scheduled to be collected over a 15-year period, was included in base rates in D.08-07-008.
 
(12) Authorized surcharges are $2.4 million from October 2007 through September 2008 and $1.9 million from October 2008 through September 2009.


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The estimated impact of rate changes compared to the prior year is listed in the following table:
 
                         
    2008     2007     2006  
    Dollars in millions  
 
General Rate Case (GRC)
  $ 31.0     $ 3.3     $ 5.7  
Step rate increases
    3.3       6.6       4.4  
Offset (purchased water/pump taxes)
    4.9       4.6       3.2  
Balancing accounts, net
    2.9       0.1       (3.4 )
Other
          0.4       0.2  
                         
Rate increases
  $ 42.1     $ 15.0     $ 10.1  
 
Remaining Unrecorded Balances from Previously Authorized Balancing Accounts Recoveries/Refunds
 
The total net under-collected memorandum and balancing accounts was approximately $1.5 million as of December 31, 2008. Included in this amount, Cal Water has amounts from districts that are pending further action when balances become large enough to warrant action of either recovery or refund.
 
Rate Case Plan
 
In December 2005, the CPUC issued the California Water Action Plan. The plan focuses on four key principles, among other things, including safe, high quality water; highly reliable water supplies; efficient use of water; and reasonable rates and viable utilities. In accordance with the Water Action Plan’s objective to streamline regulatory decision-making the CPUC issued R.06-12-016 in December 2006, to address streamlining of its water rate case plan. The CPUC issued D.07-05-062 on May 24, 2007 adopting a new rate case plan. As a result, Cal Water will be filing a company-wide general rate case every three years beginning in July 2009. Rates would be effective approximately 18 months from the filing date or January 1, 2011 in the first cycle. As an interim measure, the CPUC allowed Cal Water to incorporate general operations costs including company benefits in rates for all districts in July 2008 after a decision in its 2007 general rate case. In addition, for the sixteen districts that have a delayed effective date, the CPUC will authorize interim rates from the authorized effective date under the old rate case plan. These interim rates will be subject to adjustment based on a final determination in the 2009 general rate case filing. In addition to general rate case processing, the RCP set a schedule for separate cost of capital applications. Under the RCP, Cal Water must file its cost of capital application every three years. The first application under this procedure was made on May 1, 2008. Cal Water’s 2008 cost of capital application was consolidated with applications of two other multi-district Class A water utilities into a combined proceeding.
 
Conservation Application
 
Decision 06-08-011 directed Cal Water to file an application to implement conservation rates and a sales decoupling mechanism. On October 23, 2006, Cal Water filed Application 06-10-026 requesting a water revenue balancing account, a conservation memorandum account, and conservation rates. This request was consolidated with applications filed by other water companies in the CPUC’s Order Instituting Investigation 07-01-022.
 
On June 15, 2007, Cal Water and two consumer groups (the Commission’s Division of Ratepayer Advocates (DRA) and The Utility Reform Network (TURN)) filed a settlement jointly proposing a program of tiered residential rates, a water revenue adjustment mechanism (WRAM), and a modified balancing account (MCBA) that includes changes in source mix. Tiered rates have varying charges depending on the overall monthly usage. They are intended to provide a conservation incentive, particularly in high-usage periods. Non-residential rate design under the settlement emphasizes variable charges over service charges. The WRAM and MCBA are intended to negate any impact from customer conservation on Cal Water’s earnings.
 
On February 29, 2008, the Commission adopted the settlement. On July 1, 2008, Cal Water made its tiered rates, WRAM, and MCBA effective in compliance with the Commission’s administrative processing rules. The submitted tariffs were administratively approved in the third quarter, effective July 1, 2008.
 
In the conservation proceeding, the Commission also sought to examine the effect of sales decoupling on appropriate return on equity. On August 21, 2008, the Commission issued its decision 08-08-030 declining to make


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a specific return on equity adjustment and ordering that the issue be considered in connection with the cost of capital applications filed on May 1, 2008.
 
The conservation proceeding is still open to examine the Commission’s non-rate-related conservation policies. We are unable to predict the outcome of the proceeding with respect to these matters at this time.
 
2008 Regulatory Activity
 
Cost of Capital Application
 
On May 1, 2008, as required under the Rate Case Plan, Cal Water filed Application 08-05-002 requesting a review of its authorized rate of return. Cal Water requested a rate of return on rate base of 9.90% reflecting a 12.57% return on common equity verses the current 10.2% return on common equity previously approved by the CPUC. If Cal Water’s proposal is adopted, rates would increase $14.9 million annually or 4.26%. In September, the Commission held three days of evidentiary hearings on the applications of Cal Water, Golden State Water Company, and California-American Water Company. The Commission’s Division of Ratepayer Advocates is the only other participating party in the proceeding. All parties filed opening and reply briefs in October, 2008. An Administrative Law Judge has issued a draft decision which will be considered by the Commission in the first quarter of 2009. As the cost of capital was a contested matter, Cal Water cannot predict whether or when this application would change rates, or the magnitude of any potential changes.
 
2007 GRC Filing
 
On July 3, 2007, Cal Water filed its 2007 GRC application covering eight districts and general office costs. On July 10, 2008, the CPUC approved a settlement between Cal Water and the Division of Ratepayer Advocates, and authorized annual rate increases for eight districts of $33.4 million. In its order, the CPUC allowed Cal Water to file immediately to recover its increased general costs in all other districts. As of October 15, 2008, Cal Water had made effective $13.7 million of additional rate increases in fifteen districts. The CPUC order also allows for additional rate increases, including escalation increases, which may be requested in 2009 and 2010, and offset increases after construction of certain large capital projects. In accordance with state law, Cal Water will also be allowed to recover the difference between interim rates authorized on July 1, 2008 and final rates approved on July 10, 2008.
 
PBOP Application
 
In December 2006, Cal Water filed an application to allow it to recover additional funding associated with its postretirement benefit other than pensions (PBOP) or retiree healthcare plan. For the period 1993 through 2005, Cal Water funded and recognized as its PBOP expense at the Internal Revenue Code’s (IRC) maximum tax-deductible contribution level (Maximum Contribution Level) using an IRC 401(h) account as the funding mechanism. The excess expense between the Maximum Contribution Level and FAS 106 accrual during the employees’ expected service period was recorded as a regulatory asset. As of December 31, 2007, the regulatory asset was approximately $9.8 million.
 
On March 13, 2008, the Commission issued D.08-03-021, which granted Cal Water’s request to amortize the $9.8 million regulatory asset over a fifteen year period. Cal Water began a rate surcharge on April 1, 2008 which is expected to collect $658 annually to recover the regulatory asset. The annual amortization is included in the general allocated costs approved by the Commission in its D.08-07-008, replacing the prior adopted surcharge.
 
In 2005, Cal Water established two Voluntary Employee Beneficiary Associations (VEBAs) to allow for increased funding, which also permit a current period income tax deduction. Cal Water intends to increase its funding, so the PBOP plan accrual is fully funded each year during the employee’s service period.
 
Other 2008 Regulatory Proceedings
 
In December 2007, Cal Water received a decision on its 2006 general rate case filing. The decision allowed an increase of $7.8 million in rates for eight districts. This increase is inclusive of the $2.0 million in interim rates approved in July 2007. As a result, in December 2007 Cal Water filed advice letters to implement the adopted rates in January 2008. These advice letters were approved effective in January 2008 as requested.


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In January 2008, Cal Water filed advice letters to offset $3.9 million of increased purchased water and pump tax rates in six of its regulated districts. These advice letters were approved effective in January 2008 as requested.
 
In February 2008, Cal Water filed an advice letter to recover $2.7 million in lost revenue resulting from the delayed effective date of a final decision in its 2006 GRC. Under CPUC advice letter processing rules, Cal Water charges the rates in compliance advice letters to its customers upon filing. These advice letters were approved effective in February 2008 as requested. The lost revenue will be recovered as a surcharge on customer bills for a twelve-month period beginning in February 2008.
 
In June 2008, Cal Water filed an offset advice letter to increase rates by $1.0 million in one district to recover the capital requirements for a water treatment and supply project. The Commission had authorized recovery for this project in D.06-08-011 in August 2006. Under the Commission’s administrative processing rules, Commission approval was required. On September 18, 2008, the Commission approved Resolution W-4703, which adopted these changes.
 
In July 2008, Cal Water made effective escalation increases for four districts totaling $1.1 million in compliance with the Commission’s administrative processing rules. These advice letters were approved effective in July 2008 as requested.
 
In July and August 2008, Cal Water filed, effective in August 2008, escalation rate increases for five districts totaling $0.6 million. These filings were approved effective in August as requested.
 
In August 2008, Cal Water filed advice letters to offset increases in purchased water and pump tax charges in two districts totaling $1.8 million in annual revenue. These advice letters were approved effective in August 2008 as requested. However, expense offsets are dollar-for-dollar increases in revenue to match increased expenses and interact with the WRAM and MCBA mechanisms so that net operating revenue is not affected by an offset increase.
 
In October 2008, Cal Water filed a request to recover $0.7 million in lost revenue due to the delay in approving the 2007 general rate case increases from July 1, 2008 until July 10, 2008. The recovery is through a temporary 12-month surcharge on all affected customers. This advice letter was approved in November 2008 as requested.
 
2009 Regulatory Activity to Date
 
In January and February 2009, Cal Water filed advice letters to offset increased purchased water and pump tax rates in seven of its regulated districts totaling $9.0 million in annual revenue. Under CPUC advice letter processing rules, Cal Water charges the rates in expense offset advice letters to its customers upon filing. These rates are subject to refund until approved by the CPUC staff. While these offsets have not been approved as of February 8, 2009, Cal Water expects that they will be approved and effective as filed. However, expense offsets are dollar-for-dollar increases in revenue to match increased expenses and interact with the WRAM and MCBA mechanisms so that net operating revenue is not affected by an offset increase.
 
In January 2009 the City of Hawthorne approved Cal Water’s requested rate increase for its leased water system. The increase will take effect in phases, with a $0.8 million annual increase in February 2009, a $1.0 million annual increase in July 2009, and a $1.2 million annual increase in January 2010.
 
In January 2009 Cal Water filed an application to the CPUC for approvals and consents related to an anticipated secured debt offering. The application includes, among other things, requests for (i) a waiver of a CPUC policy, which would allow debt offerings by Cal Water of up to $100 million in principal amount be conducted through a single underwriter and (ii) clarification that complying with the terms of the indenture for the outstanding unsecured notes by granting the holders a first mortgage security interest upon the issuance of additional first mortgage debt does not use any of the Cal Water’s previously used financing authorization.
 
Throughout the calendar year, Cal Water plans to file advice letters to offset expected increases in purchased water and pump tax charges in some districts. Cal Water cannot predict the exact timing or dollar amount of the changes. However, expense offsets are dollar-for-dollar increases in revenue to match increased expenses and interact with the WRAM and MCBA mechanisms so that net operating revenue is not affected by an offset increase.


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In April 2009, as allowed in the Commission’s 2007 Rate Case Plan, Cal Water intends to file advice letters for interim rate increases for eight districts effective in July 2009. Under the Commission’s prior rate case plan, these districts would have had rates effective in July 2009. The interim rate changes will be adjusted once the Commission has issued a determination in Cal Water’s 2009 GRC, expected in the fourth quarter of 2010.
 
In May 2009, Cal Water intends to file for step rate increases effective in July for sixteen districts. The CPUC’s current practice on approving step rate increases is based partly on inflation through March 2009. Inputs to the weather-adjusted earnings test include recorded information through March 2009. Therefore, Cal Water does not know the amount of its request at this time.
 
In July 2009, Cal Water is required to file a GRC covering all 24 regulated districts and general expenses. Cal Water expects the CPUC to issue a decision in the proceeding in the fourth quarter of 2010 with rates effective in January 2011. Cal Water cannot predict the magnitude of any potential rate changes at this time.
 
Water Supply
 
Our source of supply varies among our operating districts. Certain districts obtain all of their supply from wells; some districts purchase all of their supply from wholesale suppliers; and other districts obtain supply from a combination of wells and wholesale suppliers. A small portion of supply comes from surface sources and is processed through Company-owned water treatment plants. To the best of management’s knowledge, we are meeting water quality, environmental, and other regulatory standards for all company-owned systems.
 
California’s normal weather pattern yields little precipitation between mid-spring and mid-fall. The Washington Water service areas receive precipitation in all seasons, with the heaviest amounts during the winter. New Mexico Water’s rainfall is heaviest in the summer monsoon season. Hawaii Water receives precipitation throughout the year, with the largest amounts in the winter months. Water usage in all service areas is highest during the warm and dry summers and declines in the cool winter months. Rain and snow during the winter months replenish underground water aquifers and fill reservoirs, providing the water supply for subsequent delivery to customers. To date, snowpack water content and rainfall accumulation during the 2008 — 2009 water year is 61% of normal (as of January 29, 2009 per the California Department of Water Resources). Precipitation in the prior year was below average. Management believes that supply pumped from underground aquifers and purchased from wholesale suppliers will be adequate to meet customer demand during 2009 and beyond. However, water rationing may be required in 2009, if declared by the state or local jurisdictions. Long-term water supply plans are developed for each of our districts to help assure an adequate water supply under various operating and supply conditions. Some districts have unique challenges in meeting water quality standards, but management believes that supplies will meet current standards using current treatment processes.
 
Liquidity and Capital Resources
 
Cash flow from Operations
 
During 2008 we generated cash flow from operations of approximately $96 million, compared to $50 million during 2007, and $61 million in 2006. Cash flow from operations is primarily generated by net income and non-cash expenses for depreciation and amortization and deferred income taxes. Cash generated by operations varies during the year.
 
The water business is seasonal. Billed 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 highest. This seasonality results in the possible need for short-term borrowings under the bank lines of credit in the event cash is not sufficient to cover operating and capital costs during the winter period. The increase in cash flow during the summer allows short-term borrowings to be paid down. Customer water usage can be lower than normal in years when more than normal precipitation falls in our service areas or temperatures are lower than normal, especially in the summer months. The reduction in water usage reduces cash flow from operations and increases the need for short-term bank borrowings. In addition, short-term borrowings are used to finance capital expenditures until long-term financing is arranged.


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Investing Activities
 
During 2008 we used $99 million of cash for company-funded capital expenditures and $24.9 million for acquisitions of new systems. Capital expenditures were budgeted at approximately $85 million. At December 31, 2008, we had accrued payables of $11.0 million related to company-funded capital projects. Developer funded cash capital expenditures were $8.6 in 2008 compared to $13.5 million in 2007. Developer funded projects vary year-to-year based upon housing markets in our service area.
 
Included in investing activities was the receipt of $34.2 million from our MTBE litigations. We are currently reviewing the regulatory treatment with the CPUC and are in process of filing a request for a private letter ruling from the Internal Revenue Service regarding the tax treatment. While we have not yet determined the final accounting treatment of the proceeds, we anticipate using the proceeds on infrastructure improvements.
 
Financing Activities
 
During 2008 there were no debt or equity offerings. Dividend payments were higher in 2008 from the prior year due to additional shares outstanding and a higher dividend rate in 2008. In August 2008 we redeemed and cancelled all outstanding shares of our Series C Preferred Stock.
 
Short-Term Financing
 
Short-term liquidity is provided by credit facilities extended to us and certain of our subsidiaries and by internally generated funds. Long-term financing is accomplished through use of both debt and equity. Short-term bank borrowings were $40 million at December 31, 2008, and zero at December, 2007. Cash and cash equivalents were $13.9 million at December 31, 2008, and $6.7 million at December 31, 2007. Given our ability to access our lines of credit on a daily basis, cash balances are managed to levels required for daily cash needs and excess cash is invested in short-term or cash equivalent instruments. Minimal operating levels of cash are maintained for Washington Water, New Mexico Water, and Hawaii Water.
 
Cal Water has a $55 million credit facility agreement that expires April 30, 2012 with Bank of America. The agreement requires debt as a percent of total capitalization to be less than 67%, and an interest coverage ratio of at least 2.5:1.0. As of December 31, 2008, we have met all covenant requirements and are eligible to use the full amount of the commitment. On September 24, 2008, the Cal Water line of credit was amended to allow borrowings up to $95 million for the period between September 30, 2008 and March 31, 2009. The amendment also provided that at any time the borrowings under the revolving credit facility exceed $55 million the entire principal amount outstanding of the revolving facility will bear interest annually at the lender’s prime rate minus 1.0 percentage points or alternatively at LIBOR plus 0.75 percentage points. If the borrowings do not exceed $55 million the original interest provisions will apply. In addition to borrowings, the credit facility allows for letters of credit up to $10 million, which reduces the available amount to borrow when utilized. One letter of credit was outstanding at December 31, 2008, for $0.5 million related to an insurance policy. Interest is charged on a variable basis and fees are charged for unused amounts.
 
A separate credit facility also with Bank of America, for $20 million also exists for use by the Company and its subsidiaries, including Washington Water, New Mexico Water, and Hawaii Water. In addition to borrowings, the credit facility allows for letters of credit up to $5 million, which would reduce the amount available to borrow. No letters of credit were outstanding at December 31, 2008. Interest is charged on a variable basis and fees are charged for unused amounts.
 
Credit Ratings
 
Cal Water’s first mortgage bonds are rated by Standard & Poor’s (S&P). Since 2004, the credit rating agency has maintained their rating of A+ and characterized us as stable. In the past, the credit agency has been concerned over the rate-setting process and decisions by the CPUC. Also, concerns were raised about our present level of capital expenditures, which will need to be partially financed through long-term borrowings or equity offerings. Management believes we would be able to meet financing needs even if ratings were downgraded, but a rating change could result in a higher interest rate on new debt.


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Long-Term Financing
 
Long-term financing, which includes senior notes, other debt securities, and common stock, has been used to replace short-term borrowings and fund capital expenditures. Internally generated funds, after making dividend payments, provide positive cash flow, but have not been at a level to meet the needs of our capital expenditure requirements. Management expects this trend to continue given our capital expenditures plan for the next 5 years. Some capital expenditures are funded by payments received from developers for contributions in aid of construction or advances for construction. Funds received for contributions in aid of construction are non-refundable, whereas funds classified as advances in construction are refundable. Management believes long-term financing is available to meet our cash flow needs through issuances in both debt and equity markets.
 
In September 2004, the CPUC issued a decision granting Cal Water authority to complete up to $250 million of equity and debt financing through 2010, subject to certain restrictions. Following our issuance of $79.5 million of common stock in 2006, of which $73.4 million was contributed to Cal Water, Cal Water has approximately $176 million of authorized equity and debt financing that it can complete through 2010 without seeking further authorization from the CPUC.
 
During 2006, we raised approximately $103 million of capital. Of this amount, $20 million was raised through privately placed senior unsecured notes. The remaining $83 million was raised through the issuance of 2.3 million shares of common stock.
 
In September 2006, we filed a shelf registration statement with the SEC for up to $150 million in preferred stock and common stock in addition to our prior shelf registration permitting up to $35.6 million in preferred stock and common stock. On October 12, 2006, we completed an underwritten public offering of 2,250,000 shares of our common stock (including 250,000 shares pursuant to the exercise, in part, by the underwriters of their over-allotment option) at a price per share of $36.75 to the public, raising approximately $83 million in gross proceeds. For additional information please reference our Form 8-K, dated October 12, 2006 on file with the SEC. After issuance of these shares, we had approximately $101 million in remaining securities available for future issuance under our shelf registration.
 
In 2008, we utilized cash generated from operations and financing activities in 2006. In future periods, management anticipates funding our capital needs through a relatively balanced approach between long term debt and equity.
 
We did not issue any significant long-term debt or common stock in 2008.
 
In the first half of 2009 Cal Water anticipates issuing approximately $100 million first mortgage debt guaranteed by the Company in a public offering. Cal Water’s ability to complete the offering is dependent on receiving CPUC approval which it is seeking, and public offering market conditions after it receives the approval.
 
Additional information regarding the bank borrowings and long-term debt is presented in Notes 8 and 9 in the Notes to Consolidated Financial Statements.
 
Off-Balance Sheet Transactions
 
We do not utilize off-balance-sheet financing or utilize special purpose entity arrangements for financing. We do not have equity ownership through joint ventures or partnership arrangements.


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Contractual Obligations
 
                                         
          Less Than
                After
 
    Total     1 Year     1-3 Years     3-5 Years     5 Years  
    (In thousands)  
 
Long-term debt
  $ 290,316     $ 2,818     $ 15,408     $ 52,657     $ 219,433  
Interest payments
    236,247       17,780       34,626       33,208       150,633  
Advances for construction
    176,163       6,123       12,027       11,966       146,047  
Office leases
    2,331       639       578       172       942  
System leases
    8,349       961       1,825       1,690       3,873  
Water supply contracts
    495,712       18,743       37,557       37,564       401,848  
                                         
TOTAL
  $ 1,209,118     $ 47,064     $ 102,021     $ 137,257     $ 922,776  
 
Our contractual obligations are summarized in the table above. For pension and post retirement benefits other than pension obligations see Note 12 to the Notes to the consolidated Financial Statements. Long-term debt payments include annual sinking fund payments on first mortgage bonds, maturities of long-term debt, and annual payments on other long-term obligations. Advances for construction represent annual contract refunds to developers for the cost of water systems paid for by the developers. The contracts are non-interest bearing, and refunds are generally on a straight-line basis over a 40-year period. System and office leases include obligations associated with leasing water systems and rents for office space.
 
Cal Water has water supply contracts with wholesale suppliers in 14 of its operating districts and for the two leased systems in Hawthorne and Commerce. For each contract, the cost of water is established by the wholesale supplier and is generally beyond our control. The amount paid annually to the wholesale suppliers is charged to purchased water expense on our statement of income. Most contracts do not require minimum annual payments and vary with the volume of water purchased.
 
We have a contract with the Santa Clara Water District, which contains minimal purchase provisions. The contract payment varies with the volume of water purchased above the minimal levels. Management plans to continue to purchase and use at least the minimum water requirement under this contract in the future. Total paid under this contract was $6.7 million in 2008, $6.2 million in 2007, and $5.4 million in 2006.
 
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. Due to the fixed price arrangement, we utilize 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 $5.7 million in 2008, $5.5 million in 2007, and $4.4 million in 2006. Pricing under the contract varies annually. Estimated annual contractual obligations in the above table are based on the same payment level as 2008. Future cost increases by SEWD are expected to be offset by a decline in the allocation of costs to us as more of these costs are expected to be allocated to other SEWD customers due to growth within their service areas.
 
On September 21, 2005, we entered into an agreement with Kern County Water Agency (Agency) to obtain treated water for our operations. The term of the agreement is to January 1, 2035, or until the Agency’s bonds are repaid. The Agency’s bonds are described below. Under the terms of the agreement, we were obligated to purchase approximately 11,500 acre feet of treated water in 2008 and an incrementally higher volume of water for each subsequent year until 2017, when we are obligated to purchase 20,500 acre feet of treated water per year. We are obligated to pay a capital facilities charge and a treated water charge, both of which will be expensed as invoiced, regardless of whether we can use the water in our operation, and we are obligated for these charges even if the Agency cannot produce an adequate amount to supply the 20,500 acre feet in the year. This agreement supersedes a prior agreement with Kern County Water Agency for the supply of 11,500 acre feet of water per year. Total paid, under the prior agreement, was $4.4 million, $2.9 million, and $3.3 million in 2008, 2007 and 2006, respectively.
 
Three other parties, including the City of Bakersfield, are also obligated to purchase a total of 32,500 acre feet per year under separate agreements with the Agency. Further, the Agency has the right to proportionally reduce the water supply provided to all of the participants if it cannot produce adequate supplies. The participation of all parties in the transaction for expansion of the Agency’s facilities, including its water purification plant, purchase of the


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water, and payment of interest and principal on the bonds being issued by the Agency to finance the transaction, is required as a condition to the obligation of the Agency to proceed with expansion of the Agency’s facilities. If any of the other parties does not use its allocation in a given year, that party is still obligated to pay its contracted amount.
 
The Agency has issued bonds to fund the project and will use the payments of the capital facilities charges by us and the other contracted parties to meet the Agency’s obligations to pay interest and repay principal on the bonds. If any of the parties were to default on making payments of the capital facilities charge, then the other parties are obligated to pay for the defaulting party’s share on a pro-rata basis. If there is a payment default by a party and the remaining parties have to make payments, they are also entitled to a pro-rata share of the defaulting party’s water allocation.
 
We expect to use all of its entitled water in our operations every year. If additional treated water is available, all parties have an option to purchase this additional treated water, subject to the Agency’s right to allocate the water among the parties. If we were to pay for and receive additional amounts of water due to a default of another participating party, we believe we could use this additional water in our operations without incurring substantial increases in incremental costs.
 
The total obligation of all parties, excluding us, is approximately $82.4 million to the Agency. Based on the credit worthiness of the other participants, which are government entities, our management believes it to be highly unlikely that we would be required to assume any other parties’ obligations under the contract due to their default. If a party defaults, we would receive entitlement to the additional water for assuming the additional obligation.
 
Once the project is complete, we are obligated to pay a capital facilities charge and a treated water charge that together total $6.4 million annually, which equates to $0.3 per acre foot. Annual payments of $3.6 million for the capital facilities charge began when the Agency issued bonds to fund the project. Some of the treated water charge of $2.8 million began July 1, 2007, when a portion of the planned capacity became available. Once the entire expansion project is completed, the full annual payments will be $6.4 million which will continue through the term of the agreement. As treated water is being delivered, we will also be obligated for our portion of the operating costs; that portion is currently estimated to be $0.02 per acre foot. The actual amount will vary due to variations from estimates, inflation, and other changes in the cost structure. Our overall estimated cost of $0.3 per acre foot is less than the estimated cost of procuring untreated water (assuming water rights could be obtained) and then providing treatment.
 
Capital Requirements
 
Capital requirements consist primarily of new construction expenditures for expanding and replacing utility plant facilities and the acquisition of water systems. They also include refunds of advances for construction.
 
Company-funded utility plant expenditures were $99 million, $76.0 million, and $88.4 million in 2008, 2007, and 2006, respectively. A majority of capital expenditures was associated with mains and water treatment equipment.
 
For 2009, the Company is estimating its capital expenditures to be between $100 and $130 million. We do not expect a decline in annual capital expenditure for the next five years.
 
Other capital expenditures are funded through developer advances and contributions in aid of construction (non-company funded). The cash expenditure amounts were $8.6 million, $13.5 million, and $16.1 million in 2008, 2007, and 2006, respectively. The changes from year-to-year reflect expansion projects by developers in our service areas.
 
Management expects us to incur non-company funded expenditures in 2009. These expenditures will be financed by developers through refundable advances for construction and non-refundable contributions in aid of construction. Developers are required to deposit the cost of a water construction project with us prior to our commencing construction work, or the developers may construct the facilities themselves and deed the completed facilities to us. Funds are generally received in advance of incurring costs for these projects. Advances are normally refunded over a 40-year period without interest. Future payments for advances received are listed under contractual obligations above. Because non-company-funded construction activity is solely at the discretion of developers, we


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cannot predict the level of future activity. The cash flow impact is expected to be minor due to the structure of the arrangements.
 
Capital Structure
 
Common stockholders’ equity was $402.9 million compared to $385.7 million at December 31, 2008 and 2007, respectively. During 2008, we redeemed all of the issued and outstanding shares of Series C Preferred Stock. There were no significant additional long-term debt borrowings in 2008 or 2007.
 
Total capitalization, including the current portion of long-term debt, at December 31, 2008, was $693.3 million and $681.1 million at December 31, 2007. The Company intends to issue common stock and long-term debt to finance our operations. The capitalization ratios will vary depending upon the method we choose to finance our operations.
 
At December 31, capitalization ratios were:
 
                 
    2008     2007  
 
Common equity
    58.1 %     56.9 %
Preferred stock
          0.5 %
Long-term debt
    41.9 %     42.6 %
 
The return (from both regulated and non-regulated operations) on average common equity was 10.2% in 2008 compared to 8.1% in 2007.
 
Acquisitions
 
Although there were no significant acquisitions in the periods presented, the following acquisitions were completed in 2008, 2007 and 2006.
 
In 2008, the Company’s wholly-owned subsidiary HWS Utility Services, LLC, acquired contracts to operate and maintain water and wastewater systems in Hawaii. The purchase price of $1.3 million was paid with the issuance of the Company’s common stock. The purchase price is being amortized over the remaining life of the contracts.
 
On September 2, 2008, after receiving regulatory approval, the Company’s wholly-owned subsidiary, Hawaii Water Service Company, Inc. acquired all the outstanding stock of three related privately held companies (Waikoloa Resort Utilities, Inc.; Waikoloa Water Company, Inc.; Waikoloa Sewer Company, Inc.) on the Island of Hawaii with water and wastewater operations. The combined purchase price was $20.6 million. Assets acquired were $26.9 million, including cash of $6.3 million. Liabilities assumed were $10.2 million (net of $12.6 million which was paid at close of escrow). Goodwill of $3.9 million was recorded. The Company is in the process of finalizing the valuation of certain intangible assets as well as acquired tax operating loss carryforwards; therefore the purchase price is subject to further refinement upon completion of a valuation study. On December 19, 2008, after receiving regulatory approval, Hawaii Water acquired the water and wastewater assets of two other privately held company (Kukio Utility Company and WB Maninowali) for a cash price of $10.6 million which was the assigned value of the assets. No liabilities were assumed.
 
In 2007, after receiving regulatory approval, we acquired for cash a water system with allowed rate base of approximately $0.4 million. In addition, in Washington we acquired five water systems for $1.1 million in cash, which was the approximate value of rate base of the systems.
 
In August 2006, we acquired the assets of Independent Utility Company, for approximately $0.5 million in cash in exchange for the assets of the system, including three wells and 340 acre-feet of water rights. Located 15 miles east of Albuquerque, New Mexico, we merged the system and its 400 customers into New Mexico Water Service Company. No goodwill was recorded in the transaction.


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Real Estate Program
 
We own real estate. From time to time, certain parcels are deemed no longer used or useful for water utility operations. Most surplus properties have a low cost basis. We developed a program to realize the value of certain surplus properties through sale or lease of those properties. The program will be ongoing for a period of several years. Property sales produced pretax gains of $-0- million, $2.5 million, and $0.4 million in 2008, 2007, and 2006, respectively. As sales are dependent on real estate market conditions, future sales, if any, may or may not be at prior year levels.
 
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk
 
We do not participate in hedge arrangements, such as forward contracts, swap agreements, options, or other contractual agreements to mitigate the impact of market fluctuations on our assets, liabilities, production, or contractual commitments. We operate only in the United States and, therefore, are not subject to foreign currency exchange rate risks.
 
Terrorism Risk
 
Due to terrorist risks, we have heightened security at our facilities over the past few years and have taken added precautions to protect our employees and the water delivered to customers. We have complied with EPA regulations concerning vulnerability assessments and have made filings to the EPA as required. In addition, communication plans have been developed as a component of our procedures related to this risk. While we do not make public comments on our security programs, we have been in contact with federal, state, and local law enforcement agencies to coordinate and improve our water delivery systems’ security.
 
Interest Rate Risk
 
We are subject to interest rate risk, although this risk is lessened because we operate in a regulated industry. If interest rates were to increase, management believes customer rates would increase accordingly, subject to Commission approval in future GRC filings. The majority of our debt is long-term at a fixed rate. Interest rate risk does exist on short-term borrowings within our credit facilities, as these interest rates are variable. We also have interest rate risk on new financing, as higher interest cost may occur on new debt if interest rates increase.
 
Stock Price Risk
 
Because we operate primarily in a regulated industry, our stock price volatility risk is somewhat lessened; however, regulated parameters also can be recognized as limitations to operations, earnings, and the ability to respond to certain business condition changes. An adverse change in the stock price could make issuance of common stock less attractive in the future.
 
Stock Market Performance Risk
 
Our stock price could be affected by changes in the general market. This could impact the costs of obtaining funds through the equity markets. Stock market performance could also impact us through the investments by our defined benefit plan and postretirement medical benefit plan. We are responsible for funding these plans. Plan investments are made in stock market equities using mutual funds and in corporate bonds. Poor performance of the equity and bond markets could result in increased costs and additional funding requirements due to lower investment returns. Management believes we would be able to recover these higher costs in customer rates.
 
Equity Risk
 
We do not have equity investments and, therefore, do not have equity risks.


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Item 8.   Financial Statements and Supplementary Data.
 
Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Stockholders of
California Water Service Group
San Jose, California
 
We have audited the accompanying consolidated balance sheet of California Water Service Group and subsidiaries (the “Company”) as of December 31, 2008, and the related consolidated statements of income, common stockholders’ equity and comprehensive income, and cash flows for the year ended December 31, 2008. We also have audited the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audit.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
 
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.


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In our opinion, the consolidated financial statement referred to above present fairly, in all material respects, the financial position of California Water Service Group and subsidiaries as of December 31, 2008, and the respective results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
/s/  Deloitte & Touche LLP
 
San Francisco, California
February 27, 2009


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Report of Independent Registered Public Accounting Firm
 
The Board of Directors and Stockholders
California Water Service Group:
 
We have audited the accompanying consolidated balance sheet of California Water Service Group and subsidiaries as of December 31, 2007, and the related consolidated statements of income, common stockholders’ equity and comprehensive income, and cash flows for each of the years in the two-year period ended December 31, 2007. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of California Water Service Group and subsidiaries as of December 31, 2007, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
 
/s/  KPMG LLP
 
Mountain View, California
February 28, 2008, except for the last paragraph of note 1,
which is as of February 27, 2009


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Consolidated Balance Sheets
 
                 
    December 31,  
    2008     2007  
    In thousands, except per share data  
 
ASSETS
Utility plant:
               
Land
  $ 19,058     $ 17,191  
Depreciable plant and equipment
    1,464,904       1,370,409  
Construction work in progress
    80,649       43,646  
Intangible assets
    18,468       15,801  
                 
Total utility plant
    1,583,079       1,447,047  
Less accumulated depreciation and amortization
    (470,712 )     (436,851 )
                 
Net utility plant
    1,112,367       1,010,196  
                 
Current assets:
               
Cash and cash equivalents
    13,869       6,734  
Receivables, net of allowance for doubtful accounts of $1,210 and $641, respectively:
               
Customers
    22,786       18,600  
Other
    12,071       8,617  
Unbilled revenue
    13,112       12,911  
Materials and supplies at weighted average cost
    5,070       4,744  
Prepaid income taxes
    4,968        
Taxes, prepaid expenses, and other assets
    7,922       8,369  
                 
Total current assets
    79,798       59,975  
                 
Other assets:
               
Regulatory assets
    198,293       90,908  
Unamortized debt premium and expense
    6,070       6,745  
Goodwill
    3,906        
Other
    17,673       16,675  
                 
Total other assets
    225,942       114,328  
                 
    $ 1,418,107     $ 1,184,499  
                 
 
CAPITALIZATION AND LIABILITIES
Capitalization:
               
Common stock, $0.01 par value; 25,000 shares authorized, 20,723 and 20,666, outstanding in 2008 and 2007, respectively
  $ 207     $ 207  
Additional paid-in capital
    213,922       211,885  
Retained earnings
    188,820       173,617  
                 
Total common stockholders’ equity
    402,949       385,709  
Preferred stock without mandatory redemption provision, $25 par value, 380 shares authorized, -0- and 139, outstanding in 2008 and 2007, respectively
          3,475  
Long-term debt, less current maturities
    287,498       289,220  
                 
Total capitalization
    690,447       678,404  
                 
Current liabilities:
               
Current maturities of long-term debt
    2,818       2,701  
Short-term borrowings
    40,000        
Accounts payable
    41,772       36,694  
Accrued other taxes
    2,776       2,216  
Accrued interest
    3,295       3,073  
Other accrued liabilities
    32,535       24,969  
                 
Total current liabilities
    123,196       69,653  
                 
Unamortized investment tax credits
    2,392       2,467  
Deferred income taxes
    72,344       69,712  
Regulatory liabilities
    20,728       20,386  
Pension and postretirement benefits other than pension
    152,685       39,444  
Advances for construction
    176,163       168,024  
Contributions in aid of construction
    117,568       118,012  
MTBE settlement
    34,216        
Other long-term liabilities
    28,368       18,397  
Commitments and contingencies
           
                 
    $ 1,418,107     $ 1,184,499  
                 
 
See accompanying Notes to Consolidated Financial Statements.


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Consolidated Statements of Income
 
                         
    For The Years Ended December 31,  
    2008     2007     2006  
    In thousands, except per share data  
 
Operating revenue
  $ 410,312     $ 367,082     $ 334,717  
                         
Operating expenses:
                       
Operations:
                       
Purchased water
    111,726       106,748       93,426  
Purchased power
    25,939       23,974       22,738  
Pump taxes
    8,899       8,161       8,094  
Administrative and general
    59,429       54,262       52,793  
Other
    51,196       46,310       42,923  
Maintenance
    18,969       18,336       15,591  
Depreciation and amortization
    37,339       33,563       30,652  
Income taxes
    24,507       17,887       15,297  
Property and other taxes
    14,839       13,671       12,897  
                         
Total operating expenses
    352,843       322,912       294,411  
                         
Net operating income
    57,469       44,170       40,306  
                         
Other income and expenses:
                       
Non-regulated revenue
    14,230       13,557       10,645  
Non-regulated expense
    (15,097 )     (9,114 )     (7,208 )
Gain on sale of non-utility property
    7       2,516       348  
Income tax benefit (expense) on other income and expenses
    376       (2,836 )     (1,542 )
                         
Net other (expense) income
    (484 )     4,123       2,243  
                         
Interest expense:
                       
Interest expense
    20,591       19,719       19,669  
Less: capitalized interest
    (3,411 )     (2,585 )     (2,700 )
                         
Net interest expense
    17,180       17,134       16,969  
                         
Net income
  $ 39,805     $ 31,159     $ 25,580  
                         
Earnings per share:
                       
Basic
  $ 1.90     $ 1.50     $ 1.34  
Diluted
  $ 1.90     $ 1.50     $ 1.34  
Weighted average number of common shares outstanding:
                       
Basic
    20,710       20,665       18,905  
Diluted
    20,734       20,689       18,925  
 
See accompanying Notes to Consolidated Financial Statements.


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Consolidated Statements of Common Stockholders’ Equity and Comprehensive Income
 
For the years ended December 31, 2008, 2007 and 2006
 
                                                 
                            Accumulated
       
                Additional
          Other
    Total
 
    Common Stock     Paid-in
    Retained
    Comprehensive
    Stockholders’
 
    Shares     Amount     Capital     Earnings     Income (Loss)     Equity  
    In thousands  
 
Balance at December 31, 2005
    18,390     $ 184     $ 131,991     $ 162,968     $ (1,202 )   $ 293,941  
                                                 
Net income
                        25,580             25,580  
Reclassification of minimum pension liability to regulatory asset, net of tax effect of $802, in conjunction with the implementation of SFAS no. 158 (see Note 12)
                              1,202       1,202  
                                                 
Comprehensive income
                        25,580       1,202       26,782  
Issuance of common stock, net of expenses of $3,680
    2,267       23       79,522                   79,545  
Dividends paid:
                                               
Preferred stock
                        (153 )           (153 )
Common stock
                        (21,813 )           (21,813 )
                                                 
Total dividends paid
                        (21,966 )           (21,966 )
                                                 
Balance at December 31, 2006
    20,657       207       211,513       166,582             378,302  
Net income
                        31,159             31,159  
Issuance of common stock
    9             372                   372  
Dividends paid:
                                               
Preferred stock
                        (153 )           (153 )
Common stock
                        (23,971 )           (23,971 )
                                                 
Total dividends paid
                        (24,124 )           (24,124 )
                                                 
Balance at December 31, 2007
    20,666       207       211,885       173,617             385,709  
Net income
                        39,805             39,805  
Issuance of common stock
    57             2,037                   2,037  
Premium on retirement of preferred stock
                            (253 )             (253 )
Dividends paid:
                                               
Preferred stock
                        (115 )           (115 )
Common stock
                        (24,234 )           (24,234 )
                                                 
Total dividends paid
                        (24,349 )           (24,349 )
                                                 
Balance at December 31, 2008
    20,723     $ 207     $ 213,922     $ 188,820           $ 402,949  
                                                 
 
See accompanying Notes to Consolidated Financial Statements.


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Consolidated Statements of Cash Flows
 
                         
    For the Years Ended December 31,  
    2008     2007     2006  
    In thousands  
 
Operating activities:
                       
Net income
  $ 39,805     $ 31,159     $ 25,580  
                         
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization
    39,485       33,563       30,652  
Amortization of debt premium and expenses
    673       673       665  
Other changes in noncurrent assets and liabilities
    10,659       (262 )     3,218  
Change in value of life insurance contracts
    3,763              
Gain on sale of non-utility property
    (7 )     (2,516 )     (348 )
Changes in operating assets and liabilities:
                       
Receivables
    (6,069 )     (881 )     (5,381 )
Unbilled revenue
    (201 )     (1,570 )     104  
Taxes, prepaid expenses, and other assets
    (4,421 )     (5,781 )     (437 )
Accounts payable
    2,610       2,857       (865 )
Material and supplies
    (322 )     (228 )     (322 )
Other current liabilities
    8,109       (4,282 )     11,045  
Other changes, net
    1,646       (2,678 )     (2,943 )
                         
Net adjustments
    55,925       18,895       35,388  
                         
Net cash provided by operating activities
    95,730       50,054       60,968  
                         
Investing activities:
                       
Utility plant expenditures:
                       
Company-funded
    (99,212 )     (75,996 )     (88,382 )
Developer advances and contributions in aid of construction
    (8,592 )     (13,467 )     (16,064 )
MTBE settlement received
    34,217              
Proceeds from sale of non-utility assets
    7       2,495       353  
Acquisitions
    (24,924 )     (1,479 )     (509 )
Purchase of life insurance
    (1,373 )            
                         
Net cash used in investing activities
    (99,877 )     (88,447 )     (104,602 )
                         
Financing activities:
                       
Short-term borrowings
    56,000              
Repayment of short-term borrowings
    (16,000 )            
Issuance of common stock, net of expenses
          372       79,545  
Issuance of long-term debt, net of expenses
    655       264       19,879  
Advances and contributions in aid of construction
    8,227       16,589       24,992  
Refunds of advances for construction
    (6,662 )     (6,306 )     (6,189 )
Retirement of long-term debt
    (2,871 )     (1,980 )     (1,848 )
Redemption of preferred stock
    (3,718 )            
Dividends paid
    (24,349 )     (24,124 )     (21,966 )
                         
Net cash (used in) provided by financing activities
    11,282       (15,185 )     94,413  
                         
Change in cash and cash equivalents
    7,135       (53,578 )     50,779  
Cash and cash equivalents at beginning of year
    6,734       60,312       9,533  
                         
Cash and cash equivalents at end of year
  $ 13,869     $ 6,734     $ 60,312  
                         
Supplemental disclosures of cash flow information:
                       
Cash paid during the year for:
                       
Interest (net of amounts capitalized)
  $ 16,284     $ 16,459     $ 16,146  
Income taxes
    22,586       30,220       5,471  
Supplemental disclosure of non-cash activities:
                       
Accrued payables for investments in utility plant
    10,967       11,186       10,477  
Purchase of intangible assets with Company common stock
    1,300              
Utility plant contributed by developers
    10,222       11,880       9,968  
 
See accompanying Notes to Consolidated Financial Statements.


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Notes to Consolidated Financial Statements
December 31, 2008, 2007, and 2006
Amounts in thousands, except share data
 
1 ORGANIZATION AND OPERATIONS
 
California Water Service Group (Company) is a holding company that provides water utility and other related services in California, Washington, New Mexico, and Hawaii through its wholly-owned subsidiaries. California Water Service Company (Cal Water), Washington Water Service Company (Washington Water), New Mexico Water Service Company (New Mexico Water), and Hawaii Water Service Company, Inc. (Hawaii Water) provide regulated utility services under the rules and regulations of their respective state’s regulatory commissions (jointly referred to as the Commissions). CWS Utility Services and HWS Utility Services LLC provide non-regulated water utility and utility-related services.
 
The Company operates primarily in one business segment, providing water and related utility services.
 
Basis of Presentation
 
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and include the Company accounts and those of its wholly owned subsidiaries. All intercompany transactions have been eliminated from the consolidated financial statements. In the opinion of management, the consolidated financial statements reflect all adjustments that are necessary to provide a fair presentation of the results for the periods covered.
 
The preparation of the Company’s consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the consolidated balance sheet dates and the reported amounts of revenues and expenses for the periods presented. These include, but are not limited to, estimates and assumptions used in determining the Company’s regulatory asset and liability balances based upon probability assessments of regulatory recovery, revenues earned but not yet billed, asset retirement obligations, allowance for doubtful accounts, pension and other employee benefit plan liabilities, and income tax-related assets and liabilities. Actual results could differ from these estimates.
 
In connection with the preparation of its financial statements for the year ended December 31, 2008, the Company determined that it had not properly classified the non-cash component related to developer funded construction in its statements of cash flows for the years ended December 31, 2007 and 2006. As a result, investing cash flows and financing cash flows were overstated by $11.9 million and $10.0 million for the years ended December 31, 2007 and 2006, respectively. Management has concluded that these errors are immaterial to its consolidated financial statements. Pursuant to Staff Accounting Bulletin No. 108 (SAB 108), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” the consolidated statements of cash flows for the years ended December 31, 2007 and 2006 have been adjusted to reflect the correction of these errors.
 
2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Revenue
 
Revenue includes monthly cycle customer billings for regulated water and wastewater services at rates authorized by regulatory commissions and billings to certain non-regulated customers. In addition, effective July 1, 2008 with the adoption of the Water Revenue Adjustment Mechanism (WRAM) and the Modified Cost Balancing Account (MCBA), Cal Water records the difference between what is billed to its regulated customers and that which is authorized by the California Public Utilities Commission (CPUC).
 
Under the WRAM, Cal Water records the adopted level of volumetric revenues as authorized by the CPUC for metered accounts (adopted volumetric revenues). In addition to volumetric-based revenues, the revenue requirements approved by the CPUC include service charges, flat rate charges, and other items that are not subject to the WRAM. The adopted volumetric revenue considers the seasonality of consumption of water based upon historical


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Notes to Consolidated Financial Statements — (Continued)
 
averages. The variance between adopted volumetric revenues and actual billed volumetric revenues for metered accounts is recorded as a component of revenue with an offsetting entry to a current asset or liability regulatory balancing account (tracked individually for each Cal Water district). The variance amount may be positive or negative and represents amounts that will be billed or refunded to customers in the future.
 
Under the MCBA, Cal Water will track adopted expense levels for purchased water, purchased power and pump taxes, as established by the CPUC. Variances (which include the effects of changes in both rate and volume) between adopted and actual purchased water, purchased power, and pump tax expenses are recorded as a component of revenue, as the amount of such variances will be recovered from or refunded to the Company’s customers at a later date. This is reflected with an offsetting entry to a current asset or liability regulatory balancing account (tracked individually for each Cal Water district).
 
The balances in the WRAM and MCBA assets and liabilities accounts will fluctuate on a monthly basis depending upon the variance between adopted and actual results. The recovery or refund of the WRAM is netted against the MCBA over- or under-recovery for the corresponding district and is interest bearing at the current 90 day commercial paper rate. When the net amount for any district achieves a pre-determined level at the end of any calendar year (i.e., at least 2.5 percent over- or under-recovery of the approved revenue requirement), Cal Water will file with the CPUC to refund or collect the balance in the accounts. Account balances less than those levels may be refunded or collected in Cal Water’s general rate case proceedings or aggregated with future calendar year balances for comparison with the recovery level. As of December 31, 2008, the net aggregated asset is $4,629 and the aggregate liability is $2,585 and are included in other accounts receivable and accounts payable, respectively.
 
The Company provides an allowance for doubtful accounts receivable. The allowance is based upon specific identified, potentially troubled accounts plus an estimate of uncollectible accounts based upon historical percentages. The balance of customer receivables is net of the allowance for doubtful accounts at December 31, 2008 and 2007 of $1,210 and $641, respectively.
 
The activities in the allowance for doubtful accounts are as follows:
 
                 
    2008     2007  
 
Beginning Balance
  $ 641     $ 260  
Provision for uncollectible accounts
    2,308       2,063  
Net write off of uncollectible accounts
    (1,739 )     (1,682 )
                 
Ending Balance
  $ 1,210     $ 641  
                 
 
Non-Regulated Revenue
 
Revenues from non-regulated operations and maintenance agreements are recognized when services have been rendered to companies or municipalities under such agreements. For construction and design services, revenue is generally recognized on the completed contract method, as most projects are completed in less than three months. Other non-regulated revenue is recognized when title has transferred to the buyer, or ratably over the term of the lease.
 
Expense Balancing and Memorandum Accounts
 
Prior to the adoption of the MCBA, incremental cost balancing accounts (ICBA), and memorandum accounts were used to track suppliers’ rate changes for purchased water, purchased power, and pump taxes that were not included in customer water rates. The cost changes are referred to as “Offsetable Expenses” because under certain circumstances they are recoverable from customers (or refunded to customers) in future rates designed to offset the cost changes from the suppliers. The Company does not record the ICBA and memorandum accounts until the Commission authorizes a change in customer rates and the customer has been billed. As of December 31, 2008, the balance of the ICBA and memorandum accounts not yet recognized is $1.5 million.


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Notes to Consolidated Financial Statements — (Continued)
 
Utility Plant
 
Utility plant is carried at original cost when first constructed or purchased, or at fair value. When depreciable plant is retired, the cost is eliminated from utility plant accounts and such costs are charged against accumulated depreciation. Maintenance of utility plant is charged to operating expenses as incurred. Maintenance projects are not accrued for in advance. Interest is capitalized on plant expenditures during the construction period and amounted to $3,411 in 2008, $2,585 in 2007, and $2,700 in 2006.
 
Intangible assets acquired as part of water systems purchased are recorded at fair value. All other intangibles have been recorded at cost and are amortized over their useful life. Included in intangible assets is $6,515 paid to the City of Hawthorne in 1996 to lease the city’s water system and associated water rights. The asset is being amortized on a straight-line basis over the 15-year life of the lease.
 
The following table represents depreciable plant and equipment as of December 31:
 
                 
    2008     2007  
 
Equipment
  $ 317,735     $ 291,645  
Transmission and distribution plant
    1,054,329       994,713  
Office buildings and other structures
    92,840       84,051  
                 
Total
  $ 1,464,904     $ 1,370,409  
                 
 
Depreciation of utility plant for financial statement purposes is computed on a straight-line basis over the assets’ estimated useful lives including cost of removal of certain assets as follows:
 
     
    Useful Lives
 
Equipment
  5 to 50 years
Transmission and distribution plant
  40 to 65 years
Office Buildings and other structures
  50 years
 
The provision for depreciation expressed as a percentage of the aggregate depreciable asset balances was 2.8% in 2008, 2.7% in 2007, and 2.6% in 2006. For income tax purposes, as applicable, the Company computes depreciation using the accelerated methods allowed by the respective taxing authorities. Plant additions since June 1996 are depreciated on a straight-line basis for tax purposes in accordance with tax regulations. The Company has a legal obligation to retire wells in accordance with Department of Public Health regulations. In addition, upon decommission of a wastewater plant or lift station certain wastewater infrastructure would need to be retired in accordance with Department of Public Health regulations. The Company has been generally allowed to collect retirement obligation costs from ratepayers through depreciation expense. As of December 31, 2008 and 2007 the retirement obligation is estimated to be $9,365 and $9,548, respectively.
 
Cash Equivalents
 
Cash equivalents include highly liquid investments with remaining maturities of three months or less at the time of acquisition. As of December 31, 2008 and 2007, cash equivalents included certificates of deposits and investments in money market funds in the amount of $25 and $1,775, respectively.
 
Restricted Cash
 
Restricted cash primarily represents proceeds collected through a surcharge on certain customers’ bills plus interest earned on the proceeds and is used to service California Safe Drinking Water Bond obligations. All restricted cash is classified in prepaid expenses. At December 31, 2008 and 2007, restricted cash was $1,248 and $1,197, respectively.


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Notes to Consolidated Financial Statements — (Continued)
 
Regulatory Assets and Liabilities
 
The Company operates extensively in a regulated business, and as such is subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, “Accounting for the Effects of Certain Types of Regulations” (SFAS No. 71). In accordance with SFAS No. 71, the Company defers costs and credits on the balance sheet as regulatory assets and liabilities when it is probable that those costs and credits will be recognized in the ratemaking process in a period different from the period in which they would have been reflected in income by an unregulated company. In determining the probability of costs being recognized in other periods, the Company considers regulatory rules and decisions, past practices, and other facts or circumstances that would indicate if recovery is probable. These deferred regulatory assets and liabilities are then reflected in the income statement in the period in which the same amounts are reflected in the rates charged for service. In the event that a portion of the Company’s operations were no longer subject to the provisions of SFAS No. 71, the Company would be required to write off related regulatory assets and liabilities that are not specifically recoverable and determine if other assets might be impaired. If a commission determined that a portion of the Company’s assets were not recoverable in customer rates, the Company would be required to determine if the Company had suffered an asset impairment that would require a write-down in the assets’ valuation. There was no such asset impairment in 2008, 2007 or 2006. The income tax temporary differences relate primarily to the difference between book and federal income tax depreciation on utility plant that was placed in service before the regulatory Commissions adopted normalization for rate making purposes. Previously, the tax benefit of tax depreciation was passed on to customers (flow-through). For state income tax purposes, the Commission continues to use the flow-through method. As such timing differences reverse, the Company will be able to include the impact of such differences in customer rates. These federal tax differences will continue to reverse over the remaining book lives of the related assets.
 
In addition, regulatory assets include expense items that are capitalized for financial statement purposes, because they will be recovered in future customer rates. The capitalized expenses relate to asset retirement obligations, pension benefits, postretirement benefits other than pensions (Retiree Group Health), and accrued benefits for vacation, self-insured workers’ compensation, and directors retirement benefits. Asset retirement obligations are recorded net of depreciation which has been recorded and recognized through the regulatory process.
 
Regulatory liabilities represent future benefits to ratepayers for tax deductions that will be allowed in the future. Regulatory liabilities also reflect timing differences provided at higher than the current tax rate, which will flow-through to future ratepayers.
 
Regulatory assets and liabilities are comprised of the following as of December 31:
 
                 
    2008     2007  
 
Regulatory Assets
               
Pension and Retiree Group Health
  $ 138,677     $ 34,809  
Income tax temporary differences
    35,590       35,604  
Asset retirement obligations, net
    6,100       6,391  
Other accrued benefits
    17,926       14,104  
                 
Total Regulatory Assets
  $ 198,293     $ 90,908  
                 
Regulatory Liabilities
               
Future tax benefits due ratepayers
  $ 20,728     $ 20,386  
                 
 
Long-Lived Assets
 
The Company regularly reviews its long-lived assets for impairment, annually or when events or changes in business circumstances have occurred that indicate the carrying amount of such assets may not be fully realizable. Potential impairment of assets held for use is determined by comparing the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If assets are considered to be impaired, the


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Notes to Consolidated Financial Statements — (Continued)
 
impairment to be recognized is measured as the amount by which the carrying value of the asset exceeds its fair value. There have been no asset impairments in 2008, 2007, or 2006.
 
Long-Term Debt Premium, Discount and Expense
 
The discount and issuance expense on long-term debt is amortized over the original lives of the related debt on a straight-line basis which approximates the effective interest method. Premiums paid on the early redemption of certain debt and the unamortized original issuance discount and expense are amortized over the life of new debt issued in conjunction with the early redemption. Amortization expense included in interest expense was $673, $673, and $665 for 2008, 2007, and 2006, respectively.
 
Accumulated Other Comprehensive Loss
 
The Company has an unfunded Supplemental Executive Retirement Plan. In 2005, the unfunded accumulated benefit obligation of the plan, less the accrued benefit, exceeded the unrecognized prior service cost which was recorded in accumulated other comprehensive loss, net of tax, as a separate component of Common Stockholders’ Equity. In 2006, with the adoption of Statement of Financial Accounting Standard No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” the Company determined that the amount should be reflected as a regulatory asset, as it will be recovered in future customer rates. As a result, during 2006, the Company recognized $1,202 of previously recorded net accumulated other comprehensive loss as a regulatory asset.
 
Advances for Construction
 
Advances for Construction consist of payments received from developers for installation of water production and distribution facilities to serve new developments. Advances are excluded from rate base for rate setting purposes. Annual refunds are made to developers without interest. Advances of $174,626, and $166,450 at December 31, 2008, and 2007, respectively, will be refunded primarily over a 40-year period in equal annual amounts. In addition, other Advances for Construction totaling $1,537 and $1,574 at December 31, 2008, and 2007, respectively, are refundable based upon customer connections. Estimated refunds of advances for each succeeding year (2009 through 2013) are approximately $6,123, $6,032, $5,995, $5,986, $5,980 and $146,047 thereafter.
 
Contributions in Aid of Construction
 
Contributions in Aid of Construction represent payments received from developers, primarily for fire protection purposes, which are not subject to refunds. Facilities funded by contributions are included in utility plant, but excluded from rate base. Depreciation related to assets acquired from contributions is charged to the Contributions in Aid of Construction account.
 
Income Taxes
 
The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Measurement of the deferred tax assets and liabilities is at enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.
 
It is anticipated that future rate action by the Commissions will reflect revenue requirements for the tax effects of temporary differences recognized, which have previously been flowed through to customers. The Commissions have granted the Company rate increases to reflect the normalization of the tax benefits of the federal accelerated methods and available Investment Tax Credits (ITC) for all assets placed in service after 1980. ITCs are deferred and amortized over the lives of the related properties for book purposes.


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Notes to Consolidated Financial Statements — (Continued)
 
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 contributions of fire services from taxable income.
 
Workers’ Compensation, General Liability and Other Claims
 
For workers’ compensation, the Company estimates the discounted liability associated with claims submitted and claims not yet submitted based on historical data. For general liability claims and other claims, the Company estimates the cost incurred but not yet paid using historical information.
 
Collective Bargaining Agreements
 
As of December 31, 2008, the Company had 929 employees, including 595 non-supervisory employees who are represented by the Utility Workers Union of America, AFL-CIO, except certain engineering and laboratory employees who are represented by the International Federation of Professional and Technical Engineers, AFL-CIO. The union agreements expire at the end of 2009.
 
Earnings Per Share
 
The computations of basic and diluted earnings per share are noted below. Basic earnings per share are computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Restricted Stock Awards are included in the weighted stock outstanding as the shares have all voting and dividend rights as issued and unrestricted common stock.
 
Common stock options outstanding to purchase common shares were 84,000, 90,500, and 90,500 at December 31, 2008, 2007, and 2006, respectively. Stock Appreciation Rights (SAR) covering 108,710, 61,640 and 37,969 shares of common stock were outstanding as of December 31, 2008, 2007, and 2006, respectively.
 
All options are dilutive and the SARs are antidilutive. The dilutive effect is shown in the table below.
 
                         
    2008     2007     2006  
    (In thousands, except per share data)  
 
Net income, as reported
  $ 39,805     $ 31,159     $ 25,580  
Less preferred dividends and premium paid upon retirement of preferred stock
    368       153       153  
                         
Net income available to common stockholders
  $ 39,437     $ 31,006     $ 25,427  
                         
Weighted average common shares, basic
    20,710       20,665       18,905  
Dilutive common stock equivalents (treasury method)
    24       24       20  
                         
Shares used for dilutive calculation
    20,734       20,689       18,925  
                         
Earnings per share — basic
  $ 1.90     $ 1.50     $ 1.34  
Earnings per share — diluted
  $ 1.90     $ 1.50     $ 1.34  
 
Stock-based Compensation
 
In 2006, the Company adopted the provisions of the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards No. 123 — revised 2004 (SFAS 123(R)), “Share-Based Payment” which replaced Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees.”


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Notes to Consolidated Financial Statements — (Continued)
 
Under the fair value recognition provisions of SFAS 123(R), stock-based compensation cost is measured at the grant date based on the fair value of the award. The Company recognizes compensation as expense on a straight-line basis over the requisite service period, which is the vesting period. The Company elected the modified-prospective method of adoption of SFAS No. 123(R), under which prior periods were not revised for comparative purposes. Using this method, the valuation provisions of SFAS 123(R) apply to new grants and the unvested portion of prior grants on a prospective basis. All options that were granted prior to the adoption date were vested as of the adoption date such that no compensation expense is required.
 
Prior to the adoption of SFAS 123(R), the Company presented all tax benefits for deductions resulting from the exercise of stock options and disqualifying dispositions as operating cash flows on its consolidated statement of cash flows. SFAS 123(R) requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow. This requirement reduced net operating cash flows and increase net financing cash flows in periods after adoption. Total cash flow will remain unchanged from what would have been reported under prior accounting rules.
 
The adoption of SFAS 123(R) did not have a material impact on the Company’s consolidated financial position, results of operations and cash flows. See Note 13 for further information regarding the Company’s stock-based compensation assumptions and expenses.
 
Long-Term Incentive Plan
 
The Company had a stockholder-approved Long-Term Incentive Plan (which was replaced on April 27, 2005, by a stockholder-approved Equity Incentive Plan) that allowed granting of non-qualified stock options. The Company accounted for options issued under the Long-Term Incentive Plan using the intrinsic value method of accounting as prescribed by APB 25. All outstanding options issued under the Long-Term Incentive Plan have an exercise price equal to the market price on the date they were granted. All options granted under the Long-Term Incentive Plan are fully vested. No compensation expense was recorded in 2008, 2007 or 2006, related to stock options issued under the Long-Term Incentive Plan.
 
Recent Accounting Pronouncements Adopted
 
In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157 “Fair Value Measurements.” The statement defines fair value, establishes a framework for measuring fair values in generally accepted accounting principles, and expands disclosures about fair value measurements. The statement is effective for years beginning after November 15, 2007. The Company adopted SFAS No. 157 on January 1, 2008 and it did not have a material impact on the Company’s financial position, results of operations, or cash flows.
 
In February 2007, the FASB issued SFAS No. 159, “the Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115.” The statement permits entities to choose to measure many financial instruments and certain other items at fair value. The statement is effective for years beginning after November 15, 2007. The Company adopted SFAS No. 159 on January 1, 2008, but did not elect to report any financial assets or liabilities at fair value. The adoption of this statement did not have a material impact to the Company’s financial position, results of operations or cash flows.
 
Accounting Pronouncements Issued But Not Yet Adopted
 
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.” The statement applies prospectively to business combinations for which the acquisition date is on or after years beginning after December 15, 2008. SFAS 141(R) significantly changes current practices regarding business combinations. Among the more significant changes, SFAS 141(R) expands the definition of a business and a business combination; requires the acquirer to recognize the assets acquired, liabilities assumed and noncontrolling interests (including goodwill), measured at fair value at the acquisition date; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination and requires assets acquired and liabilities assumed from contractual and non-contractual contingencies to be recognized at their acquisition date fair


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Notes to Consolidated Financial Statements — (Continued)
 
values with subsequent changes recognized in earnings. The adoption of this statement is not expected to have a material impact on the Company’s financial position, results of operations, or cash flows.
 
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” — an amendment of ARB No. 51. the statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. The statement is effective for years beginning after December 15, 2008. The adoption of this standard is not expected to have a material impact on the Company’s financial position, results of operation, or cash flows.
 
In May 2008, the FASB staff revisited Emerging Issues Task Force (“EITF”) issue No. 03-6 and issued FASB Staff Position (“FSP”) No. EITF 03-6-1, “Determining Whether Instruments Granted in Shared-Based Payment Transactions are Participating Securities.” FSP EITF 03-6-1 requires unvested share-based payments that entitle employees to receive nonrefundable dividends to also be considered participating securities, as defined in EITF 03-6. The FSP is effective for fiscal years beginning after December 15, 2008 and interim periods within those years with early adoption prohibited. The Company currently grants certain unvested share-based payment awards that include rights to dividends similar to common shareholders. The Company is currently analyzing the impact that FSP EITF 03-6-1 will have on its computation on earnings per share and financial statements and related footnotes, if any.
 
In December 2008, the FASB issued FSP FAS 132(R)-1,“Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP 132(R)-1”). FSP 132(R)-1 amends and expands the disclosure requirements of SFAS No. 132. An entity is required to provide qualitative disclosures about how investment allocation decisions are made, the inputs and valuation techniques used to measure the fair value of plan assets, and the concentration of risk within plan assets. Additionally, quantitative disclosures are required showing the fair value of each major category of plan assets, the levels in which each asset is classified within the fair value hierarchy, and a reconciliation for the period of plan assets which are measured using significant unobservable inputs. FSP 132(R)-1 is effective prospectively for fiscal years ending after December 15, 2009. The Company is currently evaluating the impact of FSP 132(R)-1.
 
3  OTHER INCOME AND EXPENSES
 
The Company conducts various non-regulated activities as reflected in the table below.
 
                                                 
    2008     2007     2006  
    Revenue     Expense     Revenue     Expense     Revenue     Expense  
 
Operating and maintenance
  $ 7,180     $ 7,327     $ 5,705     $ 5,247     $ 5,141     $ 4,476  
Meter reading and billing
    1,150       898       1,187       902       1,159       865  
Leases
    2,048       690       1,958       613       1,714       571  
Design and construction
    1,292       887       1,142       847       1,151       744  
Interest income
    423             1,435             758        
Change in value of life insurance contracts
          3,763       539             615        
Non-regulated expenses and other
    2,137       1,532       1,591       1,505       107       552  
                                                 
Total
  $ 14,230     $ 15,097     $ 13,557     $ 9,114     $ 10,645     $ 7,208  
                                                 
 
Operating and maintenance services and meter reading and billing services are provided for water and wastewater systems owned by private companies and municipalities. The agreements call for a fee-per-service or a flat-rate amount per month. Leases have been entered into with telecommunications companies for cellular phone antennas placed on the Company’s property. Design and construction services are for the design and installation of water mains and other water infrastructure for others outside the Company’s regulated service areas.


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Notes to Consolidated Financial Statements — (Continued)
 
4  ACQUISITIONS
 
In 2008, the Company’s wholly-owned subsidiary HWS Utility Services, LLC, acquired contracts to operate and maintain water and wastewater systems in Hawaii. The purchase price of $1.3 million was paid with the issuance of the Company’s common stock. The purchase price is being amortized over the remaining life of the contracts.
 
In 2008, after receiving regulatory approval, the Company’s wholly-owned subsidiary, Hawaii Water Service Company, Inc. acquired in two separate transactions, business on the Island of Hawaii which are accounted for under SFAS No. 141. The first acquisition was for all the outstanding stock of three related privately held companies (Waikoloa Resort Utilities, Inc.; Waikoloa Water Company, Inc.; Waikoloa Sewer Company, Inc.) with water and wastewater operations. The combined purchase price was $20,581. Assets acquired were $26,885, including cash of $6,268. Liabilities assumed were $10,209 (net of $12,608 which was paid at close of escrow). Goodwill of $3,906 was recorded. The Company is in the process of finalizing the valuation of certain intangible assets as well as acquired tax operating loss carryforwards; therefore the purchase price is subject to further refinement upon completion. The second acquisition was for the water and wastewater assets of two other companies, (Kukio Utility Company and WB Maninowali) was for a cash price of $10,610 for assets acquired. No liabilities were assumed.
 
In 2007, after receiving regulatory approval, the Company’s wholly owned subsidiary, Cal Water, acquired a water system with allowed rate base of approximately $425 for $388 in cash. In addition, the Company’s wholly-owned subsidiary, Washington Water, acquired five water systems for $1,091 in cash, which was the approximate value of rate base of the systems.
 
In 2006, after receiving regulatory approval, the Company’s wholly owned subsidiary, New Mexico Water, acquired a water system by purchasing the assets of the system for a purchase price of approximately $500 which was allowed as the rate base of the system
 
Condensed balance sheets and pro forma results of operations for these acquisitions have not been presented since the impact of the purchases was not material.
 
5  INTANGIBLE ASSETS
 
As of December 31, 2008 and 2007, intangible assets that will continue to be amortized and those not amortized were:
 
                                                         
    Weighted
    2008     2007  
    Average
    Gross
          Net
    Gross
          Net
 
    Amortization
    Carrying
    Accumulated
    Carrying
    Carrying
    Accumulated
    Carrying
 
    Period     Value     Amortization     Value     Value     Amortization     Value  
 
Amortized intangible assets:
                                                       
Hawthorne lease
    15     $ 6,515     $ 5,589     $ 926     $ 6,515     $ 5,140     $ 1,375  
Water pumping rights
    usage       1,084       23       1,061       1,084       14       1,070  
Water planning studies
    9       5,454       1,403       4,051       3,901       1,175       2,726  
Leasehold improvements and other
    20       2,484       1,391       1,093       1,390       693       697  
                                                         
Total
    13     $ 15,537     $ 8,406     $ 7,131     $ 12,890     $ 7,022     $ 5,868  
                                                         
Unamortized intangible assets:
                                                       
Perpetual water rights and other
          $ 2,931           $ 2,931     $ 2,911           $ 2,911  
 
For the years ended December 31, 2008, 2007, and 2006, amortization of intangible assets was $1,838, $866, and $853, respectively. Estimated future amortization expense related to intangible assets for the succeeding five years is approximately $1,260, $1,276, $628, $529, $483, and $2,955 thereafter.


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Notes to Consolidated Financial Statements — (Continued)
 
6  PREFERRED STOCK
 
In 2008, the Company redeemed all 139,000 outstanding shares of its 4.4% Series C Preferred Stock, with a par value of $25 per share, at the pre-determined redemption price of $26.75 per share and all shares of the Series C Preferred Stock were cancelled. The resulting premium of $253 was charged to retained earnings and subtracted from net earnings available to common stockholders in the Company’s 2008 earnings per common share.
 
See Note 7 for a description of the Series D preferred Stock.
 
7  COMMON STOCKHOLDERS’ EQUITY
 
The Company is authorized to issue 25 million shares of $0.01 par value common stock. As of December 31, 2008 and 2007, 20,723,202 shares and 20,666,204 shares, respectively, of common stock were issued and outstanding.
 
Dividend Reinvestment and Stock Repurchase Plan
 
The Company has a Dividend Reinvestment and Stock Purchase Plan (DRIP Plan). Under the DRIP Plan, stockholders may reinvest dividends to purchase additional Company common stock without commission fees. The Plan also allows existing stockholders and other interested investors to purchase Company common stock through the transfer agent up to certain limits. The Company’s transfer agent operates the DRIP Plan and purchases shares on the open market to provide shares for the Plan.
 
Stockholder Rights Plan
 
The Company’s Stockholder Rights Plan (Plan) expired in February 2008. The Company’s Board elected not to renew the Plan, and the Plan expired by its own terms. 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 were for a ten-year period that expired in February 2008 and no Series D Preferred Stock were issued under the Plan.
 
8  SHORT-TERM BORROWINGS
 
At December 31, 2008, the Company maintained a bank revolving line of credit with Bank of America providing unsecured borrowings of up to $20 million at the prime lending rate less 1.5 percentage points. Cal Water maintained a separate bank revolving line of credit also with Bank of America for an additional $95 million with the same interest rate provision as the Company.
 
On September 24, 2008, the Cal Water line of credit was amended to allow borrowings up to $95 million (from the original line of $55 million) for the period between September 30, 2008 and March 31, 2009. The amendment also provided that at any time the borrowings under the revolving credit facility exceed $55 million the entire principal amount outstanding of the revolving facility will bear interest annually at the lender’s prime rate less 1.0 percentage points or alternatively at LIBOR plus 0.75 percentage points. If the borrowings do not exceed $55 million the original interest provisions will apply. The line of credit agreement expires on April 30, 2012.
 
As of December 31, 2008, the outstanding borrowings on the Cal Water and Company lines of credit were $28,000 and $12,000, respectively.
 
The following table represents borrowings under the bank lines of credit:
 
                         
    2008     2007     2006  
 
Maximum short-term borrowings
  $ 44,000     $     $ 30,250  
Average amount outstanding
  $ 25,748     $     $ 7,237  
Weighted average interest rate
    3.24 %     n/a       6.76 %
Interest rate at December 31
    1.75 %     n/a       n/a  


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Notes to Consolidated Financial Statements — (Continued)
 
9  LONG-TERM DEBT
 
As of December 31, 2008 and 2007, long-term debt outstanding was:
 
                                         
          Interest
    Maturity
             
    Series     Rate     Date     2008     2007  
 
First Mortgage Bonds:
    J       8.86 %     2023     $ 3,000     $ 3,200  
      K       6.94 %     2012       2,900       3,600  
      CC       9.86 %     2020       17,800       17,900  
                                         
Total First Mortgage Bonds
                            23,700       24,700  
                                         
Unsecured Senior Notes:
    A       7.28 %     2025       20,000       20,000  
      B       6.77 %     2028       20,000       20,000  
      C       8.15 %     2030       20,000       20,000  
      D       7.13 %     2031       20,000       20,000  
      E       7.11 %     2032       20,000       20,000  
      F       5.90 %     2017       20,000       20,000  
      G       5.29 %     2022       20,000       20,000  
      H       5.29 %     2022       20,000       20,000  
      I       5.54 %     2023       10,000       10,000  
      J       5.44 %     2018       9,091       10,000  
      K       4.58 %     2010       10,000       10,000  
      L       5.48 %     2018       10,000       10,000  
      M       5.52 %     2013       20,000       20,000  
      N       5.55 %     2013       20,000       20,000  
      O       6.02 %     2031       20,000       20,000  
                                         
Total Unsecured Senior Notes
                            259,091       260,000  
                                         
California Department of Water Resources loans
            2.6 % to
8.0%
    2009-32       2,595       2,229  
Other long-term debt
                            4,930       4,992  
                                         
Total long-term debt
                            290,316       291,921  
Less current maturities
                            2,818       2,701  
                                         
Long-term debt excluding current maturities
                          $ 287,498     $ 289,220  
                                         
 
The first mortgage bonds and unsecured senior notes are obligations of Cal Water and contain certain restrictive covenants. The Company believes that it is in material compliance with such covenants as of December 31, 2008. All bonds are held by institutional investors and secured by substantially all of Cal Water’s utility plant. The unsecured senior notes are held by institutional investors and require interest-only payments until maturity, except series J which has an annual sinking fund payment amount of $909 annually, and series G and H which have an annual sinking fund requirement of $1,818 starting in 2012, and Series I which has an annual sinking fund requirement of $909 starting in 2013. The terms of the unsecured notes require Cal Water to grant a first mortgage security interest upon the issuance of additional first mortgage debt. The California Department of Water Resources (DWR) loans were financed under the California Safe Drinking Water Bond Act. Repayment of principal and interest on the DWR loans is through a surcharge on customer bills. Other long-term debt includes other equipment and system acquisition financing arrangements with financial institutions. Aggregate maturities and sinking fund requirements for each of the succeeding five years (2009 through 2013) are $2,818, $12,763, $2,645, $6,298, and $46,359, and $219,433, thereafter.


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Notes to Consolidated Financial Statements — (Continued)
 
10  OTHER ACCRUED LIABILITIES
 
As of December 31, 2008 and 2007, other accrued liabilities were:
 
                 
    2008     2007  
 
Accrued and deferred compensation
  $ 11,429     $ 10,844  
Accrued benefit and workers’ compensation claims
    8,118       5,774  
Other
    12,988       8,351  
                 
    $ 32,535     $ 24,969  
                 
 
11  INCOME TAXES
 
Income tax expense consists of the following:
 
                         
    Federal     State     Total  
 
2008
                       
Current
  $ 15,233     $ 4,679     $ 19,912  
Deferred
    4,486       (267 )     4,219  
                         
Total
  $ 19,719     $ 4,412     $ 24,131  
                         
2007
                       
Current
  $ 16,028     $ 4,662     $ 20,690  
Deferred
    522       (489 )     33  
                         
Total
  $ 16,550     $ 4,173     $ 20,723  
                         
2006
                       
Current
  $ 10,523     $ 3,107     $ 13,630  
Deferred
    3,489       (280 )     3,209  
                         
Total
  $ 14,012     $ 2,827     $ 16,839  
                         
 
Income tax expense computed by applying the current federal 35% tax rate to pretax book income differs from the amount shown in the Consolidated Statements of Income. The difference is reconciled in the table below:
 
                         
    2008     2007     2006  
 
Computed “expected” tax expense
  $ 22,378     $ 18,159     $ 14,847  
Increase (reduction) in taxes due to:
                       
State income taxes net of federal tax benefit
    3,674       2,981       2,437  
Investment tax credits
    (32 )     (32 )     (32 )
Other
    (1,889 )     (385 )     (413 )
                         
Total income tax
  $ 24,131     $ 20,723     $ 16,839  
                         
 
Included in Other in the above table is the recognition of the flow-through accounting for Federal depreciation expense on assets acquired prior to 1982 and retirement costs of such assets. For assets acquired prior to 1982, the benefit of excess tax depreciation was previously passed through to the ratepayers. The tax benefit is now reversing and a higher tax expense is being recognized and is included in customer rates. Offsetting the flow-through depreciation in 2008 and 2007 was the impact of cost to remove pre-1982 assets. Also included is the federal income tax deduction from qualified U.S. production activities, which is being phased in from 2006 through 2011. Qualified production activities include production of potable water, but exclude the transmission and distribution of the potable water. The impact of the deduction is being reported in the year in which the deduction is claimed on the


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Notes to Consolidated Financial Statements — (Continued)
 
Company’s tax return. The impact was to lower the income tax provision by $1,276, $490, and $260 in 2008, 2007, and 2006, respectively.
 
The components of deferred income tax expense were:
 
                         
    2008     2007     2006  
 
Depreciation
  $ 4,726     $ 2,121     $ 3,386  
Developer advances and contributions
    (521 )     (504 )     (875 )
Prepaid expenses
    1,361       378       434  
Accrued expenses
    (800 )     (1,362 )     (716 )
Investment tax credits
    (106 )     (106 )     (106 )
Other
    (441 )     (494 )     1,086  
                         
Total deferred income tax expense
  $ 4,219     $ 33     $ 3,209  
                         
 
We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN 48) on January 1, 2007. As of December 31, 2008 and 2007, we had no material unrecognized tax benefits and no adjustments to liabilities or operations were required.
 
In connection with the adoption of FIN 48, the Company will include interest and penalties related to uncertain tax positions as a component of income taxes.
 
During 2007, there was a federal tax examination covering 2005 which resulted in a tax liability of $87. Tax years of 2006 and 2007, and 2002 through 2007 are subject to examination by the federal and state taxing authorities, respectively. There are no income tax examinations currently in progress.
 
The tax effects of differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007 are presented in the following table:
 
                 
    2008     2007  
 
Deferred tax assets:
               
Developer deposits for extension agreements and contributions in aid of construction
  $ 47,055     $ 47,588  
Federal benefit of state tax deductions
    8,925       8,367  
Book plant cost reduction for future deferred ITC amortization
    1,413       1,457  
Insurance loss provisions
    2,431       2,434  
Pension plan, net
    2,043       2,367  
                 
Total deferred tax assets
    61,867       62,213  
                 
Deferred tax liabilities:
               
Utility plant, principally due to depreciation differences
    131,652       127,187  
Prepaid expense
    4,123       2,762  
Premium on early retirement of bonds
    1,745       1,961  
Other
    814       15  
                 
Total deferred tax liabilities
    138,334       131,925  
                 
Net deferred tax liabilities
  $ 76,467     $ 69,712  
                 
 
A valuation allowance was not required at December 31, 2008 and 2007. Based on historical taxable income and future taxable income projections over the period in which the deferred assets are deductible, management believes it is more likely than not that the Company will realize the benefits of the deductible differences.


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Notes to Consolidated Financial Statements — (Continued)
 
12  EMPLOYEE BENEFIT PLANS
 
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an Amendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS No. 158). The statement requires an employer to recognize in its statement of financial position an asset for a plan’s over-funded status or a liability for a plan’s under-funded status. The measurement date of the plans’ assets and obligations that determine the funded status is as of the end of the employer’s fiscal year effective in 2006.
 
Savings Plan
 
The Company sponsors a 401(k) qualified, defined contribution savings plan that allows participants to contribute up to 20% of pre-tax compensation. The Company matches fifty cents for each dollar contributed by the employee up to a maximum Company match of 4.0%. Company contributions were $1,786, $1,733, and $1,628, for the years 2008, 2007, and 2006, respectively.
 
Pension Plans
 
The Company provides a qualified, defined-benefit, non-contributory pension plan for substantially all employees. The accumulated benefit obligations of the pension plan are $130,206 and $73,845 as of December 31, 2008 and 2007, respectively. The fair value of pension plan assets was $66,941 and $85,303 as of December 31, 2008 and 2007, respectively.
 
Plan assets in the defined-benefit pension plan as of December 31, 2008 and 2007 were as follows:
 
                 
Asset Category
  2008     2007  
 
Cash equivalents
    19.0 %     10.9 %
Bond Funds
    36.8 %     28.9 %
Domestic Equity Funds
    37.2 %     49.5 %
Foreign Equity Funds
    7.0 %     10.7 %
 
The investment objective of the fund is to maximize the return on assets, commensurate with the risk the Company Trustees deem appropriate to meet the obligations of the Plan, and minimize the volatility of the pension expense. The target allocation of plan assets is to have 55% to 65% invested in equity funds and the balance to be invested in bond funds or cash equivalents. The Trustees periodically measure fund performance against specific indexes in an effort to generate a rate of return for the total portfolio that equals or exceeds the actuarial investment rate assumptions.
 
Pension payment obligations are generally funded by the purchase of an annuity from a life insurance company. If monthly benefits are paid to future retirees, rather than with a purchase of an annuity, payments are expected to be made in each year from 2009 to 2013 are $1,822, $2,535, $3,397, $4,431, and $5,914, respectively. The aggregate benefits expected to be paid in the five years 2014 through 2018 would be $50,321. If annuities are purchased for the retirees rather than making monthly payments, the payments for the same period would be approximately, $8,559, $8,994, $12,586, $14,633, and $16,082. The aggregate payments to be paid for annuities in the five years 2014 through 2018 would be approximately $111,014. The expected benefit payments are based upon the same assumptions used to measure the Company’s benefit obligation at December 31, 2008, and include estimated future employee service.
 
The Company also maintains an unfunded, non-qualified, supplemental executive retirement plan. The unfunded supplemental executive retirement plan accumulated benefit obligations were $15,043 and $10,340 as of December 31, 2008 and 2007, respectively. Benefit payments under the supplemental executive retirement plan are paid currently and are included in the preceding paragraph.
 
The costs of the pension and retirement plans are charged to expense and utility plant. The Company makes annual contributions to fund the amounts accrued for pension cost.


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Notes to Consolidated Financial Statements — (Continued)
 
Other Postretirement Plan
 
The Company provides substantially all active, permanent employees with medical, dental, and vision benefits through a self-insured plan. Employees retiring at or after age 58, along with their spouses and dependents, continue participation in the plan by payment of a premium. Plan assets are invested in mutual funds, short-term money market instruments and commercial paper based upon the same asset mix as the pension plan. Retired employees are also provided with a $5,000 life insurance benefit.
 
The Company records the costs of postretirement benefits other than pension during the employees’ years of active service. Postretirement benefit expense recorded in 2008, 2007, and 2006, was $3,246, $2,521, and $2,369, respectively. The Company has recorded a regulatory asset in prior years for the difference between the Company-funded amount and the net periodic benefit cost. Prior to the adoption of SFAS No. 158, the remaining net periodic benefit cost was $9,790 and is being recovered through future customer rates and is recorded as a regulatory asset. The expected benefit payments, net of retiree premiums and Medicare part D subsidies, for the next five years are $929, $1,068, $1,196, $1,311, and $1,467, respectively.
 
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, 2008 and 2007:
 
                                 
    Pension Benefits     Other Benefits  
    2008     2007     2008     2007  
 
Change in projected benefit obligation:
                               
Beginning of year
  $ 105,884     $ 109,077     $ 27,492     $ 21,659  
Service cost
    6,423       5,291       1,430       1,154  
Interest cost
    8,991       6,522       1,716       1,317  
Assumption change
    20,239       (7,415 )     6,651       2,997  
Amendment
    51,173                   627  
Experience (gain) loss
    6,135       (1,538 )     (300 )     443  
Benefits paid, net of retiree premiums
    (5,967 )     (6,053 )     (781 )     (705 )
                                 
End of year
  $ 192,878     $ 105,884     $ 36,208     $ 27,492  
                                 
Change in plan assets:
                               
Fair value of plan assets at beginning of year
  $ 85,303     $ 78,393     $ 8,287     $ 5,547  
Actual return on plan assets
    (17,856 )     6,021       (1,206 )     403  
Employer contributions
    5,461       6,942             3,042  
Retiree contributions
                924       863  
Benefits paid
    (5,967 )     (6,053 )     (1,705 )     (1,568 )
                                 
Fair value of plan assets at end of year
  $ 66,941     $ 85,303     $ 6,300     $ 8,287  
                                 
Funded status
  $ (125,937 )   $ (20,581 )   $ (29,908 )   $ (19,205 )
Unrecognized actuarial (gain) or loss
    51,771       2,042       14,798       6,949  
Unrecognized prior service cost
    60,807       13,637       885       1,001  
Unrecognized transition obligation
                1,113       1,389  
                                 
Net amount recognized
  $ (13,359 )   $ (4,902 )   $ (13,112 )   $ (9,866 )
                                 
 
Prior to 2006, the unfunded status for the pension plans and other postretirement plans was disclosed primarily in the footnotes to the financial statements. As of December 31, 2006, SFAS No. 158 requires the full recognition of the projected benefit obligation over the fair value of plan assets, reflecting the difference on the balance sheet. Therefore, previously disclosed but unrecognized amounts of gains and losses, unrecognized prior service costs and


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Notes to Consolidated Financial Statements — (Continued)
 
credits, net transition assets or obligations and related taxes have been charged to regulatory assets as a cumulative adjustment upon adoption of SFAS No. 158.
 
Amounts recognized on the balance sheet, after consideration of the impact of SFAS 158, consist of:
 
                                 
    Pension Benefits     Other Benefits  
    2008     2007     2008     2007  
 
Prepaid (Accrued) benefit costs
  $     $     $ (13,112 )   $ (9,866 )
Accrued benefit liability
    (125,937 )     (20,581 )     (16,796 )     (9,339 )
Regulatory asset
    112,578       15,679       16,796       9,339  
                                 
Net amount recognized
  $ (13,359 )   $ (4,902 )   $ (13,112 )   $ (9,866 )
                                 
 
Below are the actuarial assumptions used in determining the benefit obligation for the benefit plans:
 
                                 
    Pension Benefits     Other Benefits  
    2008     2007     2008     2007  
 
Weighted average assumptions as of December 31:
                               
Discount rate
    6.40 %     6.30 %     5.80 %     6.40 %
Long-term rate of return on plan assets
    8.00 %     8.00 %     7.00 %     7.00 %
Rate of compensation increases
    5.00 %     3.75 %            
 
The long-term rate of return assumption is the expected rate of return on a balanced portfolio invested roughly 60% in equities and 40% in fixed income securities. The average return for the pension plan for the last five and ten years was 2.5% and 4.4%, respectively. The expected average return over the next 30 years is expected to be 8.0%. The discount rate was derived from the Citigroup Pension Discount Curve using the expected payouts for the plan.
 
Net periodic benefit costs for the pension and other postretirement plans for the years ended December 31, 2008, 2007, and 2006 included the following components:
 
                                                 
    Pension Plan     Other Benefits  
    2008     2007     2006     2008     2007     2006  
 
Service cost
  $ 6,423     $ 5,291     $ 5,347     $ 1,430     $ 1,154     $ 1,153  
Interest cost
    8,991       6,522       6,055       1,716       1,317       1,144  
Expected return on plan assets
    (6,012 )     (5,704 )     (5,797 )     (574 )     (469 )     (408 )
Net amortization and deferral
    4,516       2,883       2,674       674       519       480  
                                                 
Net periodic benefit cost
  $ 13,918     $ 8,992     $ 8,279     $ 3,246     $ 2,521     $ 2,369  
                                                 
 
Below are the actuarial assumptions used in determining the net periodic benefit costs for the benefit plans, which uses the end of the prior year as the measurement date:
 
                                 
    Pension Benefits     Other Benefits  
    2008     2007     2008     2007  
 
Weighted average assumptions as of December 31:
                               
Discount rate
    6.30 %     5.90 %     6.40 %     5.90 %
Long-term rate of return on plan assets
    8.00 %     8.00 %     7.00 %     8.00 %
Rate of compensation increases
    3.75 %     3.75 %            


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Notes to Consolidated Financial Statements — (Continued)
 
For 2008 measurement purposes, the Company assumed a 9.5% annual rate of increase in the per capita cost of covered benefits with the rate decreasing 1.0% per year for the next three years, then gradually grading down to 5.1% over the next 48 years. The health care cost trend rate assumption has a significant effect on the amounts reported. A one-percentage point change in assumed health care cost trends is estimated to have the following effect:
 
                 
    1-Percentage
    1-Percentage Point
 
    Point Increase     Decrease  
 
Effect on total service and interest costs
  $ 631     $ (491 )
Effect on accumulated postretirement benefit obligation
  $ 6,919     $ (5,446 )
 
The Company intends to make annual contributions to the plans up to the amount deductible for tax purposes. The Company estimates in 2009 that the annual contribution to the pension plans will be $26.9 million and the annual contribution to the other postretirement plan will be $9.5 million.
 
13  STOCK-BASED COMPENSATION PLANS
 
The Company has two stockholder-approved stock-based compensation plans.
 
Long-term Incentive Plan
 
Under the Long-Term Incentive Plan that allowed granting of nonqualified stock options, some of which are currently outstanding, there will be no future grants made. Options were granted at an exercise price that was not less than the per share common stock market price on the date of grant. The options vest at a 25% rate on their anniversary date over their first four years and are exercisable over a ten-year period. At December 31, 2008, 84,000 options are fully vested and exercisable at a weighted average price of $24.90. The intrinsic value of the vested shares at December 31, 2008 was $1,763 and the weighted average fair value at date of grant was $4.67 per share. No options were granted in 2008, 2007, or 2006.
 
The following table summarizes the activity of the Long-Term Incentive Plan:
 
                                 
          Weighted
    Weighted
       
          Average
    Average
       
          Exercise
    Remaining
    Options
 
    Shares     Price     Contractual Life     Exercisable  
 
Outstanding at December 31, 2005
    98,000     $ 24.95       5.4       86,500  
Exercised
    (7,500 )     25.15              
                                 
Outstanding at December 31, 2006
    90,500       24.94       4.3       90,500  
Exercised
                       
                                 
Outstanding at December 31, 2007
    90,500       24.94       3.3       90,500  
Exercised
    (6,500 )     25.39              
                                 
Outstanding at December 31, 2008
    84,000       24.90       2.1       84,000  
                                 
 
Equity Incentive Plan
 
The Equity Incentive Plan, which was approved by shareholders in April 2005, is authorized to issue up to 1,000,000 shares of common stock. In 2008 and 2007, the Company granted Restricted Stock Awards (RSAs) of 16,630 and 10,170 shares, respectively, of common stock both to employees and to directors of the Company. Employee awards vest ratably over 48 months, while independent director awards vest at the end of 12 months. The shares were valued at the weighted average price of $37.60 and $38.30 per share, respectively based upon the fair market value of the Company’s common stock on the date of grant. In 2008, Stock Appreciation Rights (SARs) equivalent to 47,070 shares were granted to employees, which vest ratably over 48 months and expire at the end of 10 years. The grant-date fair value for SARs was determined by using the Black Scholes model, which arrived at a


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Notes to Consolidated Financial Statements — (Continued)
 
fair value of $6.03 per share. Upon exercise of a SAR, the appreciation is payable in common shares of the Company.
 
The assumptions utilized to determine the grant date fair value of the SARs were:
 
                 
    2008     2007  
 
Expected dividend yield
    3.11 %     2.99 %
Expected volatility
    21.96 %     32.30 %
Risk-free interest rate
    2.63 %     4.48 %
Expected holding period in years
    6.0       5.2  
 
The Company did not apply a forfeiture rate in the expense computation relating to SARs and RSAs issued to employees as they vest monthly and, as a result, the expense is recorded for actual number vested during the period. For outside directors, the Company did not apply a forfeiture rate in the expense computation relating to RSAs, as the Company expects 100% to vest at the end of twelve months.
 
The table below reflects SARs granted under the Equity Incentive Plan.
 
                                         
          Weighted
    Weighted
          Weighted
 
          Average
    Average
          Average
 
          Exercise
    Remaining
    SAR
    Fair
 
    Shares     Price     Contractual Life     Exercisable     Value  
 
Stock Appreciation Rights
                                       
Outstanding at December 31, 2006
    37,969     $ 38.77       9.02       8,847     $ 7.73  
Granted
    24,140       38.30                   10.41  
Cancelled
    (469 )     38.51                   7.73  
                                         
Outstanding at December 31, 2007
    61,640     $ 38.59       8.49       22,070     $ 8.77  
Granted
    47,070       37.60                   6.03  
                                         
Outstanding at December 31, 2008
    108,710     $ 38.16       8.22       46,304     $ 7.58  
                                         
 
The Company has recorded compensation expense for the RSAs and SARs of $545 and $372 in 2008 and 2007, respectively. The unrecognized future compensation expense for the RSAs and SARs at December 31, 2008 is $1,001.
 
14  FAIR VALUE OF FINANCIAL INSTRUMENTS
 
For those financial instruments for which it is practicable to estimate a fair value, the following methods and assumptions were used. For cash equivalents, accounts receivable and accounts payable, the carrying amount approximates the fair value because of the short-term maturity of the instruments. The fair value of the Company’s long-term debt is estimated at $290 million and $358 million as of December 31, 2008 and 2007, respectively, using a discounted cash flow analysis, based on the current rates available to the Company for debt of similar maturities and credit risk. The book value of the long-term debt is $287 million and $289 million as of December 31, 2008 and 2007, respectively. The fair value of advances for construction contracts is estimated at $66 million as of December 31, 2008, and $64 million as of December 31, 2007, based on data of recent market transactions.


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Notes to Consolidated Financial Statements — (Continued)
 
15  COMMITMENTS AND CONTINGENCIES
 
Commitments
 
The Company leases office facilities and two water systems from cities, and has long-term commitments to purchase water from water wholesalers. The commitments are noted in the table below.
 
                         
    Office
    System
    Water
 
    Leases     Leases     Contracts  
 
2009
  $ 639     $ 961     $ 18,743  
2010
    443       961       18,775  
2011
    135       864       18,782  
2012
    120       845       18,778  
2013
    52       845       18,786  
Thereafter
    942       3,873       401,848  
 
The Company leases office facilities in many of its operating districts. The total paid and charged to operations for such leases was $808 in 2008, $677 in 2007, and $666 in 2006.
 
The Company leases the City of Hawthorne water system, which in addition to the upfront lease payment, includes an annual payment. The 15-year lease expires in 2011. There were annual payments of $116 in 2008, 2007, and 2006. In July 2003, the Company negotiated a 15-year lease of the City of Commerce water system. The lease includes an annual lease payment of $845 per year plus a cost savings sharing arrangement.
 
The Company has a long-term contract with the Santa Clara Water District that requires the Company to purchase minimum annual water quantities. Purchases are priced at the districts then-current wholesale water rate. The Company operates to purchase sufficient water to equal or exceed the minimum quantities under the contract. The total paid under the contract was $6,739 in 2008, $6,193 in 2007, and $5,361 in 2006.
 
The Company also has a water supply contract with Stockton East Water District (SEWD) that requires a fixed, annual payment and does not vary during the year with the quantity of water delivered by the district. Because of the fixed price arrangement, the Company operates to receive as much water as possible from SEWD in order to minimize the cost of operating Company-owned wells used to supplement SEWD deliveries. The total paid under the contract was $5,743 in 2008, $5,509 in 2007, and $4,420 in 2006. Pricing under the contract varies annually.
 
Estimated annual contractual obligations in the table above are based on the same payment levels as 2007, due to an expected decrease in the future payments from the 2008 level. Future increased costs by SEWD are expected to be offset by a decline in the allocation of costs to the Company, as other customers of SEWD are expected to receive a larger allocation based upon growth of their service areas.
 
On September 21, 2005, the Company entered into an agreement with Kern County Water Agency (Agency) to obtain treated water for the Company’s operations. The term of the agreement is to January 1, 2035, or until the repayment of the Agency’s bonds (described hereafter) occurs. Under the terms of the agreement, the Company is obligated to purchase approximately 11,500 acre feet of treated water in 2009 and an incrementally higher volume of water for each subsequent year until 2017, when the Company is obligated to purchase 20,500 acre feet of treated water per year. The Company is obligated to pay the Capital Facilities Charge and the Treated Water Charge regardless of whether it can use the water in its operation, and is obligated for these charges even if the Agency cannot produce an adequate amount to supply the 20,500 acre feet in the year. (This agreement supersedes a prior agreement with Kern County Water Agency for the supply of 11,500 acre feet of water per year). Total annual cost in 2008 was $4,369, $2,871 in 2007, and $3,301 in 2006.
 
Three other parties, including the City of Bakersfield, are also obligated to purchase a total of 32,500 acre feet per year under separate agreements with the Agency. Further, the Agency has the right to proportionally reduce the water supply provided to all of the participants if it cannot produce adequate supplies. The participation of all parties in the transaction for expansion of the Agency’s facilities, including the Water Purification Plant, purchase of the


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Notes to Consolidated Financial Statements — (Continued)
 
water, and payment of interest and principal on the bonds being issued by the Agency to finance the transaction is required as a condition to the obligation of the Agency to proceed with expansion of the Agency’s facilities. If any of the other parties does not use its allocation, that party is obligated to pay its contracted amount.
 
The Agency has issued bonds to fund the project and uses the payments of the Capital Facilities Charges by the Company and the other contracted parties to meet the Agency’s obligations to pay interest and repay principal on the bonds. If any of the parties were to default on making payments of the Capital Facilities Charge, then the other parties are obligated to pay for the defaulting party’s share on a pro-rata basis. If there is a payment default by a party and the remaining parties have to make payments, they are also entitled to a pro-rata share of the defaulting party’s water allocation.
 
The Company expects to use all its entitled water in its operations every year. In addition, if the Company were to pay for and receive additional amounts of water due to a default of another participating party; the Company believes it could use this additional water in its operations without incurring substantial incremental cost increases. If additional treated water is available, all parties have an option to purchase this additional treated water, subject to the Agency’s right to allocate the water among the parties.
 
The total obligation of all parties, excluding the Company, is approximately $82.4 million to the Agency. Based on the credit worthiness of the other participants, which are government entities, it is believed to be highly unlikely that the Company would be required to assume any other parties’ obligations under the contract due to their default. In the event of default by a party, the Company would receive entitlement to the additional water for assuming any obligation.
 
Once the project is complete, the Company is obligated to pay a Capital Facilities Charge and a Treated Water Charge that together total $6,400 annually, which equates to $0.3 per acre foot. Annual payments of $3,600 for the Capital Facilities Charge began when the Agency issued bonds to fund the project. Some of the Treated Water Charge of $2,800 began July 1, 2007, when a portion of the planned capacity became available. Once the entire expansion project is completed the full annual payments will be $6,400 which will continue through the term of the agreement. As treated water is being delivered, the Company is also obligated for its portion of the operating costs; that portion is currently estimated to be $0.02 per acre foot. The actual amount will vary due to variations from reimbursable operating cost estimates, inflation, and other changes in the cost structure. The Company’s overall estimated cost of $0.3 per acre foot is less than the estimated cost of procuring untreated water (assuming water rights could be obtained) and then providing treatment.
 
Contingencies
 
Chico Groundwater/Wausau Insurance Matter
 
In 1995, the State of California’s Department of Toxic Substances Control (DTSC) named us as a potential responsible party for cleanup of toxic contamination plumes, which contain perchloroethylene, also know as tetrachloroethylene (PCE) in the Chico groundwater. In December 2002, we were named along with other defendants in two lawsuits filed by DTSC for the cleanup of the plumes. In 2007, we entered into Court approved consent decrees (Consent Decrees). The Consent Decrees conditioned our performance upon many factors, including, but not limited to, water pumped and treated by us must meet regulatory standards so we may distribute to its customers. Pursuant to the terms of the Consent Decrees, we will incur capital costs of $1.5 million and future operating costs with a present value of approximately $2.6 million. In our 2007 general rate case (GRC) settlement negotiations, the Division of Ratepayer Advocates have tentatively agreed to track all costs associated with the Consent Decrees, including legal costs to pursue insurance coverage, for potential future recovery in rates.
 
In connection with these suits, our insurance carrier, Employers Insurance of Wausau (Wausau) filed a separate lawsuit against us for reimbursement of past defense costs which approximate $1.5 million and a declaratory determination of coverage. On January 23, 2008, the Court heard various parties’ motions and on September 25, 2008 issued its rulings that Wausau had a duty to defend; therefore, the Company will not have to reimburse Wausau for previously incurred defense costs. The Court did not find Wausau’s actions were intended to harm the Company,


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Notes to Consolidated Financial Statements — (Continued)
 
so punitive damages will not be recoverable by the Company. However, the Court also found that the issue of policy coverage will be determined at trial. A trial date has been set for May 26, 2009. Based on the Court’s rulings, the Company has not recorded any liability associated with reimbursement of costs to defend and expensing the related costs as incurred. We continue to believe that the claims are covered under the insurance policies. However, if our claim is ultimately found to be excludable under the insurance policies, the Company believes that recovery of costs associated with the Consent Decrees are probable from either its equitable indemnity lawsuit against manufacturers and distributors of perchloroethylene, also know as tetrachloroethylene, (PCE) in California; or through rate increases in the future. Therefore, no accrual or contingency has been recorded for this matter.
 
Other Groundwater Contamination
 
The Company has been and is involved in litigation against third parties to recover past and future costs related to ground water contamination in our service areas. The cost of litigation is expensed as incurred and any settlement is first offset against such costs. Any settlement in excess of the cost to litigate is accounted for on a case by case basis based upon the nature of the settlement. It is anticipated that the majority of the settlement will be reflected as a benefit to the rate payers by offsetting future operating or capital costs.
 
The Company is involved in a lawsuit against major oil refineries regarding the contamination of the ground water as a result of the gas additive MTBE. The Company entered into a partial settlement with the defendants in April of 2008 that represent approximately 70% of the responsible parties (as determined by the Superior Court). The Company is aggressively pursuing legal action against the remaining responsible parties.
 
On October 22, 2008, the Company received $34.2 million in cash representing the pro-rata portion of the partial settlement in the MTBE litigation, after deduction of attorneys’ fee and litigation expenses. The Company is in the process of determining with the Commission the appropriate regulatory treatment of the proceeds. It is anticipated that the proceeds will be used by the Company on infrastructure improvements. The Company is in the process of filing with the Internal Revenue Service a request for a private letter ruling regarding the taxability of the proceeds.
 
As of December 31, 2008, the Company believes the proceeds are non-taxable based upon its intent to reinvest them in qualifying assets. In 2009, when an agreement is reached with the Commission regarding the regulatory treatment, or when the taxability is determined based upon proceedings with the Internal Revenue Service, the Company will adjust the accounting of the settlement accordingly. The amount is presently reported as a long-term liability.
 
As previously reported, Cal Water has filed with the City of Bakersfield, in the Superior Court of California, a lawsuit that names potentially responsible parties, who manufactured and distributed products containing 1,2,3 trichloropropane (TCP) in California. TCP has been detected in the ground water. The lawsuit seeks to recover treatment costs necessary to remove TCP. The Court has now coordinated our action with other water purveyor cases (TCP Cases JCCP 4435) in San Bernardino County. No trial date has yet been set.
 
The Company has filed in San Mateo County Superior Court a complaint (California Water Service Company v. The Dow Chemical Company, et al. CIV 473093) against potentially responsible parties that manufactured and distributed products, which contained perchloroethylene, also know as tetrachloroethylene (PCE) in California, to recover the past, present, and future treatment costs. No trial date has yet been set.
 
Other Legal Matters
 
In the past few years, the Company has been named as a co-defendant in several asbestos related lawsuits. The company has been dismissed without prejudice in two of these cases. In Case No. BC360406, reported in our prior year annual report, the Court has approved a confidential settlement between the Company, the plaintiff and his heirs. The settlement was paid for by our contractor’s and our insurance policy carriers. There was no effect on our financial statements. On February 6, 2009, plaintiffs filed in Alameda County William and Barbara Church vs. Asbestos Corporation, LTD et al., Case No. RG09434913, against the Company and numerous other defendants.


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Notes to Consolidated Financial Statements — (Continued)
 
Plaintiffs’ complaint alleges personal injury from his exposure to asbestos. The complaint states negligence, false representations, strict liability, premise/owner liability and loss of consortium causes of actions. The Complaint does not state any amount of damages. The Company does not believe that the plaintiffs’ have any valid causes of actions against the Company. The Company will vigorously defend itself in this matter. Accordingly, the Company has not recorded an accrual for this matter.
 
From time to time, the Company is involved in various disputes and litigation matters that arise in the ordinary course of business. We review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount of the range of loss can be estimated, we accrue a liability for the estimated loss in accordance with SFAS No 5, “Accounting of Contingencies.” Legal proceedings are subject to uncertainties, and the outcomes are difficult to predict. Because of such uncertainties, accruals are based on the best information available at the time. While the outcome of these disputes and litigation matters cannot be predicted with any certainty, management does not believe that when taking into account existing reserves that the ultimate resolution of these matters will materially affect our financial position, results of operations, or cash flows.
 
16  QUARTERLY FINANCIAL DATA (UNAUDITED)
 
The Company’s common stock is traded on the New York Stock Exchange under the symbol “CWT.”
 
                                 
2008
  First     Second     Third     Fourth  
 
Operating revenue
  $ 72,921     $ 105,581     $ 131,702     $ 100,108  
Net operating income
    4,831       14,482       26,762       11,394  
Net income
    185       10,116       22,186       7,318  
Diluted earnings per share
    0.01       0.48       1.06       0.35  
Common stock market price range:
                               
High
    40.68       41.04       40.22       46.43  
Low
    33.58       31.69       31.16       29.73  
Dividends paid per common share
    0.2925       0.2925       0.2925       0.2925  
 
                                 
2007
  First     Second     Third     Fourth  
 
Operating revenue
  $ 71,570     $ 95,782     $ 113,851     $ 85,879  
Net operating income
    5,242       11,389       17,535       10,004  
Net income
    1,581       7,727       13,809       8,042  
Diluted earnings per share
    0.07       0.37       0.67       0.39  
Common stock market price range:
                               
High
    44.54       40.85       43.96       44.39  
Low
    36.75       34.46       35.39       35.85  
Dividends paid per common share
    0.2900       0.2900       0.2900       0.2900  


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Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
 
None
 
Item 9A.   Controls and Procedures
 
Management’s Evaluation of Disclosure Controls and Procedures
 
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d -15(e) under the Securities Exchange Act of 1934, as amended) that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Security and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.
 
In designing and evaluation the disclosure controls and procedures, management, including the Chief Executive Officer and Chief Financial Officer, recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Accordingly, our disclosure controls and procedures have been designed to provide reasonable assurance of achieving their objectives.
 
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2008. Based on that evaluation, we concluded that our disclosure controls and procedures were effective at the reasonable assurance level.
 
There was no change in our internal control over financial reporting during the quarter ended December 31, 2008, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
Management’s Report on Internal Control over Financial Reporting
 
Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended). Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in “Internal Control-Integrated Framework.” Management has concluded that, as of December 31, 2008, our internal control over financial reporting is effective based on these criteria. Our independent registered public accounting firm, Deloitte & Touche LLP, has audited the effectiveness of our internal control over financial reporting as of December 31, 2008, as stated in their report, which is included herein.
 
Item 9B.   Other Information
 
None.
 
PART III
 
Item 10.   Directors and Executive Officers and Corporate Governance.
 
The information required by this Item as to directors of the Company and the Company’s Audit Committee is contained in the sections captioned “Board Structure” and “Proposal No. 1 — Election of Directors” of the 2009 Proxy Statement, and is incorporated herein by reference.
 
Information required by this Item regarding executive officers is included in a separate section captioned “Executive Officers of the Registrant” contained in Part I of this report.


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Information required by this Item as to our Code of Ethics is contained in the section captioned “Other Matters — Code of Ethics” of the 2009 Proxy Statement, and is incorporated herein by reference.
 
Information required to be disclosed by this Item as to compliance with Section 16(a) filing requirements is contained in the section captioned “Stock Ownership of Management and Certain Beneficial Owners” of the 2009 Proxy Statement, and is incorporated herein by reference.
 
Item 11.   Executive Compensation.
 
The information required by this Item is contained under the captions “Compensation Discussion and Analysis,” “Report of the Organization and Compensation Committee of the Board of Directors on Executive Compensation,” and “Organization and Compensation Committee Interlocks and Insider Participation” of the 2009 Proxy Statement and is incorporated herein by reference.
 
Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
 
The information required by this Item regarding security ownership of certain beneficial owners and management is contained in the section captioned “Stock Ownership of Management and Certain Beneficial Owners” of the 2009 Proxy Statement and is incorporated herein by reference.
 
Information required by this Item regarding our equity compensation plans is included in a separate section captioned “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” contained in Part I of this report.
 
The following table represents securities authorized to be issued under our equity compensation plans:
 
                         
                Number of
 
                Securities
 
    Number of
          Remaining Available
 
    Securities to be
          for Future Issuance
 
    Issued upon
          under Equity
 
    Exercise of
    Weighted-Average
    Compensation Plans
 
    Outstanding
    Exercise Price of
    (Excluding
 
    Options, Warrants
    Outstanding
    Securities
 
    and Rights
    Options, Warrants
    Reflected in Column
 
Plan Category
  (a)     and Rights     (a))  
 
Equity compensation plans approved by security holders
    192,710     $ 32.38       852,253  
Equity compensation plans not approved by security holders
    -0-       -0-       -0-  
                         
Total
    192,710     $ 32.38       852,253  
 
Item 13.   Certain Relationships and Related Transactions and Director Independence.
 
The information required by this Item is contained in the sections captioned “Certain Related Persons Transactions” and “board Structure” of the 2009 Proxy Statement and is incorporated herein by reference.
 
Item 14.   Principal Accountant Fees and Services.
 
The information required by this Item is contained in the section captioned “Report of the Audit Committee” and “Relationship with the Independent Registered Public Accounting Firm” of the 2009 Proxy Statement and is incorporated herein by reference.


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PART IV
 
Item 15.   Exhibits, Financial Statement Schedules.
 
(a) As part of this Form 10-K, the following documents are being filed:
 
1. Financial Statement: See “Index to Consolidated Financial Statements” in Part II, Item 8 of this Form 10-K.
 
2. Financial Statement Schedules: No financial statement schedules are being included since the information otherwise required is included in the financial statements and the notes thereto.
 
3. Exhibits: The exhibits listed in the accompanying index to exhibits are filed or incorporated by reference.


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SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized
 
CALIFORNIA WATER SERVICE GROUP
 
  By 
/s/  Peter C. Nelson
PETER C. NELSON,
President and Chief Executive Officer
 
Date: March 2, 2009
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
             
         
/s/  Robert W. Foy

ROBERT W. FOY
  Chairman, Board of Directors   Date: March 2, 2009
         
/s/  Douglas M. Brown

DOUGLAS M. BROWN
  Member, Board of Directors   Date: March 2, 2009
         
/s/  Edwin A. Guiles

EDWIN A. GUILES
  Member, Board of Directors   Date: March 2, 2009
         
/s/  Edward D. Harris, Jr.

EDWARD D. HARRIS, JR., M.D.
  Member, Board of Directors   Date: March 2, 2009
         
/s/  Bonnie G. Hill

BONNIE G. HILL
  Member, Board of Directors   Date: March 2, 2009
         
/s/  Richard P. Magnuson

RICHARD P. MAGNUSON
  Member, Board of Directors   Date: March 2, 2009
         
/s/  Linda R. Meier

LINDA R. MEIER
  Member, Board of Directors   Date: March 2, 2009
         
/s/  Peter C. Nelson

PETER C. NELSON
  President and Chief Executive Officer, Principal Executive Officer;
Member, Board of Directors
  Date: March 2, 2009
         
/s/  George A. Vera

GEORGE A. VERA
  Member, Board of Directors   Date: March 2, 2009
         
/s/  Martin A. Kropelnicki

MARTIN A. KROPELNICKI
  Chief Financial Officer and Treasurer; Principal Financial Officer   Date: March 2, 2009
         
/s/  Calvin L. Breed

CALVIN L. BREED
  Controller, Assistant Secretary and Assistant Treasurer; Principal Accounting Officer   Date: March 2, 2009


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EXHIBIT INDEX
 
         
Exhibit
   
Number
   
 
Unless filed with this Form 10-K, the documents listed are incorporated by reference to the filings referred to:
  3 .1   Certificate of Incorporation of California Water Service Group (Exhibit 3.1 to the Quarterly Report on Form 10-Q filed August 9, 2006)
  3 .2   Restated Bylaws of California Water Service Group as amended on November 28, 2007 (Exhibit 3.1 to Current Report on Form 8-K filed December 3, 2007)
  4 .1   [reserved]
  4 .2   Certificate of Designations regarding Series D Participating Preferred Stock, as filed with Delaware Secretary of State on September 16, 1999 (Exhibit 4.2 to Annual Report on Form 10-K for the year ended December 31, 2003)
  4 .3   Thirty-fourth Supplemental Indenture dated as of November 1, 1990, covering First Mortgage 9.86% Bonds, Series CC. (Exhibit 4 to Annual Report on Form 10-K for the year ended December 31, 1990)
  4 .4   [reserved]
  4 .5   [reserved]
  4 .6   [reserved]
  4 .7   Note Agreement dated August 15, 1995, pertaining to issuance of $20,000,000, 7.28% Series A Unsecured Senior Notes, due November 1, 2025 (Exhibit 4 to Quarterly Report on Form 10-Q for the quarter ended September 30, 1995)
  4 .8   Note Agreement dated March 1, 1999, pertaining to issuance of $20,000,000, 6.77% Series B Unsecured Senior Notes, due November 1, 2028 (Exhibit 4.1 to Annual Report on Form 10-K for the year ended December 31, 1999)
  4 .9   First Supplement dated October 1, 2000, to Note Agreement of March 1, 1999, pertaining to issuance of $20,000,000, 8.15% Series C Unsecured Senior Notes, due November 1, 2030 (Exhibit 4.12 to Annual Report on Form 10-K for year ended December 31, 2000)
  4 .10   Second Supplement dated September 1, 2001, to Note Agreement of March 1, 1999, pertaining to issuance of $20,000,000, 7.13% Series D Unsecured Senior Notes, due November 1, 2031 (Exhibit 4.1 to Quarterly Report on Form 10-Q for the quarter ended September 30, 2001)
  4 .11   Third Supplement dated May 1, 2002, to Note Agreement of March 1, 1999, pertaining to issuance of $20,000,000, 7.11% Series E Unsecured Senior Notes, due May 1, 2032 (Exhibit 4.1 to Quarterly Report on Form 10-Q for the quarter ended June 30, 2002)
  4 .12   Fourth Supplement dated August 15, 2002, to Note Agreement of March 1, 1999, pertaining to issuance of $20,000,000, 5.90% Series F Unsecured Senior Notes, due November 1, 2017 (Exhibit 4.14 to Annual Report on Form 10-K for the year ended December 31, 2002)
  4 .13   Fifth Supplement dated November 1, 2002, to Note Agreement of March 1, 1999, pertaining to issuance of $20,000,000, 5.29% Series G Unsecured Senior Notes, due November 1, 2022 (Exhibit 4.15 to Annual Report on Form 10-K for the year ended December 31, 2002)
  4 .14   Sixth Supplement dated December 1, 2002, to Note Agreement of March 1, 1999, pertaining to issuance of $20,000,000, 5.29% Series H Unsecured Senior Notes, due December 1, 2022 (Exhibit 4.16 to Annual Report on Form 10-K for the year ended December 31, 2002)
  4 .15   Ninth Supplement dated February 15, 2003, to Note Agreement of March 1, 1999, pertaining to issuance of $10,000,000, 4.58% Series K Unsecured Senior Notes, due June 30, 2010 (Exhibit 4.17 to Annual Report on Form 10-K for the year ended December 31, 2002)
  4 .16   Tenth Supplement dated February 15, 2003, to Note Agreement of March 1, 1999, pertaining to issuance of $10,000,000, 5.48% Series L Unsecured Senior Notes, due March 1, 2018 (Exhibit 4.18 to Annual Report on Form 10-K for the year ended December 31, 2002)
  4 .17   Thirteenth Supplemental Trust Indenture whereby California Water Service Company became the successor to Dominguez Water Corporation in the original trust indenture for Dominguez Water Corporation dated August 1, 1954 (Exhibit 4.13 to Annual Report on Form 10-K for the year ended December 31, 2000 [included within Exhibit 4.12 to such report])


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Exhibit
   
Number
   
 
  4 .18   Eleventh Supplemental Trust Indenture dated as of December 8, 1992, covering First Mortgage 8.86% Bonds, Series J (Exhibit 10.2 to Annual Report on Form 10-K for the year ended December 31, 1997, of Dominguez Services Corporation)
  4 .19   Twelfth Supplemental Indenture dated as of December 1, 1997, covering First Mortgage 6.94% Bonds, Series K due 2012 (Exhibit 10.3 to Annual Report on Form 10-K for the year ended December 31, 1997, of Dominguez Services Corporation)
  4 .20   Seventh Supplement dated May 1, 2003, to Note Agreement of March 1, 1999, pertaining to issuance of $10,000,000, 5.54% Series I Unsecured Senior Notes, due May 1, 2023 (Exhibit 4.22 to Quarterly Report on Form 10-Q for the quarter ended March 31, 2003)
  4 .21   Amended and Restated Eighth Supplement dated May 1, 2003, to Note Agreement of March 1, 1999, pertaining to issuance of $10,000,000, 5.44% Series J Unsecured Senior Notes, due May 1, 2018 (Exhibit 4.23 to Quarterly Report on Form 10-Q for the quarter ended March 31, 2003)
  4 .22   Twelfth Supplement dated October 24, 2003, to Note Agreement of March 1, 1999, pertaining to the issuance of $20,000,000, 5.55%, Series N Unsecured Senior Notes due December 1, 2013, (Exhibit 4.24 to Quarterly Report on Form 10-Q for the quarter ended September 30, 2003)
  4 .23   Eleventh Supplement dated November 3, 2003, to Note Agreement of March 1, 1999, pertaining to the issuance of $20,000,000, 5.52%, Unsecured Series M Senior Notes due November 1, 2013 (Exhibit 4.25 to Quarterly Report on Form 10-Q for the quarter ended September 30, 2003)
  4 .24   Thirteenth Supplement dated August 31, 2006, to Note Agreement of March 1, 1999, pertaining to the issuance of $20,000,000, 6.02% Unsecured Series O Senior Notes due August 31, 2031 (Exhibit 4.24 to Annual Report on Form 10-K for the year ended December 31, 2006.)
  10 .1   Water Supply Contract between Cal Water and County of Butte relating to Cal Water’s Oroville District; Water Supply Contract between Cal Water and the Kern County Water Agency relating to Cal Water’s Bakersfield District; Water Supply Contract between Cal Water and Stockton East Water District relating to Cal Water’s Stockton District. (Exhibits 5(g), 5(h), 5(i), 5(j), Registration Statement No. 2-53678, which exhibits are incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1974)
  10 .2   Settlement Agreement and Master Water Sales Contract between the City and County of San Francisco and Certain Suburban Purchasers dated August 8, 1984; Supplement to Settlement Agreement and Master Water Sales Contract, dated August 8, 1984; Water Supply Contract between Cal Water and the City and County of San Francisco relating to Cal Water’s Bear Gulch District dated August 8, 1984; Water Supply Contract between Cal Water and the City and County of San Francisco relating to the Cal Water’s San Carlos District dated August 8, 1984; Water Supply Contract between Cal Water and the City and County of San Francisco relating to Cal Water’s San Mateo District dated August 8, 1984; Water Supply Contract between Cal Water and the City and County of San Francisco relating to Cal Water’s South San Francisco District dated August 8, 1984. (Exhibit 10.2 to Annual Report on Form l0-K for the year ended December 31,1984)
  10 .3   Water Supply Contract dated January 27, 1981, between Cal Water and the Santa Clara Valley Water District relating to Cal Water’s Los Altos District (Exhibit 10.3 to Annual Report on Form 10-K for the year ended December 31, 1992)
  10 .4   Amendments No. 3, 6 and 7 and Amendment dated June 17, 1980, to Water Supply Contract between Cal Water and the County of Butte relating to Cal Water’s Oroville District. (Exhibit 10.5 to Annual Report on Form 10-K for the year ended December 31, 1992)
  10 .5   Amendment dated May 31, 1977, to Water Supply Contract between Cal Water and Stockton East Water District relating to Cal Water’s Stockton District. (Exhibit 10.6 to Annual Report on Form 10-K for the year ended December 31, 1992)
  10 .6   Second Amended Contract dated September 25, 1987, among Stockton East Water District, California Water Service Company, the City of Stockton, the Lincoln Village Maintenance District, and the Colonial Heights Maintenance District Providing for the Sale of Treated Water. (Exhibit 10.7 to Annual Report on Form 10-K for the year ended December 31, 1987)
  10 .7   Water Supply Contract dated April 19, 1927, and Supplemental Agreement dated June 5, 1953, between Cal Water and Pacific Gas and Electric Company relating to Cal Water’s Oroville District. (Exhibit 10.9 to Annual Report on Form 10-K for the year ended December 31, 1992)


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Exhibit
   
Number
   
 
  10 .8   [reserved]
  10 .9   [reserved]
  10 .10   Agreement between the City of Hawthorne and California Water Service Company for the 15-year lease of the City’s water system. (Exhibit 10.17 to Quarterly Report on Form 10-Q for the quarter ended March 31, 1996)
  10 .11   Water Supply Agreement dated September 25, 1996, between the City of Bakersfield and California Water Service Company. (Exhibit 10.18 to Quarterly Report on Form 10-Q for the quarter ended September 30, 1996)
  10 .12   Water Supply Contract dated November 16, 1994, between California Water Service Company and Alameda County Flood Control and Water Conservation District relating to Cal Water’s Livermore District (Exhibit 10.15 to Annual Report on Form 10-K for the year ended December 31, 1994)
  10 .13   [reserved]
  10 .14   California Water Service Group Directors’ Retirement Plan (As amended and restated on February 22, 2006) (Exhibit 10.14 to the Annual Report on Form 10-K for the year ended December 31, 2005)
  10 .15   [reserved]
  10 .16   $20,000,000 Business Loan Agreement between Bank of America and California Water Service Group, CWS Utility Services, Washington Water Service Company, New Mexico Water Service Company, and Hawaii Water Service Company, Inc. dated May 30, 2007 (Exhibit 10.16 to the Quarter Report on Form 10-Q for the quarter ended June 30, 2007)
  10 .17   $55,000,000 Business Loan Agreement between Bank of America and California Water Service Company dated May 30, 2007 (Exhibit 10.17 to the Quarter Report on Form 10-Q for the quarter ended June 30, 2007)
  10 .18   Executive Severance Plan (Exhibit 10.24 to Annual Report on Form 10-K for the year ended December 31, 1998)*
  10 .19   California Water Service Group Long-Term Incentive Plan (filed as Appendix A of the California Water Service Group proxy statement dated March 17, 2000)*
  10 .20   California Water Service Group Deferred Compensation Plan effective January 1, 2001 (Exhibit 10.22 to Annual Report on Form 10-K for the year ended December 31, 2000)*
  10 .21   California Water Service Company Supplemental Executive Retirement Plan effective January 1, 2001 (Exhibit 10.23 to Annual Report on Form 10-K for the year ended December 31, 2000)*
  10 .22   Amendment No. 1 to California Water Service Company Supplemental Executive Retirement Plan effective January 1, 2001 (Exhibit 10.22 to Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)*
  10 .23   Amendment No. 1 effective June 25, 2003, to agreement with Bank of America dated February 28, 2003 (Exhibit 10.24 to Quarterly Report on Form 10-Q for the quarter ended June 30, 2003)
  10 .24   Water Supply Contract 99-73 between the City of Bakersfield and California Water Service Company, dated March 31, 1999 (Exhibit 10.25 to Quarterly Report on Form 10-Q for the quarter ended September 30, 2003)
  10 .25   Amendment No. 1 to Water Supply Contract between the City of Bakersfield and California Water Service Company, dated October 3, 2001 (Exhibit 10.26 to Quarterly Report on Form 10-Q for the quarter ended September 30, 2003)
  10 .26   [reserved]
  10 .27   Amendment No. 2 to California Water Service Company Supplemental Executive Retirement Plan effective January 1, 2001 (Exhibit 10.27 to Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)*
  10 .28   [reserved]
  10 .29   [reserved]
  10 .30   California Water Service Group Equity Incentive Plan (filed as Appendix B of the California Water Service Group proxy statement dated March 25, 2005, for its Annual Meeting of Stockholders to be held on April 27, 2005, as filed with the SEC on March 22, 2005 (File No. 1-13883))*


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Exhibit
   
Number
   
 
  10 .31   The registrant’s policy on option repricing under its Equity Incentive Plan (incorporated by reference to Item 8.01 Other Events in the registrant’s Current Report on Form 8-K dated April 7, 2005)*
  10 .32   Water Supply Contract dated September 21, 2005, between Cal Water and the Kern County Water Agency. (Exhibit 10.1 to Current Report on Form 8-K filed on September 21, 2005)
  10 .33   Separation Agreement between California Water Service Group and Richard D. Nye. (Exhibit 10 to Current Report on Form 8-K filed on December 22, 2005)*
  10 .34   Form of Stock Appreciation Right Grant Notice under the California Water Service Group Equity Incentive Plan. (Exhibit 10.34 to the Annual Report on Form 10-K for the year ended December 31, 2005)
  10 .35   Form of Stock Appreciation Right Agreement under the California Water Service Group Equity Incentive Plan with Notice of Exercise. (Exhibit 10.35 to the Annual Report on Form 10-K for the year ended December 31, 2005)
  10 .36   Form of Restricted Stock Award Grant Notice under the California Water Service Group Equity Incentive Plan. (Exhibit 10.36 to the Annual Report on Form 10-K for the year ended December 31, 2005)
  10 .37   [reserved]
  10 .38   Form of Restricted Stock Award Agreement under the California Water Service Group Equity Incentive Plan with Assignment Separate From Certificate and Joint Escrow Instructions. (Exhibit 10.38 to the Annual Report on Form 10-K for the year ended December 31, 2005)
  10 .39   Form of Stock Option Grant Notice for outside director under the California Water Service Group Equity Incentive Plan. (Exhibit 10.39 to the Annual Report on Form 10-K for the year ended December 31, 2005)
  10 .40   Form of Stock Option Grant Notice under the California Water Service Group Equity Incentive Plan. (Exhibit 10.40 to the Annual Report on Form 10-K for the year ended December 31, 2005)
  10 .41   Form of Stock Option Agreement (Incentive Stock Option or Nonstatutory Stock Option) under the California Water Service Group Equity Incentive Plan with Notice of Exercise. (Exhibit 10.41 to the Annual Report on Form 10-K for the year ended December 31, 2005)
  10 .42   Offer Letter between the registrant and Martin A. Kropelnicki, dated February 15, 2006 (incorporated by reference to Exhibit 10.1 to Amendment No. 1 to Current Report on Form 8-K of the registrant, dated February 22, 2006)
  10 .43   Underwriting Agreement between California Water Service Group and Robert W. Baird & Co. Incorporated, as representative of the underwriters, October 5, 2006 (incorporated by reference to Exhibit 1.1 to Current Report on Form 8-K filed on October 6, 2006)
  10 .44   Form of Indemnification Agreement to be entered between California Water Service Group and its directors and officers. (Exhibit 10.44 to the Annual Report on Form 10-K for the year ended December 31, 2006)
  10 .45   Amendment No. 1 to Loan Agreement dated as of September 24, 2008, between Bank of America N.A. and California Water Service Company (Exhibit 10.1 to Current Report on Form 8-K of the registrant dated September 25, 2008)
  10 .46   [reserved]
  21 .   Subsidiaries of the Registrant
  23 .1   Consent of Independent Registered Public Accounting Firm
  23 .2   Consent of Independent Registered Public Accounting Firm
  31 .1   Chief Executive Officer certification of financial statements pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31 .2   Chief Financial Officer certification of financial statements pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32 .   Chief Executive Officer and Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
* Management contract or compensatory plan or arrangement


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