Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2015

 

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 number 1-13883

 

CALIFORNIA WATER SERVICE GROUP

(Exact name of registrant as specified in its charter)

 

 

 

408-367-8200

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

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 x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No 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):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act)  Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common shares outstanding as of July 22, 2015 — 47,878,659

 

 

Table of Contents

 

TABLE OF CONTENTS

 

	Page
PART I Financial Information	3
Item 1 Financial Statements	3
Condensed Consolidated Balance Sheets (unaudited) as of June 30, 2015 and December 31, 2014	3
Condensed Consolidated Statements of Income (unaudited) For the Three Months Ended June 30, 2015 and 2014	4
Condensed Consolidated Statements of Income (unaudited) For the Six Months Ended June 30, 2015 and 2014	5
Condensed Consolidated Statements of Cash Flows (unaudited) For the Six Months Ended June 30, 2015 and 2014	6
Notes to Unaudited Condensed Consolidated Financial Statements	7
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3 Quantitative and Qualitative Disclosure about Market Risk	34
Item 4 Controls and Procedures	35
PART II Other Information	36
Item 1 Legal Proceedings	36
Item 1A Risk Factors	36
Item 6 Exhibits	36
Signatures	37
Index to Exhibits	38

 

2

Table of Contents

 

PART I FINANCIAL INFORMATION

 

Item 1.

 

FINANCIAL STATEMENTS

 

The condensed consolidated financial statements presented in this filing on Form 10-Q have been prepared by management and are unaudited.

 

CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATED BALANCE SHEETS

 

Unaudited

(In thousands, except shares and per share data)

 

		June 30, 2015			December 31, 2014
ASSETS
Utility plant:
Utility plant		$	2,419,050		$	2,342,471
Less accumulated depreciation and amortization		(782,374		)	(752,040		)
Net utility plant		1,636,676			1,590,431
Current assets:
Cash and cash equivalents		24,515			19,587
Receivables:
Customers		29,519			25,803
Regulatory balancing accounts		42,941			53,199
Other		14,279			14,136
Unbilled revenue		25,985			23,740
Materials and supplies at average cost		6,078			6,041
Taxes, prepaid expense, and other assets		6,889			11,618
Total current assets		150,206			154,124
Other assets:
Regulatory assets		403,042			390,331
Goodwill		2,615			2,615
Other assets		50,510			49,850
Total other assets		456,167			442,796
		$	2,243,049		$	2,187,351
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock, $.01 par value; 68,000 shares authorized, 47,880 and 47,806 outstanding in 2015 and 2014, respectively		$	479		$	478
Additional paid-in capital		331,574			330,558
Retained earnings		290,983			295,590
Total common stockholders’ equity		623,036			626,626
Long-term debt, less current maturities		416,779			419,233
Total capitalization		1,039,815			1,045,859
Current liabilities:
Current maturities of long-term debt		6,556			6,607
Short-term borrowings		126,615			79,115
Accounts payable		68,677			59,395
Regulatory balancing accounts		2,647			6,126
Accrued interest		4,212			4,194
Accrued expenses and other liabilities		61,708			62,269
Total current liabilities		270,415			217,706
Unamortized investment tax credits		2,032			2,032
Deferred income taxes, net		221,333			214,842
Pension and postretirement benefits other than pensions		276,591			270,865
Regulatory liabilities and other		81,873			83,279
Advances for construction		181,615			182,284
Contributions in aid of construction		169,375			170,484
Commitments and contingencies (Note 10)		—			—
		$	2,243,049		$	2,187,351

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

3

Table of Contents

 

CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

 

Unaudited

(In thousands, except per share data)

 

For the three months ended		June 30, 2015			June 30, 2014
Operating revenue		$	144,414		$	158,416
Operating expenses:
Operations:
Water production costs		53,022			61,915
Administrative and general		26,637			23,796
Other operations		17,512			16,004
Maintenance		5,326			4,988
Depreciation and amortization		15,354			16,087
Income taxes		5,102			7,190
Property and other taxes		4,968			5,144
Total operating expenses		127,921			135,124
Net operating income		16,493			23,292
Other income and expenses:
Non-regulated revenue		3,479			3,474
Non-regulated expenses, net		(3,504		)	(2,253		)
Income tax benefit (expense) on other income and expenses		10			(481		)
Net other (loss) income		(15		)	740
Interest expense:
Interest expense		7,061			7,077
Less: capitalized interest		(428		)	(215		)
Net interest expense		6,633			6,862
Net Income		$	9,845		$	17,170
Net income per share
Basic		$	0.21		$	0.36
Diluted		0.21			0.36
Weighted average shares outstanding
Basic		47,880			47,804
Diluted		47,892			47,837
Dividends declared per share of common stock		$	0.1675		$	0.1625

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

4

Table of Contents

 

CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

 

Unaudited

(In thousands, except per share data)

 

For the six months ended		June 30, 2015			June 30, 2014
Operating revenue		$	266,399		$	268,931
Operating expenses:
Operations:
Water production costs		98,224			107,317
Administrative and general		54,332			48,937
Other operations		33,355			32,380
Maintenance		9,783			9,993
Depreciation and amortization		30,673			32,140
Income taxes		5,715			3,351
Property and other taxes		10,327			10,369
Total operating expenses		242,409			244,487
Net operating income		23,990			24,444
Other income and expenses:
Non-regulated revenue		6,726			7,754
Non-regulated expenses, net		(5,747		)	(6,372		)
Income tax (expense) on other income and expenses		(393		)	(560		)
Net other income		586			822
Interest expense:
Interest expense		14,130			14,152
Less: capitalized interest		(974		)	(580		)
Net interest expense		13,156			13,572
Net Income		$	11,420		$	11,694
Net income per share
Basic		$	0.24		$	0.24
Diluted		0.24			0.24
Weighted average shares outstanding
Basic		47,853			47,780
Diluted		47,873			47,818
Dividends declared per share of common stock		$	0.3350		$	0.3250

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

5

Table of Contents

 

CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

Unaudited

(In thousands)

 

For the six months ended:		June 30, 2015			June 30, 2014
Operating activities
Net income		$	11,420		$	11,694
Adjustments to reconcile net income to net cash:
Depreciation and amortization		31,652			33,162
Change in value of life insurance contracts		50			(721		)
Changes in operating assets and liabilities:
Receivables		(7,511		)	(17,161		)
Accounts payable		1,458			12,802
Other current assets		(1,014		)	(4,384		)
Other current liabilities		3,664			(16,336		)
Other changes in noncurrent assets and liabilities		8,630			24,128
Net cash provided by operating activities		48,349			43,184
Investing activities:
Utility plant expenditures		(75,827		)	(57,047		)
Purchase of life insurance contracts		(214		)	(1,707		)
Change in restricted cash		46			313
Net cash used in investing activities		(75,995		)	(58,441		)
Financing activities:
Short-term borrowings		52,500			39,400
Repayment of short-term borrowings		(5,000		)	(5,000		)
Proceeds from long-term debt		50			—
Repayment of long-term debt		(2,554		)	(4,163		)
Advances and contributions in aid of construction		6,921			5,950
Refunds of advances for construction		(3,316		)	(3,203		)
Dividends paid		(16,027		)	(15,527		)
Net cash provided by financing activities		32,574			17,457
Change in cash and cash equivalents		4,928			2,200
Cash and cash equivalents at beginning of period		19,587			27,506
Cash and cash equivalents at end of period		$	24,515		$	29,706
Supplemental information
Cash paid for interest (net of amounts capitalized)		$	12,664		$	13,032
Income tax refunds		—			(6,000		)
Supplemental disclosure of non-cash activities:
Accrued payables for investments in utility plant		$	21,890		$	12,244
Utility plant contribution by developers		3,246			4,319

 

See Accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

6

Table of Contents

 

CALIFORNIA WATER SERVICE GROUP

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2015

(Amounts in thousands, except share and per share amounts)

 

Note 1. Organization and Operations and Basis of Presentation

 

California Water Service Group (the 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 herein as the commissions). CWS Utility Services and HWS Utility Services LLC provide non-regulated water utility and utility-related services.

 

The Company operates in one reportable segment, providing water and related utility services.

 

Basis of Presentation

 

The unaudited interim financial information has been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (SEC) and therefore do not contain all of the information and footnotes required by GAAP and the SEC for annual financial statements. The condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements for the year ended December 31, 2014, included in its annual report on Form 10-K as filed with the SEC on February 26, 2015.

 

The preparation of the Company’s condensed consolidated unaudited interim 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 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 the opinion of management, the accompanying condensed consolidated unaudited interim financial statements reflect all adjustments, consisting of normal recurring transactions that are necessary to provide a fair presentation of the results for the periods covered. The results for interim periods are not necessarily indicative of the results for any future period.

 

Due to the seasonal nature of the water business, the results for interim periods are not indicative of the results for a 12-month period. Revenue and income are generally higher in the warm, dry summer months when water usage and sales are greater. Revenue and income are generally lower in the winter months when cooler temperatures and rainfall curtail water usage and sales.

 

Note 2. Summary of Significant Accounting Policies

 

Revenue

 

Revenue generally includes monthly cycle customer billings for regulated water and wastewater services at rates authorized by the commissions (plus an estimate for water used between the customer’s last meter reading and the end of the accounting period) and billings to certain non-regulated customers at rates authorized by contract with government agencies.

 

The Company’s regulated water and waste water revenue requirements are authorized by the commissions in the states in which it operates. The revenue requirements are intended to provide the Company an opportunity to recover its operating costs and earn a reasonable return on investments.

 

For metered customers, Cal Water recognizes revenue from rates which are designed and authorized by the California Public Utilities Commission (CPUC). Under the Water Revenue Adjustment Mechanism (WRAM), Cal Water records the adopted level of volumetric revenues, which would include recovery of cost of service and a return on investments, 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 regulatory asset or liability balancing account (tracked individually for each Cal Water district) subject to certain criteria under the accounting for regulated operations being met. The variance amount may be positive or negative and represents amounts that will be billed or refunded to customers in the future.

 

7

Table of Contents

 

Cost-recovery rates are designed to permit full recovery of certain costs. Cost-recovery rates such as the Modified Cost Balancing Account (MCBA) provides for recovery of adopted expense levels for purchased water, purchased power and pump taxes, as established by the CPUC. In addition, cost-recovery rates include recovery of cost related to water conservation programs and certain other operation expenses adopted by the CPUC. There is no markup for return or profit for cost-recovery expenses and such costs are generally recognized when expenses are incurred.  Variances (which include the effects of changes in both rate and volume for the MCBA) between adopted and actual costs are 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.  The off-setting entries are recorded to a regulatory asset or liability balancing account (transferred individually for each Cal Water District) subject to certain criteria under the accounting for regulated operations being met.

 

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. At the end of any calendar year, Cal Water files with the CPUC to refund or collect the balance in the accounts. Most undercollected net WRAM and MCBA receivable balances are collected over 12 or 18 months. Cal Water defers net WRAM and MCBA operating revenues and associated costs whenever the net receivable balances are estimated to be collected more than 24 months after the respective reporting periods in which it was recognized. The deferred net WRAM and MCBA revenues and associated costs were determined using forecasts of rate payer consumption trends in future reporting periods and the timing of when the CPUC will authorize Cal Water’s filings to recover the undercollected balances. Deferred net WRAM and MCBA revenues and associated costs will be recognized as revenues and costs in future periods when collection is within twenty-four months of the respective reporting period.

 

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 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. The unearned revenue liability was $1.4 million and $1.5 million as of June 30, 2015 and December 31, 2014, respectively. This liability is included in “accrued expenses and other liabilities” on the condensed consolidated balance sheets.

 

Cash and Cash Equivalents

 

Cash equivalents include highly liquid investments with maturities of three months or less.  Cash and cash equivalents was $24.5 million and $19.6 million as of June 30, 2015 and December 31, 2014, respectively.  Restricted cash of $0.8 million was presented on the condensed consolidated balance sheet as “taxes, prepaid expenses and other assets” as of June 30, 2015 and December 31, 2014.

 

Adoption of New Accounting Standards

 

On May 28, 2014 the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers.  This update creates a single, principles based framework for revenue recognition and is based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when goods or services are transferred to customers.  ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017.  Early adoption is permitted.  The Company is currently evaluating the impact of adopting the new revenue standard on its consolidated financial statements and related disclosures.

 

On April 7, 2015 the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs.  This update requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability because these costs provide no future economic benefit.  ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.  The new accounting standard will be applied on a retrospective basis.  The Company completed a review of all debt issuance costs and concluded this change will not have a material impact on the Company’s consolidated financial statements and related disclosures.

 

Note 3. Stock-based Compensation

 

Equity Incentive Plan

 

During the six months ended June 30, 2015 and 2014, the Company granted annual Restricted Stock Awards (RSAs) of 60,997 and 58,378 shares, respectively, of common stock to officers and directors of the Company and 13,220 and 5,376 shares of RSAs were cancelled during the six months ended June 30, 2015 and June 30, 2014, respectively. The Company granted 1,846 shares of RSAs and 2,573 shares of RSAs were cancelled during the three months ended June 30, 2015. The Company did not grant RSAs and no RSAs were cancelled during the three months ended June 30, 2014.  Employee RSAs granted in 2015 and 2014 vest over 36 months.  Director RSAs generally vest at the end of 12 months. During the first six months of 2015 and 2014, the RSAs granted were valued at $24.29 and $23.61 per share, respectively, based upon the fair market value of the Company’s common stock on the date of grant.

 

8

Table of Contents

 

During the six months ended June 30, 2015 and 2014, the Company granted performance-based Restricted Stock Unit Awards (RSUs) of 38,983 shares and 37,143 shares of common stock, respectively, to officers.  The Company granted 1,846 shares of RSUs during the three months ended June 30, 2015 and did not grant RSUs during the three months ended June 30, 2014.  Each award reflects a target number of shares that may be issued to the award recipient.  The 2015 and 2014 awards may be earned upon the completion of the three-year performance period ending on March 3, 2018 and March 4, 2017, respectively.  Whether RSUs are earned at the end of the performance period will be determined based on the achievement of certain performance objectives set by the Board of Director Compensation Committee in connection with the issuance of the RSUs.  The performance objectives are based on the Company’s business plan covering the performance period.  The performance objectives include achieving the budgeted return on equity, budgeted investment in utility plant, customer service standards, water quality standards, and safety standards.  Depending on the results achieved during the three-year performance period, the actual number of shares that a grant recipient receives at the end of the performance period may range from 0% to 200% of the target shares granted, provided that the grantee is continuously employed by the Company through the vesting date.  If prior to the vesting date employment is terminated by reason of death, disability or normal retirement, then a pro rata portion of this award will vest.  RSUs are not included in diluted shares for financial reporting until authorized by the Board of Director Compensation Committee.  The 2015 and 2014 RSUs are recognized as expense ratably over the three year performance period using a fair market value of $24.28 per share and $23.61 per share, respectively, and an estimate of RSUs earned during the performance period.

 

The Company has recorded compensation costs for the RSAs and RSUs in administrative and general operating expenses in the amount of $1.0 million for the six months ended June 30, 2015 and June 30, 2014.

 

Note 4. Equity

 

The Company’s changes in total common stockholders’ equity for the six months ended June 30, 2015 were as follows:

 

		Total Common Stockholders’ Equity
Balance at December 31, 2014		$	626,626
Common stock issued		1
Share-based compensation expense		1,016
Common stock dividends declared		(16,027		)
Net income		11,420
Balance at June 30, 2015		$	623,036

 

Note 5. Net Income Per Share Calculations

 

The computations of basic and diluted net income per weighted average common share are noted below. Basic net income per share is computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts were exercised or converted into common stock. RSAs are included in the weighted average common shares outstanding because the shares have all the same voting and dividend rights as issued and unrestricted common stock.

 

A total of 65,436 shares and 212,920 shares of Stock Appreciation Rights (SARs) were vested and outstanding and all were dilutive as of June 30, 2015 and June 30, 2014, respectively, as shown in the table below.

 

		Three Months Ended June 30
		2015			2014
Net income available to common stockholders		$	9,845		$	17,170
Weighted average common shares outstanding, basic		47,880			47,804
Dilutive SARs (treasury method)		12			33
Weighted average common shares outstanding, dilutive		47,892			47,837
Net income per share - basic		$	0.21		$	0.36
Net income per share - diluted		$	0.21		$	0.36

 

		Six Months Ended June 30
		2015			2014
Net income available to common stockholders		$	11,420		$	11,694
Weighted average common shares outstanding, basic		47,853			47,780
Dilutive SARs (treasury method)		20			38
Weighted average common shares outstanding, dilutive		47,873			47,818
Net income per share - basic		$	0.24		$	0.24
Net income per share - diluted		$	0.24		$	0.24

 

9

Table of Contents

 

Note 6. Pension Plan and Other Postretirement Benefits

 

The Company provides a qualified, defined-benefit, non-contributory pension plan for substantially all employees. The Company makes annual contributions to fund the amounts accrued for in the qualified pension plan. The Company also maintains an unfunded, non-qualified, supplemental executive retirement plan. The costs of the plans are charged to expense or are capitalized in utility plant as appropriate.

 

The Company offers medical, dental, vision, and life insurance benefits for retirees and their spouses and dependents. Participants are required to pay a premium, which offsets a portion of the cost.

 

Cash contributions by the Company related to pension plans were $14.1 million and $14.0 million for the six months ended June 30, 2015 and June 30, 2014, respectively. Cash contributions by the Company related to other postretirement benefit plans were $3.7 million and $2.4 million for the six months ended June 30, 2015 and June 30, 2014, respectively. The 2015 estimated cash contribution to the pension plans is $31.2 million and to the other postretirement benefit plans is $15.0 million.

 

The following table lists components of net periodic benefit costs for the pension plans and other postretirement benefits. The data listed under “pension plan” includes the qualified pension plan and the non-qualified supplemental executive retirement plan. The data listed under “other benefits” is for all other postretirement benefits.

 

		Three Months Ended June 30
		Pension Plan						Other Benefits
		2015			2014			2015			2014
Service cost		$	5,632		$	4,217		$	2,500		$	1,620
Interest cost		5,003			4,726			1,614			1,337
Expected return on plan assets		(4,792		)	(4,179		)	(876		)	(754		)
Amortization of prior service cost		1,502			1,510			11			11
Recognized net actuarial loss		2,400			1,003			1,458			775
Net periodic benefit cost		$	9,745		$	7,277		$	4,707		$	2,989

 

		Six Months Ended June 30
		Pension Plan						Other Benefits
		2015			2014			2015			2014
Service cost		$	11,265		$	8,434		$	5,001		$	3,239
Interest cost		10,006			9,453			3,227			2,674
Expected return on plan assets		(9,584		)	(8,358		)	(1,752		)	(1,507		)
Amortization of prior service cost		3,004			3,020			22			22
Recognized net actuarial loss		4,800			2,006			2,917			1,550
Net periodic benefit cost		$	19,491		$	14,555		$	9,415		$	5,978

 

Note 7. Short-term and Long-term Borrowings

 

On March 10, 2015, the Company and Cal Water entered into Syndicated Credit Agreements, which provide for unsecured revolving credit facilities of up to an initial aggregate amount of $450 million for a term of five years.  The Syndicated Credit Facilities amend, expand, and replace the Company’s and its subsidiaries’ existing credit facilities originally entered into on June 29, 2011.  The new credit facilities extended the terms until March 10, 2020, and increased the Company’s unsecured revolving line of credit. The Company and subsidiaries that it designates may borrow up to $150 million under the Company’s revolving credit facility. Cal Water may borrow up to $300 million under its revolving credit facility; however, all borrowings need to be repaid within 12-months unless otherwise authorized by the CPUC.  The credit facilities may each be expanded by up to $50 million subject to certain conditions.  The proceeds from the revolving credit facilities may be used for working capital purposes, including the short-term financing of capital projects.  The base loan rate may vary from LIBOR plus 72.5 basis points to LIBOR plus 95 basis points, depending on the Company’s total capitalization ratio.  Likewise, the unused commitment fee may vary from 8 basis points to 12.5 basis points based on the same ratio.

 

Both short-term unsecured credit agreements contain affirmative and negative covenants and events of default customary for credit facilities of this type including, among other things, limitations and prohibitions relating to additional indebtedness, liens, mergers, and asset sales. Also, these unsecured credit agreements contain financial covenants governing the Company and its subsidiaries’ consolidated total capitalization ratio and interest coverage ratio.

 

The outstanding borrowings on the Company lines of credit were $64.2 million and $61.7 million as of June 30, 2015 and December 31, 2014, respectively. The outstanding borrowings on the Cal Water lines of credit were $62.4 million and $17.4 million as of June 30, 2015 and December 31, 2014, respectively.  The average borrowing rate for borrowings on the Company and Cal Water lines of credit during the six months ended June 30, 2015 was 1.07% compared to 1.20% for the same period last year.

 

Note 8. 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 be applied 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.

 

10

Table of Contents

 

We anticipate that future rate actions by the commissions will reflect revenue requirements for the tax effects of temporary differences recognized, which have previously 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 (ITCs) for all assets placed in service after 1980. ITCs are deferred and amortized over the lives of the related properties for book purposes.

 

During 2012, the Company filed an application for a change in tax accounting method with the Internal Revenue Service (IRS) regarding the classification of expenditures related to tangible property as deductible repairs and capitalizable improvements deductible over time as tax depreciation.  In September 2013, the U.S. Department of the Treasury (U.S. Treasury) and the IRS issued the final regulations for repairs and maintenance deductions with an effective date of January 1, 2014.  In August 2014, the U.S. Treasury and IRS issued the final regulations regarding dispositions of tangible property with an effective date of January 1, 2014. These tax regulations allow the Company to deduct a significant amount of costs to maintain its depreciable plant that were previously capitalized for tax purposes and continue to be capitalizable for book purposes.  The Company intends to implement the final regulations on its 2014 tax return.

 

As of June 30, 2015 and December 31, 2014, the Company had unrecognized tax benefits of approximately $9.2 million and $7.9 million respectively.  Included in the balance of unrecognized tax benefits as of June 30, 2015 and December 31, 2014 is approximately $1.9 million and $1.6 million respectively of tax benefits that, if recognized, would result in an adjustment to the Company’s effective tax rate. The Company does not expect its unrecognized tax benefits to change significantly within the next twelve months.

 

The State of California Franchise Tax Board is presently auditing the Company’s 2008 through 2011 enterprise zone filings.  The State of Hawaii Department of Taxation is presently auditing the Company’s 2013 sales tax filing.  It is uncertain when the state audits will be completed.  The Company believes that the final resolution of the state audits will not have a material impact on its financial condition or results of operations.

 

Note 9. Regulatory Assets and Liabilities

 

Regulatory assets and liabilities were comprised of the following as of June 30, 2015 and December 31, 2014:

 

		June 30, 2015			December 31, 2014
Regulatory Assets
Pension and retiree group health		$	244,679		$	245,008
Property-related temporary differences (tax benefits flowed through to ratepayers)		73,797			72,350
Other accrued benefits		31,453			32,959
Net WRAM and MCBA long-term accounts receivable		21,675			14,449
Asset retirement obligations, net		14,478			13,863
Interim rates long-term accounts receivable		7,057			10,627
Tank coating		5,762			—
Health care balancing account		2,469			1,075
Other regulatory assets		1,672			—
Total Regulatory Assets		$	403,042		$	390,331
Regulatory Liabilities
Future tax benefits due ratepayers		$	26,620		$	26,114
Conservation program		3,975			2,669
Pension balancing account		2,341			4,291
Other regulatory liabilities		2,321			3,373
Total Regulatory Liabilities		$	35,257		$	36,447

 

Short-term regulatory assets and liabilities are excluded from the above table. The short-term regulatory assets were $42.9 million as of June 30, 2015 and $53.2 million as of December 31, 2014. The short-term regulatory assets were primarily interim rates and net WRAM and MCBA accounts receivable as of June 30, 2015 and December 31, 2014. The short-term portions of regulatory liabilities were $2.6 million as of June 30, 2015 and $6.1 million as of December 31, 2014. The short-term regulatory liabilities were primarily short term net WRAM payables and net refund balances to rate payers for the water conservation program from the 2009 General Rate Case (GRC).

 

11

Table of Contents

 

Note 10. Commitment and Contingencies

 

Commitments

 

The Company has significant commitments to lease certain office spaces and water systems and to purchase water from water wholesalers. These commitments are described in Form 10-K for the year ended December 31, 2014.  As of June 30, 2015, there were no significant changes from December 31, 2014.

 

Contingencies

 

Groundwater Contamination

 

The Company has undertaken litigation against third parties to recover past and anticipated costs related to groundwater contamination in our service areas. The cost of litigation is expensed as incurred and any settlement is first offset against such costs. The CPUC’s general policy requires all proceeds from groundwater contamination litigation to be used first to pay transactional expenses, then to make ratepayers whole for water treatment costs to comply with the CPUC’s water quality standards. The CPUC allows for a risk-based consideration of contamination proceeds which exceed the costs of the remediation described above and may result in some sharing of proceeds with the shareholder, determined on a case by case basis. The CPUC has authorized various memorandum accounts that allow the Company to track significant litigation costs to request recovery of these costs in future filings and uses of proceeds to comply with CPUC’s general policy.

 

LEGAL PROCEEDINGS

 

From time to time, the Company has been named as a co-defendant in asbestos-related lawsuits. Several of these cases against the Company have been dismissed without prejudice. In other cases, Company’s contractors and insurance policy carriers have settled the cases with no effect on the Company’s financial statements. As such, the Company does not currently believe there is any potential loss that is probable to occur related to these matters and therefore no accrual has been recorded.

 

Other Legal Matters

 

From time to time, the Company is involved in various disputes and litigation matters that arise in the ordinary course of business. The status of each significant matter is reviewed and assessed for 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, a liability is accrued for the estimated loss in accordance with the accounting standards for 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 when taking into account existing reserves the ultimate resolution of these matters will materially affect the Company’s financial position, results of operations, or cash flows.  The Company recognized a liability of $2.0 million and $3.2 million for known legal matters as of June 30, 2015 and December 31, 2014, respectively.  The reasonably possible losses in excess of the amounts accrued were $1.5 million. 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, dependent on the nature of the settlement.

 

Note 11. Fair Value of Financial Assets and Liabilities

 

The accounting guidance for fair value measurements and disclosures provides a single definition of fair value and requires certain disclosures about assets and liabilities measured at fair value. A hierarchical framework for disclosing the observability of the inputs utilized in measuring assets and liabilities at fair value is established by this guidance. The three levels in the hierarchy are as follows:

 

Level 1 -  Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. The types of assets and liabilities included in Level 1 are highly liquid and actively traded instruments with quoted prices.

 

Level 2 -  Pricing inputs are other than quoted prices inactive markets, but are either directly or indirectly observable as of the reporting date. The types of assets and liabilities included in Level 2 are typically either comparable to actively traded securities or contracts, or priced with discounted cash flow or option pricing models using highly observable inputs.

 

12

Table of Contents

 

Level 3 -  Significant inputs to pricing have little or no observability as of the reporting date. The types of assets and liabilities included in Level 3 are those valued with models requiring significant management judgment or estimation.

 

Specific valuation methods include the following:

 

Cash equivalents, restricted cash, accounts receivable and accounts payable carrying amounts approximated the fair value because of the short-term maturity of the instruments.

 

Long-term debt fair values were estimated using the published quoted market price, if available, or the discounted cash flow analysis, based on the current rates available using a risk-free rate (a U.S. Treasury securities yield curve) plus a risk premium of 1.19%.

 

Advances for construction fair values were estimated using broker quotes from companies that frequently purchase these investments.

 

		June 30, 2015
					Fair Value
		Cost			Level 1			Level 2			Level 3			Total
Long-term debt, including current maturities		$	423,335		—			$	514,064		—			$	514,064
Advances for construction		181,615			—			73,899			—			73,899
Total		$	604,950		$	—		$	587,963		$	—		$	587,963

 

		December 31, 2014
					Fair Value
		Cost			Level 1			Level 2			Level 3			Total
Long-term debt, including current maturities		$	425,840		$	—		$	534,068		$	—		$	534,068
Advances for construction		182,284			—			72,571			—			72,571
Total		$	608,124		—			$	606,639		$	—		$	606,639

 

Note 12. Condensed Consolidating Financial Statements

 

On April 17, 2009, Cal Water issued $100 million aggregate principal amount of 5.875% First Mortgage Bonds due 2019, and on November 17, 2010, Cal Water issued $100 million aggregate principal amount of 5.500% First Mortgage Bonds due 2040, all of which are fully and unconditionally guaranteed by the Company.  As a result of these guarantee arrangements, the Company is required to present the following condensed consolidating financial information.  The investments in affiliates are accounted for and presented using the “equity method” of accounting.

 

The following tables present the condensed consolidating balance sheets as of June 30, 2015 and December 31, 2014, the condensed consolidating statements of income for the three months ended June 30, 2015 and 2014, condensed consolidating statements of income for the six months ended June 30, 2015 and 2014, and the condensed consolidating statements of cash flows for the six months ended June 30, 2015 and 2014 of (i) California Water Service Group, the guarantor of the first mortgage bonds and the parent company; (ii) California Water Service Company, the issuer of the first mortgage bonds and a 100% owned consolidated subsidiary of California Water Service Group; and (iii) the other 100% owned non-guarantor consolidated subsidiaries of California Water Service Group.

 

13

Table of Contents

 

CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATING BALANCE SHEET

As of June 30, 2015

(In thousands)

 

		Parent Company			Cal Water			All Other Subsidiaries			Consolidating Adjustments			Consolidated
ASSETS
Utility plant:
Utility plant		$	1,318		$	2,228,013		$	196,916		$	(7,197	)	$	2,419,050
Less accumulated depreciation and amortization		(491		)	(738,379		)	(45,276		)	1,772			(782,374		)
Net utility plant		827			1,489,634			151,640			(5,425		)	1,636,676
Current assets:
Cash and cash equivalents		3,219			19,973			1,323			—			24,515
Receivables and unbilled revenue, net		—			108,363			4,361			—			112,724
Receivables from affiliates		24,265			723			134			(25,122		)	—
Other current assets		284			11,490			1,193			—			12,967
Total current assets		27,768			140,549			7,011			(25,122		)	150,206
Other assets:
Regulatory assets		—			399,621			3,421			—			403,042
Investments in affiliates		634,127			—			—			(634,127		)	—
Long-term affiliate notes receivable		24,716			—			—			(24,716		)	—
Other assets		832			48,661			5,057			(1,425		)	53,125
Total other assets		659,675			448,282			8,478			(660,268		)	456,167
		$	688,270		$	2,078,465		$	167,129		$	(690,815	)	$	2,243,049
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stockholders’ equity		$	623,036		$	565,038		$	74,487		$	(639,525	)	$	623,036
Affiliate long-term debt		—			—			24,716			(24,716		)	—
Long-term debt, less current maturities		—			415,555			1,224			—			416,779
Total capitalization		623,036			980,593			100,427			(664,241		)	1,039,815
Current liabilities:
Current maturities of long-term debt		—			6,191			365			—			6,556
Short-term borrowings		64,215			62,400			—			—			126,615
Payables to affiliates		102			2,347			22,673			(25,122		)	—
Accounts payable		—			65,847			2,830			—			68,677
Accrued expenses and other liabilities		95			64,969			3,503			—			68,567
Total current liabilities		64,412			201,754			29,371			(25,122		)	270,415
Unamortized investment tax credits		—			2,032			—			—			2,032
Deferred income taxes, net		822			221,963			—			(1,452		)	221,333
Pension and postretirement benefits other than pensions		—			276,591			—			—			276,591
Regulatory liabilities and other		—			72,784			9,089			—			81,873
Advances for construction		—			181,101			514			—			181,615
Contributions in aid of construction		—			141,647			27,728			—			169,375
		$	688,270		$	2,078,465		$	167,129		$	(690,815	)	$	2,243,049

 

14

Table of Contents

 

CALIFORNIA WATER SERVICE GROUP

CONDENSED CONSOLIDATING BALANCE SHEET

As of December 31, 2014

(In thousands)

 

		Parent Company			Cal Water			All Other Subsidiaries			Consolidating Adjustments			Consolidated
ASSETS
Utility plant:
Utility plant		$	1,318		$	2,154,146		$	194,204		$	(7,197	)	$	2,342,471
Less accumulated depreciation and amortization		(377		)	(710,840		)	(42,545		)	1,722			(752,040		)
Net utility plant		941			1,443,306			151,659			(5,475		)	1,590,431
Current assets:
Cash and cash equivalents		4,108			13,929			1,550			—			19,587
Receivables		—			108,815			9,114			(1,051		)	116,878
Receivables from affiliates		20,001			3,608			—			(23,609		)	—
Other current assets		—			16,443			1,216			—			17,659
Total current assets		24,109			142,795			11,880			(24,660		)	154,124
Other assets:
Regulatory assets		—			387,387			2,944			—			390,331
Investments in affiliates		637,998			—			—			(637,998		)	—
Long-term affiliate notes receivable		25,263			—			—			(25,263		)	—
Other assets		891			47,617			4,278			(321		)	52,465
Total other assets		664,152			435,004			7,222			(663,582		)	442,796
		$	689,202		$	2,021,105		$	170,761		$	(693,717	)	$	2,187,351
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stockholders’ equity		$	626,626		$	569,319		$	74,107		$	(643,426	)	$	626,626
Affiliate long-term debt		—			—			25,263			(25,263		)	—
Long-term debt, less current maturities		—			417,884			1,349			—			419,233
Total capitalization		626,626			987,203			100,719			(668,689		)	1,045,859
Current liabilities:
Current maturities of long-term debt		—			6,173			434			—			6,607
Short-term borrowings		61,715			17,400			—			—			79,115
Payables to affiliates		—			270			23,339			(23,609		)	—
Accounts payable		—			56,666			2,930			(201		)	59,395
Accrued expenses and other liabilities		861			71,203			1,281			(756		)	72,589
Total current liabilities		62,576			151,712			27,984			(24,566		)	217,706
Unamortized investment tax credits		—			2,032			—			—			2,032
Deferred income taxes, net		—			210,789			4,515			(462		)	214,842
Pension and postretirement benefits other than pensions		—			270,865			—			—			270,865
Regulatory and other liabilities		—			74,282			8,997			—			83,279
Advances for construction		—			181,763			521			—			182,284
Contributions in aid of construction		—			142,459			28,025			—			170,484
		$	689,202		$	2,021,105		$	170,761		$	(693,717	)	$	2,187,351

 

15