Management’s Discussion and Analysis (continued) tion is structured so that the Company will exchange on a tax-free basis surplus real property to the contractor for the new facility. The exchange is expected to occur after mid-year 2002 at which time the contractor will repay the construction loan and the Company’s commitment will be extinguished. Washington Water has a line of credit totaling $0.1 million from a bank to meet its operating and cap- ital equipment purchase requirements. At December 31, 2001, nothing was outstanding under the commitment. Generally, short-term borrowings under the commitment are converted annually to long-term borrowings with repayment terms tied to system and equipment acquisitions. The water business is seasonal. Revenue is lower in the cool, wet winter months when less water is used compared to the warm, dry summer months when water use is higher and more revenue is generated. During the winter period, the need for short-term borrowings under the bank lines of credit increases. The increase in cash flow during the summer allows short-term borrowings to be paid down. Short-term borrowings that remain outstanding more than one year have generally been converted to long-term debt. In years when more than normal precipitation falls in the Company’s service areas or temperatures are lower than normal, especially in the summer months, customer water usage can be lower than normal. The reduction in water usage reduces cash flow from operations and increases the need for short-term bank borrowings.Regulatory lag, the delay in receiving authorization to increase customer rates to cover capital expenditures and higher operating costs, can also result in the need for increased short-term bank borrowings. The Company believes that long-term financing is available to it through debt and equity markets. Standard & Poor’s and Moody’s have maintained their ratings of Cal Water’s first mortgage bonds at AA- and Aa3, respectively. These are the highest ratings for senior debt in the water industry. The Company’s bank line of credit agreement contains a provision that if the Company’s Standard & Poor’s or Moody’s senior debt ratings fall below investment grade, the credit line may be terminated by the banks. The senior note covenants include cross default provisions that would be triggered if the bank line of credit provisions are not met. The Company believes the credit rating agencies will maintain investment grade ratings for the Company’s first mortgage bonds. Long-term financing, which includes common stock, first mortgage bonds, senior notes and other debt securities, has been used to replace short-term borrowings and fund construction. Developer contribu- tions in aid of construction which are not refundable and refundable advances for construction are sources of funds for various contractor funded construction projects. Internally generated funds come from retention of earnings not paid out as dividends, depreciation and deferred income taxes. Additional information regarding the bank borrowings and long-term debt is presented in Notes 7 and 8 to the financial statements. In both 2001 and 2000, long-term financing was provided by issuance of $20 million, 30-year senior notes for a total of $40 million. The Series D, 7.13% senior notes were issued in September 2001, and in October 2000, the Series C, 8.15% notes were issued. The senior notes do not require sinking fund payments. Cash flow during 2001 was lower than expected because of reduced water usage by existing customers, regulatory lag in receiving rate relief and increased operating costs, especially for purchased power. As a result, funds required to pay 2001 dividends exceeded net income by $2.1 million, resulting in a reduction of stock- holders’ equity. The reduced cash flow also required the Company to borrow additional funds under the bank line of credit agreement. In 2000 and 1999, $3.6 million and $6.6 million of net income had been reinvested in the business after payment of dividends. The Company has a Dividend Reinvestment and Stock Purchase Plan (Plan). Under the Plan, stock- holders may reinvest dividends to purchase additional Company common stock. The Plan also allows existing stockholders and other interested investors to purchase Company common stock through the transfer agent. The Plan provides that shares required for the Plan may be purchased on the open market or be newly issued shares. Therefore, the Plan presents the Company with an alternative means of developing additional equity if new shares were issued. During 2001 and 2000, shares were purchased on the open market. At this time, the Company intends to continue purchasing shares required for the Plan on the open market. However, if new shares were issued to satisfy future Plan requirements, the impact on earnings per share could be dilu- tive because of the additional shares outstanding. Also, stockholders may experience dilution of their owner- ship percentage. Contractual Obligations. The Company’s contractual obligations as of December 31, 2001 are summarized in the table below. Long-term debt payments include annual sinking fund payments on first mortgage bonds, maturities of first mortgage bonds and annual payments on other long-term obligations. Advances for con- struction represent annual contract refunds to developers for the cost of water systems paid for by the develop- Capital Structure. Common stockholders’ equity was reduced in 2001 by the $2.1 million that dividends paid exceeded net income. In 2000 and 1999, common stockholders’ equity increased by annual retained earnings of $3.6 million and $6.6 million. New equity was issued in 2001 to acquire a water system. The long-term debt portion of the capital structure increased in 2001 and 2000 due to the issuance of Series C and Series D, $20 million senior notes. It was reduced by first mortgage bond sinking fund payments. Company-funded construction budgets over the next five years are projected to be about $350 million. Included in the estimated amount is $125 million for compliance with arsenic water quality regulations, com- pletion of the Bakersfield treatment plant and expansion and replacement of water plant infrastructure. An application was filed in January 2002 requesting authorization from the CPUC for $250 million of debt and equity financing through 2005. The 2002 Company-funded construction budget was authorized at $76.8 million. It includes $32.0 mil- lion for the fourth year of a five-year program to construct a water treatment plant to accommodate growth and meet water quality standards in the Bakersfield district. Over the five-year period, the plant and related pump- ing and pipeline facilities are estimated to cost $49.0 million. Also in the 2002 budget is $12.0 million for new and replacement water mains and $5.0 million for new wells and storage facilities. The budget will be funded by funds from operations, bank borrowings and long-term debt and equity financing. New subdivision construc- tion will be financed by developers’ contributions and advances for construction. Utility plant expenditures in 2001 totaled $62.0 million compared to $37.2 million in 2000 and $48.6 million in 1999. The 2001 construction program included $53.4 million of Company-funded projects and $8.6 million of projects funded by funds received from developers for non-refundable contributions in aid of construc- tion and refundable advances for construction. The Company’s 2001 projects were funded by internally gener- ated funds, borrowings under bank credit lines, and issuance of the $20 million Series D senior notes. The 2000 expenditures included $33.5 million provided by Company funds and $3.6 million received from developers. The Company’s 2000 projects were funded by internally generated funds, short-term bank borrowings, and issuance of the $20 million Series C senior notes. Capital Requirements. Capital requirements consist primarily of new construction expenditures for expand- ing and replacing the Company’s utility plant facilities and the acquisition of new water properties. They also include refunds of advances for construction and retirement of first mortgage bonds. The Company has water supply contracts with wholesale suppliers in 16 of its operating districts. For each contract, the cost of water is established by the wholesale supplier and is generally beyond the Company’s control. In the past two years, wholesaler price increases have averaged 2.5%. The amount paid annually to the wholesale suppliers is charged to purchased water expense on the Company’s statement of income. Three contracts noted below require minimum payments. The other contracts do not require minimum annual pay- ments. The amount paid under the contracts, except for the contract with Stockton East Water District (SEWD), varies with the volume of water purchased from the wholesalers. The contract with SEWD requires an annual payment of $3,198,000. The amount paid under this contract is fixed annually and does not vary with the quan- tity of water delivered by the district. Because of the fixed price arrangement, the Company operates to receive as much water as possible from SEWD in order to minimize the cost of operating wells to supplement SEWD deliveries. Two contracts require the Company to purchase minimum quantities of water at the contractors’ current wholesale rate for purchased water. Under both contracts, the Company operates so that purchases exceed the contractual minimum amount. The Company plans to continue to purchase at least the minimum water requirement under both contracts in the future. ers. The contracts are non-interest bearing with refunds generally on a straight-line basis over a 40-year period. Operating leases are generally rents for office space. The total amount presented for operating leases is for a 20- year period. Contractual Less Than After Obligations (In thousands) Total 1 Year 2-3 Years 4-5 Years 5 Years Long-term debt $207,981 $5,381 $7,783 $ 5,184 $189,633 Advances for construction 106,657 4,475 9,630 10,621 81,931 Operating leases 21,000 750 1,610 1,778 16,862 23 CALIFORNIA WATER SERVICE GROUP 22 CALIFORNIA WATER SERVICE GROUP