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

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

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

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

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

In 2002 and 2000, $1.9 million and $3.6 million, respectively, of net income was reinvested in the business after payment of dividends. Cash flow during 2001 was lower than expected because of lower water usage by existing customers, regulatory lag in receiving rate relief and increased operating costs, espe- cially for purchased power costs. As a result, funds required to pay 2001 dividends exceeded net income by $2.1 million, resulting in a reduction of stockholders’ equity.The reduced cash flow also required the Company to borrow additional funds under the bank line of credit agreement. 

