AMERICAN STATES WATER COMPANY The following discussion and analysis provides information on AWR's consolidated operations and assets, and, where necessary, includes specific references to AWR's individual segments and/or its subsidiaries: GSWC and ASUS and its subsidiaries. Included in the following analysis is a discussion of water and electric gross margins. Water and electric gross margins are computed by subtracting total supply costs from total revenues. Registrant uses these gross margins as important measures in evaluating its operating results. Registrant believes these measures are useful internal benchmarks in evaluating the performance of GSWC. The discussions and tables included in the following analysis also present Registrant's operations in terms of earnings per share by business segment. Registrant believes that the disclosure of earnings per share by business segment provides investors with clarity surrounding the performance of its different services. Furthermore, the retroactive earnings impact for fiscal 2018 resulting from the CPUC's final decision on the electric general rate case issued inAugust 2019 , has been excluded when communicating the electric segment's 2019 financial results to help facilitate comparisons of the company's performance from period to period. Registrant reviews these measurements regularly and compares them to historical periods and to its operating budget. However, these measures, which are not presented in accordance with Generally Accepted Accounting Principles ("GAAP"), may not be comparable to similarly titled measures used by other enterprises and should not be considered as an alternative to operating income or earnings per share, which are determined in accordance with GAAP. A reconciliation of water and electric gross margins to the most directly comparable GAAP measures is included in the table under the section titled "Operating Expenses: Supply Costs." Reconciliations to AWR's diluted earnings per share are included in the discussions under the sections titled "Summary Results by Segment." Overview Factors affecting our financial performance are summarized under Forward-Looking Information. Water and Electric Segments: GSWC's revenues, operating income and cash flows are earned primarily through delivering potable water to homes and businesses inCalifornia and the delivery of electricity in the Big Bear area ofSan Bernardino County, California . Rates charged to GSWC customers are determined by the CPUC. These rates are intended to allow recovery of operating costs and a reasonable rate of return on capital. GSWC plans to continue to seek additional rate increases in future years from the CPUC to recover operating and supply costs and receive reasonable returns on invested capital. Capital expenditures in future years at GSWC are expected to remain at higher levels than depreciation expense. When necessary, GSWC obtains funds from external sources in the capital markets and through bank borrowings. General Rate Case Filings and Other Matters: Water Segment: InJuly 2017 , GSWC filed a general rate case application for all of its water regions and the general office to determine new rates for the years 2019 - 2021. OnMay 30, 2019 , the CPUC issued a final decision on GSWC's water general rate case with rates retroactive toJanuary 1, 2019 . Among other things, the final decision approves in its entirety anAugust 2018 settlement agreement that had been entered into between GSWC and the CPUC's Public Advocates Office. As a result, the final decision authorizes GSWC to invest approximately$334.5 million over the rate cycle. The$334.5 million of infrastructure investment includes$20.4 million of capital projects to be filed for revenue recovery through advice letters when those projects are completed. Excluding the advice letter project revenues, the new rates approved increased the water gross margin for 2019 by approximately$7.1 million , adjusted for updated inflation index values since theAugust 2018 settlement, as compared to the 2018 adopted water gross margin. The 2019 water revenue requirement has been reduced to reflect a decrease of approximately$7.0 million in depreciation expense, compared to the adopted 2018 depreciation expense, due to a reduction in the overall composite depreciation rates based on a revised study filed in the general rate case. The decrease in depreciation expense lowers the water gross margin and is offset by a corresponding decrease in depreciation expense, resulting in no impact to net earnings. In addition, the 2019 water revenue requirement includes a decrease of approximately$2.2 million for excess deferred tax refunds as a result of the 2017 Tax Cuts and Jobs Act ("Tax Act"), with a corresponding decrease in income tax expense also resulting in no impact to net earnings. Had depreciation remained the same as the 2018 adopted amount and there were no excess deferred tax refunds that lowered the 2019 revenue requirement, the water gross margin for 2019 would have increased by approximately$16.3 million . As a result of theMay 2019 CPUC final decision, GSWC implemented new water rates onJune 8, 2019 . The CPUC in the final decision also approved the recovery of previously incurred costs that were being tracked in CPUC-authorized 26
--------------------------------------------------------------------------------
Table of Contents
memorandum accounts. This resulted in a reduction to administrative and general expense of approximately$1.1 million , or$0.02 per share, which was recorded during the second quarter of 2019. The final decision also allowed for a water gross margin increase of approximately$10.4 million from new customer rates for 2020, which were effectiveJanuary 1, 2020 , as well as a potential additional increase of approximately$11.4 million in 2021, subject to the results of an earnings test and changes to the forecasted inflationary index values. Electric Segment: InMay 2017 , GSWC filed its electric general rate case application with the CPUC to determine new electric rates for the years 2018 through 2021. InNovember 2018 , GSWC and the Public Advocates Office filed a joint motion to adopt a settlement agreement between the two parties resolving all issues in connection with the general rate case. OnAugust 15, 2019 , the CPUC issued a final decision on this general rate case, adopting the settlement agreement in its entirety. Among other things, the decision (i) extends the rate cycle by one year (new rates were effective for 2018 - 2022); (ii) increases the electric gross margin for 2018 by approximately$2.3 million compared to the 2017 adopted electric gross margin, adjusted for Tax Act changes; (iii) authorizes BVES to construct all the capital projects requested in its application, which are dedicated to improving system safety and reliability and total approximately$44 million over the 5-year rate cycle; and (iv) increases the adopted electric gross margin by$1.2 million for each of the years 2019 and 2020, by$1.1 million in 2021, and by$1.0 million in 2022. The rate increases for 2019 - 2022 are not subject to an earnings test. The decision authorizes a return on equity for GSWC's electric segment of 9.60%, as compared to its previously authorized return of 9.95% and includes a capital structure and debt cost that is consistent with those approved by the CPUC inMarch 2018 in connection with GSWC's water segment cost of capital proceeding. Due to the delay in finalizing the electric general rate case, electric revenues recognized during 2018 were based on 2017 adopted rates. Because theAugust 2019 CPUC final decision is retroactive toJanuary 1, 2018 , the cumulative retroactive earnings impact was recorded as part of fiscal 2019 results, which includes approximately$0.04 per share relating to fiscal 2018. Contracted Services Segment: ASUS's revenues, operating income and cash flows are earned by providing water and/or wastewater services, including operation and maintenance services and construction of facilities at the water and/or wastewater systems at various military installations, pursuant to 50-year firm fixed-price contracts. The contract price for each of these 50-year contracts is subject to annual economic price adjustments. Additional revenues generated by contract operations are primarily dependent on new construction activities under contract modifications with theU.S. government or agreements with other third-party prime contractors.Fort Riley : OnJuly 1, 2018 , ASUS assumed the operation, maintenance and construction management of the water distribution and wastewater collection and treatment facilities atFort Riley , aUnited States Army installation located inKansas , after completing a transition period and a detailed inventory study. The contract was awarded by theU.S. government inSeptember 2017 with a value of$681 million over a 50-year period. The 50-year contract is also subject to annual economic price adjustments. Summary Results by Segment
The table below sets forth a comparison of diluted earnings per share by business segment for AWR's operations:
Diluted Earnings per Share
Year Ended
12/31/2019 12/31/2018 CHANGE
Water $ 1.61 $ 1.19 $ 0.42
Electric, adjusted (2019 excludes
retroactive impact of CPUC decision in
the general rate case related to 2018) 0.15 0.11 0.04
Contracted services 0.47 0.42 0.05
AWR (parent) 0.01 - 0.01
Consolidated diluted earnings per
share, adjusted 2.24 1.72 0.52
Retroactive impact of CPUC decision in
the electric general rate case related
to the full year of 2018 0.04 - 0.04
Totals from operations, as reported $ 2.28 $ 1.72 $ 0.56
27--------------------------------------------------------------------------------
Table of Contents
Water Segment: Diluted earnings per share from the water segment for the year endedDecember 31, 2019 increased by$0.42 per share as compared to the same period in 2018 largely due to the approval of the water general rate case inMay 2019 and effectiveJanuary 1, 2019 . Also included in the earnings for 2019 was a$1.1 million reduction to administrative and general expense, positively impacting earnings by$0.02 per share, which reflects the CPUC's approval received in the general rate case for recovery of costs previously expensed as incurred and tracked in memorandum accounts. Excluding this$0.02 per share impact, diluted earnings per share from the water segment for 2019 increased by$0.40 per share due to the following items (excluding billed surcharges): • An overall increase in the water gross margin of$0.21 per share, largely
as a result of the
approved new water rates and adopted supply costs for 2019. The 2019 water
revenue requirement has also been reduced to reflect a decrease in
depreciation expense, due to a reduction in the overall composite
depreciation rates based on a revised study filed in the general rate
case. The decrease in depreciation expense lowers the water gross margin
and is offset by a corresponding decrease in depreciation expense,
resulting in no impact to net earnings.
• An overall decrease in operating expenses (excluding supply costs)
increased earnings by approximately
lower depreciation expense. As discussed above, the lower depreciation
expense is reflected in the new revenue requirement approved in the
general rate case. There was also a decrease in administrative and general
expenses primarily due to lower regulatory-related costs resulting from
timing of the rate case cycle and when such costs are incurred. These
decreases were partially offset by an overall increase in labor costs and
property and other taxes.
• An increase in interest and other income (net of interest expense), which
increased earnings by approximately
during 2019 on Registrant's investments held to fund a retirement benefit
plan, as compared to losses incurred during 2018 due to market conditions.
These gains were partially offset by interest income on a federal tax
refund recorded in 2018 with no similar item in 2019, and an increase in
interest expense resulting from higher borrowings to fund a portion of
GSWC's capital expenditures.
• Changes in the water segment's effective income tax rate resulting fromcertain flow-through taxes and permanent items for the year ended December
31, 2019 as compared to the same period in 2018, increased earnings at the
water segment by approximately
Electric Segment: The CPUC'sAugust 2019 final decision on the electric general rate case set new rates for 2018 through 2022 and was retroactive toJanuary 1, 2018 . As a result, the retroactive impact of the new electric rates for all of fiscal 2018 has been reflected in the results for 2019. Of the electric segment's$0.19 earnings per share for the year endedDecember 31, 2019 , approximately$0.04 per share relates to the full year endedDecember 31, 2018 , which is shown on a separate line in the table above. Excluding the retroactive impact related to 2018, diluted earnings from the electric segment for 2019 were$0.15 per share as compared to$0.11 per share for the same period in 2018. The increase was due to a higher electric gross margin as a result of new rates authorized by the CPUC'sAugust 2019 final decision, partially offset by an increase in operating expenses and a higher effective income tax rate as compared to 2018 due to changes in certain flow-through taxes. Contracted Services Segment: For the year endedDecember 31, 2019 , diluted earnings from contracted services were$0.47 per share, compared to$0.42 per share for the same period in 2018. This was due, in part, to the commencement of operations atFort Riley inJuly 2018 . There was also an increase in management fees at several other military bases due to the successful resolution of various price adjustments during 2018 and 2019. AWR (parent): For the year endedDecember 31, 2019 , diluted earnings from AWR (parent) increased$0.01 per share compared to 2018 due primarily to changes in state unitary taxes. The following discussion and analysis for the years endedDecember 31, 2019 and 2018 provides information on AWR's consolidated operations and assets and, where necessary, includes specific references to AWR's individual segments and subsidiaries: GSWC and ASUS and its subsidiaries. 28
--------------------------------------------------------------------------------
Table of Contents
Consolidated Results of Operations - Years Ended
Year Ended Year Ended $ %
12/31/2019 12/31/2018 CHANGE CHANGE
OPERATING REVENUES
Water $ 319,830 $ 295,258 $ 24,572 8.3 %
Electric 39,548 34,350 5,198 15.1 %
Contracted services 114,491 107,208 7,283 6.8 %
Total operating revenues 473,869 436,816 37,053 8.5 %
OPERATING EXPENSES
Water purchased 72,289 68,904 3,385 4.9 %
Power purchased for pumping 8,660 8,971 (311 ) -3.5 %
Groundwater production assessment 18,962 19,440 (478 ) -2.5 %
Power purchased for resale 11,796 11,590 206 1.8 %
Supply cost balancing accounts (7,026 ) (15,649 ) 8,623 -55.1 %
Other operation 32,756 31,650 1,106 3.5 %
Administrative and general 83,034 82,595 439 0.5 %
Depreciation and amortization 35,397 40,425 (5,028 ) -12.4 %
Maintenance 15,466 15,682 (216 ) -1.4 %
Property and other taxes 20,042 18,404 1,638 8.9 %
ASUS construction 55,673 53,906 1,767 3.3 %
Gain on sale of assets (253 ) (85 ) (168 ) 197.6 %
Total operating expenses 346,796 335,833 10,963 3.3 %
OPERATING INCOME 127,073 100,983 26,090 25.8 %
OTHER INCOME AND EXPENSES
Interest expense (24,586 ) (23,433 ) (1,153 ) 4.9 %
Interest income 3,249 3,578 (329 ) -9.2 %
Other, net 3,276 760 2,516 331.1 %
(18,061 ) (19,095 ) 1,034 -5.4 %
INCOME FROM OPERATIONS BEFORE INCOME TAX
EXPENSE 109,012 81,888 27,124 33.1 %
Income tax expense 24,670 18,017 6,653 36.9 %
NET INCOME $ 84,342 $ 63,871 $ 20,471 32.1 %
Basic earnings per Common Share $ 2.28 $ 1.73 $ 0.55 31.8 %
Fully diluted earnings per Common Share
0.56 32.6 %
29--------------------------------------------------------------------------------
Table of Contents
Operating Revenues General GSWC relies upon approvals by the CPUC of rate increases to recover operating expenses and to provide for a return on invested and borrowed capital used to fund utility plant. Registrant relies on economic price and equitable adjustments by theU.S. government in order to recover operating expenses and provide a profit margin for ASUS. Current operating revenues and earnings can be negatively impacted if the Military Privatization Subsidiaries do not receive adequate price increases or adjustments in a timely manner. ASUS's earnings are also impacted by the level of additional construction projects at the Military Utility Privatization Subsidiaries, which may or may not continue at current levels in future periods. Water For the year endedDecember 31, 2019 , revenues from water operations increased by$24.6 million to$319.8 million , compared to the year endedDecember 31, 2018 . This increase was a result of new CPUC-approved water rates effectiveJanuary 1, 2019 as part of theMay 2019 general rate case final decision. There were also revenue increases related to CPUC-approved surcharges resulting from theMay 2019 decision, as well as surcharges to cover increases in supply costs experienced in most ratemaking areas. The increase in surcharge revenues was offset by a corresponding increase in operating expenses, resulting in no impact to earnings. Billed water consumption for the year endedDecember 31, 2019 decreased approximately 6% as compared to 2018. In general, changes in consumption do not have a significant impact on recorded revenues due to the CPUC-approved WRAM accounts in place in the majority of GSWC's rate-making areas. GSWC records the difference between what it bills its water customers and that which is authorized by the CPUC in the WRAM accounts as regulatory assets or liabilities. Electric For the year endedDecember 31, 2019 , revenues from electric operations were$39.5 million as compared to$34.4 million for the year endedDecember 31, 2018 . This increase was primarily due to new rates approved in theAugust 2019 CPUC final decision on the electric general rate case, which were retroactive toJanuary 1, 2018 . Included in revenues for the year endedDecember 31, 2019 was approximately$2.3 million which related to the full year of 2018. Billed electric usage for the year endedDecember 31, 2019 increased 3% as compared to the same period in 2018. Due to the CPUC-approved base revenue requirement adjustment mechanism ("BRRAM"), which adjusts base revenues to adopted levels authorized by the CPUC, changes in usage do not have a significant impact on earnings. Contracted Services Revenues from contracted services are composed of construction revenues (including renewal and replacements) and management fees for operating and maintaining the water and/or wastewater systems at various military bases. For the year endedDecember 31, 2019 , revenues from contracted services were$114.5 million as compared to$107.2 million for 2018. The increase was primarily due to the commencement of operations atFort Riley inJuly 2018 . ASUS's subsidiaries continue to enter intoU.S. government-awarded contract modifications and agreements with third-party prime contractors for new construction projects at the military bases served. During 2019, ASUS was awarded approximately$23 million in new construction projects for completion in 2019 and 2020. Earnings and cash flows from modifications to the original 50-year contracts with theU.S. government and agreements with third-party prime contractors for additional construction projects may or may not continue in future periods. 30
--------------------------------------------------------------------------------
Table of Contents
Operating Expenses: Supply Costs Supply costs for the water segment consist of purchased water, purchased power for pumping, groundwater production assessments and changes in the water supply cost balancing accounts. Supply costs for the electric segment consist primarily of purchased power for resale, the cost of natural gas used by BVES's generating unit, the cost of renewable energy credits and changes in the electric supply cost balancing account. Water and electric gross margins are computed by subtracting total supply costs from total revenues. Registrant uses these gross margins and related percentages as an important measure in evaluating its operating results. Registrant believes these measures are useful internal benchmarks in evaluating the utility business performance within its water and electric segments. Registrant reviews these measurements regularly and compares them to historical periods and to its operating budget. However, these measures, which are not presented in accordance with GAAP, may not be comparable to similarly titled measures used by other enterprises and should not be considered as an alternative to operating income, which is determined in accordance with GAAP. Total supply costs comprise the largest segment of total operating expenses. Supply costs accounted for 30.2% and 27.8% of total operating expenses for the years endedDecember 31, 2019 and 2018, respectively. The table below provides the amounts (in thousands) of increases (decreases) and percent changes in water and electric revenues, supply costs and gross margins during the years endedDecember 31, 2019 and 2018. There was an increase in surcharges of$1.4 million recorded in water revenues to recover previously incurred costs, which did not impact water earnings. Surcharges to recover previously incurred costs are recorded to revenues when billed to customers and are offset by a corresponding amount in operating expenses, resulting in no impact to earnings. Year Ended Year Ended $ % 12/31/2019 12/31/2018 CHANGE CHANGE WATER OPERATING REVENUES (1)$ 319,830 $ 295,258 $ 24,572 8.3 % WATER SUPPLY COSTS: Water purchased (1) 72,289 68,904 3,385 4.9 % Power purchased for pumping (1) 8,660 8,971 (311 ) -3.5 % Groundwater production assessment (1) 18,962 19,440 (478 ) -2.5 % Water supply cost balancing accounts (1) (8,153 ) (17,116 ) 8,963 -52.4 % TOTAL WATER SUPPLY COSTS$ 91,758 $ 80,199 $ 11,559 14.4 % WATER GROSS MARGIN (2)$ 228,072 $ 215,059 $ 13,013 6.1 % ELECTRIC OPERATING REVENUES (1)$ 39,548 $ 34,350 $ 5,198 15.1 % ELECTRIC SUPPLY COSTS: Power purchased for resale (1) 11,796 11,590 206 1.8 % Electric supply cost balancing accounts (1) 1,127 1,467 (340 ) -23.2 % TOTAL ELECTRIC SUPPLY COSTS$ 12,923 $ 13,057 $ (134 ) -1.0 % ELECTRIC GROSS MARGIN (2)$ 26,625 $ 21,293 $ 5,332 25.0 % (1) As reported on AWR's Consolidated Statements of Income, except for supply-cost-balancing accounts. The sums of water and electric supply-cost balancing accounts in the table above are shown on AWR's Consolidated Statements of Income and totaled$(7,026,000) and$(15,649,000) for the years endedDecember 31, 2019 and 2018, respectively. Revenues include surcharges that have no net earnings impact because they increase both revenues and operating expenses by corresponding amounts. (2) Water and electric gross margins do not include depreciation and amortization, maintenance, administrative and general, property and other taxes, and other operation expenses. Two of the principal factors affecting water supply costs are the amount of water produced and the source of the water. Generally, the variable cost of producing water from wells is less than the cost of water purchased from wholesale suppliers. Under the CPUC-approved Modified Cost Balancing Account ("MCBA"), GSWC tracks adopted and actual expense levels for purchased water, power purchased for pumping and pump taxes. GSWC records the variances (which include the effects of changes in both rate and volume) between adopted and actual purchased water, purchased power and pump tax expenses. GSWC recovers from or refunds to customers the amount of such variances. GSWC tracks these variances individually for each water ratemaking area. 31
--------------------------------------------------------------------------------
Table of Contents
The overall actual percentages for purchased water for the years endedDecember 31, 2019 and 2018 were 44% and 41%, respectively, as compared to the adopted percentages of 36% and 28% for 2019 and 2018, respectively. The higher actual percentages of purchased water as compared to adopted percentages resulted primarily from several wells being out of service. For 2020, the percentage of purchased water is expected to continue being higher than the adopted percentage. Purchased water costs for the year endedDecember 31, 2019 increased to$72.3 million as compared to$68.9 million for the same period in 2018 primarily due to the higher mix of purchased water as compared to pumped water and an increase in wholesale water costs, partially offset by lower customer usage. The cost of power purchased for pumping decreased to$8.7 million in 2019 as compared to$9.0 million for the same period in 2018, and groundwater production assessments decreased to$19.0 million in 2019 as compared to$19.4 million in 2018. The decrease in both of these areas was due, in part, to a higher mix of purchased water as compared to pumped water resulting from several wells being out of service as previously discussed, as well as lower customer usage. The under-collection in the water supply cost balancing account decreased$9.0 million during the year endedDecember 31, 2019 as compared to the same period in 2018 due to updated adopted supply costs approved in theMay 2019 general rate case decision, as well as CPUC-approved rate increases to cover increases in supply costs experienced in most ratemaking areas. For the year endedDecember 31, 2019 , the cost of power purchased for resale to BVES's customers was$11.8 million as compared to$11.6 million for the same period in 2018 due to an increase in customer usage, partially offset by a lower average price per megawatt-hour ("MWh"). The average price per MWh, including fixed costs, decreased to$75.47 per MWh in 2019 from$79.90 per MWh for the year endedDecember 31, 2018 . Other Operation The primary components of other operation expenses for GSWC include payroll, materials and supplies, chemicals and water-treatment costs, and outside service costs of operating the regulated water and electric systems, including the costs associated with transmission and distribution, pumping, water quality, meter reading, billing, and operations of district offices. Registrant's contracted services operations incur many of the same types of expenses. For the years endedDecember 31, 2019 and 2018, other operation expenses by business segment consisted of the following amounts (in thousands): Year Year Ended Ended $ % 12/31/2019 12/31/2018 CHANGE CHANGE Water Services$ 23,664 $ 22,525 $ 1,139 5.1 % Electric Services 2,672 2,809 (137 ) -4.9 % Contracted Services 6,420 6,316 104 1.6 % Total other operation$ 32,756 $ 31,650 $ 1,106 3.5 % For the year endedDecember 31, 2019 , there was an increase in billed surcharges at the water segment related to the recovery of previously incurred other operation-related expenses of$653,000 . This increase in billed surcharges has a corresponding increase in other operation expense, resulting in no impact to earnings. The remaining increase was mostly due to higher labor costs. 32
--------------------------------------------------------------------------------
Table of Contents
Administrative and General Administrative and general expenses include payroll related to administrative and general functions, the related employee benefits, insurance expenses, outside legal and consulting fees, regulatory utility commission expenses, expenses associated with being a public company and general corporate expenses charged to expense accounts. For the years endedDecember 31, 2019 and 2018, administrative and general expenses by business segment, including AWR (parent), consisted of the following amounts (in thousands): Year Year Ended Ended $ % 12/31/2019 12/31/2018 CHANGE CHANGE Water Services$ 51,755 $ 54,212 $ (2,457 ) -4.5 % Electric Services 8,150 7,944 206 2.6 % Contracted Services 23,120 20,446 2,674 13.1 % AWR (parent) 9 (7 ) 16 *
Total administrative and general
0.5 %
* not meaningful For the year endedDecember 31, 2019 , administrative and general expenses at the water segment decreased due, in part, to a$1.1 million reduction to reflect the CPUC's approval in theMay 2019 final decision on the water general rate case for recovery of previously incurred costs that were being tracked in CPUC-authorized memorandum accounts. The remaining decrease was due primarily to lower regulatory-related costs resulting from timing of the rate case cycle and when such costs are incurred. GSWC will file its next water general rate case inJuly 2020 and therefore, regulatory costs are expected to increase in 2020 compared to 2019. For the year endedDecember 31, 2019 , administrative and general expenses for contracted services increased by$2.7 million due to the commencement of operations atFort Riley inJuly 2018 , as well as an increase in legal and labor-related costs. Depreciation and Amortization For the years endedDecember 31, 2019 and 2018, depreciation and amortization expense by segment consisted of the following amounts (in thousands): Year Year Ended Ended $ % 12/31/2019 12/31/2018 CHANGE CHANGE Water Services$ 29,956 $ 36,137 $ (6,181 ) -17.1 % Electric Services 2,485 2,258 227 10.1 % Contracted Services 2,956 2,030
926 45.6 %
Total depreciation and amortization
The final CPUC decision approved inMay 2019 in the water general rate case approved lower overall composite depreciation rates based on a revised depreciation study. The decrease in composite depreciation rates lowers the adopted water gross margin, with a corresponding decrease in adopted depreciation expense, resulting in no impact to net earnings. The decrease in depreciation expense resulting from the new composite rates was partially offset by increased depreciation from additions to utility plant. The increases in depreciation expense at the electric and contracted services segments were due to plant additions in 2018 and 2019. 33
--------------------------------------------------------------------------------
Table of Contents
Maintenance
For the years ended
Year Year
Ended Ended $ %
12/31/2019 12/31/2018 CHANGE CHANGE
Water Services $ 11,850 $ 12,102 $ (252 ) -2.1 %
Electric Services 993 1,002 (9 ) -0.9 %
Contracted Services 2,623 2,578 45 1.7 %
Total maintenance $ 15,466 $ 15,682 $ (216 ) -1.4 %
Property and Other Taxes
For the years ended
Year Year
Ended Ended $ %
12/31/2019 12/31/2018 CHANGE CHANGE
Water Services $ 17,034 $ 15,750 $ 1,284 8.2 %
Electric Services 1,134 1,059 75 7.1 %
Contracted Services 1,874 1,595 279
17.5 %
Total property and other taxes
Property and other taxes increased overall by$1.6 million during 2019 as compared to 2018 primarily due to capital additions and the associated higher assessed property values. Increases in property taxes are reflected in the new adopted water revenue requirement approved by the CPUC in the general rate case.ASUS Construction For the year endedDecember 31, 2019 , construction expenses for contracted services were$55.7 million , increasing by$1.8 million compared to the same period in 2018 due to an overall increase in construction activity as compared to 2018 due, in part, to the commencement of operations atFort Riley inJuly 2018 . Interest Expense For the years endedDecember 31, 2019 and 2018, interest expense by segment, including AWR (parent), consisted of the following amounts (in thousands): Year Year Ended Ended $ % 12/31/2019 12/31/2018 CHANGE CHANGE Water Services$ 21,966 $ 21,212 $ 754 3.6 % Electric Services 1,433 1,409 24 1.7 % Contracted Services 587 362 225 62.2 % AWR (parent) 600 450 150 33.3 % Total interest expense$ 24,586 $ 23,433 $ 1,153 4.9 % The overall increase in interest expense is due to higher average borrowings, as well as an overall increase in the weighted average interest rate incurred during 2019 on the revolving credit facility, as compared to 2018. InMarch 2019 , AWR amended this credit facility to increase its borrowing capacity from$150.0 million to$200.0 million , and inOctober 2019 further amended the credit facility to temporarily increase its borrowing capacity to$225.0 million , effective untilJune 30, 2020 . Borrowings made during 2019 were used to repay$40.0 million of GSWC's 6.70% senior note, which matured inMarch 2019 , as well as to fund a portion of GSWC's capital expenditures. InFebruary 2020 , AWR received a binding commitment from its lender for the option to revise the temporary increase of the credit facility to$260.0 million through the end of 2020. When needed, AWR will be able to exercise this commitment and have immediate access to the additional funds. OnDecember 31, 2020 , the borrowing capacity will revert to$200.0 million . GSWC intends to issue debt in 2020 and use the proceeds to reduce its intercompany borrowings from AWR and to partially fund capital expenditures. AWR intends to use the proceeds from GSWC to pay down the amounts outstanding under its credit facility. 34
--------------------------------------------------------------------------------
Table of Contents
Interest Income For the years endedDecember 31, 2019 and 2018, interest income by business segment, including AWR (parent), consisted of the following amounts (in thousands): Year Year Ended Ended $ % 12/31/2019 12/31/2018 CHANGE CHANGE Water Services$ 1,662 $ 2,809 $ (1,147 ) -40.8 % Electric Services 205 81 124 * Contracted Services 1,321 689 632 * AWR (parent) 61 (1 ) 62 * Total interest income$ 3,249 $ 3,578 $ (329 ) -9.2 % * not meaningful For the year endedDecember 31, 2019 , interest income decreased overall by$329,000 as compared to the same period in 2018 due primarily to interest income related to a federal tax refund recorded at the water segment in 2018, with no similar item in 2019. This was partially offset by interest income recognized in 2019 on certain initial construction projects performed at the contacted services segment, as well as interest related to regulatory assets for the electric segment as a result of theAugust 2019 CPUC final decision. Other, net For the year endedDecember 31, 2019 , other income increased by$2.5 million primarily due to gains recorded on investments held for a retirement benefit plan resulting from favorable market conditions, as compared to losses recorded in 2018. This was partially offset by an increase in the non-service cost components of net periodic benefit costs related to Registrant's defined benefit pension plans and other retirement benefits. However, as a result of GSWC's pension balancing account authorized by the CPUC, changes in net periodic benefit costs are mostly offset by corresponding changes in revenues, having no material impact to earnings. Income Tax Expense For the years endedDecember 31, 2019 and 2018, income tax expense by segment, including AWR (parent), consisted of the following amounts (in thousands): Year Year Ended Ended $ % 12/31/2019 12/31/2018 CHANGE CHANGE Water Services$ 17,295 $ 12,391 $ 4,904 39.6 % Electric Services 2,882 1,212 1,670 137.8 % Contracted Services 5,202 4,939 263 5.3 % AWR (parent) (709 ) (525 ) (184 ) 35.0 % Total income tax expense$ 24,670 $ 18,017 $ 6,653 36.9 % Consolidated income tax expense for the year endedDecember 31, 2018 increased by$6.7 million primarily due to an increase in pretax income at all segments. AWR's consolidated effective income tax rate ("ETR") was 22.6% and 22.0% for the years endedDecember 31, 2019 and 2018, respectively. The increase was due primarily to the increase in GSWC's ETR, which was 23.2% for 2019 as compared to 22.1% for 2018 resulting primarily from net changes in certain permanent and flow-through items, including the amortization of the excess deferred income tax liability brought about by the lower federal corporate income tax rate beginning in 2018. Partially offsetting the overall increase in GSWC's ETR were lower state taxes at AWR (parent). 35
--------------------------------------------------------------------------------
Table of Contents
Critical Accounting Policies and Estimates Critical accounting policies and estimates are those that are important to the portrayal of AWR's financial condition, results of operations and cash flows, and require the most difficult, subjective or complex judgments of AWR's management. The need to make estimates about the effect of items that are uncertain is what makes these judgments difficult, subjective and/or complex. Management makes subjective judgments about the accounting and regulatory treatment of many items. The following are accounting policies that are critical to the financial statements of AWR. For more information regarding the significant accounting policies of Registrant, see Note 1 of "Notes to Financial Statements" included in Part II, Item 8, in Financial Statements and Supplementary Data. Accounting for Rate Regulation - Because GSWC operates extensively in a regulated business, it is subject to the authoritative guidance for accounting for the effects of certain types of regulation. Application of this guidance requires accounting for certain transactions in accordance with regulations adopted by the regulatory commissions of the states in which rate-regulated operations are conducted. Utility companies defer 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. 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. Regulation and the effects of regulatory accounting have the most significant impact on the financial statements of GSWC. When GSWC files for adjustments to rates, the capital assets, operating costs and other matters are subject to review, and disallowances may occur. In the event that a portion of GSWC's operations is no longer subject to the accounting guidance for the effects of certain types of regulation, GSWC is required to write-off related regulatory assets that are not specifically recoverable and determine if other assets might be impaired. If the CPUC determines that a portion of GSWC's assets are not recoverable in customer rates, GSWC is required to determine if it has suffered an asset impairment that would require a write-down in the asset valuation. Management continually evaluates the anticipated recovery, settlement or refund of regulatory assets, liabilities, and revenues subject to refund and provides for allowances and/or reserves that it believes to be necessary. In the event that GSWC's assessment as to the probability of the inclusion in the ratemaking process is incorrect, the associated regulatory asset or liability will be adjusted to reflect the change in assessment or the impact of regulatory approval of rates. Reviews by the CPUC may also result in additional regulatory liabilities to refund previously collected revenues to customers if the CPUC were to disallow costs included in the ratemaking process. Registrant also reviews its utility plant in-service for possible impairment in accordance with accounting guidance for regulated entities for abandonments and disallowances of plant costs. Revenue Recognition - GSWC records water and electric utility operating revenues when the service is provided to customers. Operating revenues include unbilled revenues that are earned (i.e., the service has been provided) but not billed by the end of each accounting period. Unbilled revenues are calculated based on the number of days and total usage from each customer's most recent billing record that was billed prior to the end of the accounting period and is used to estimate unbilled consumption as of the year-end reporting period. Unbilled revenues are recorded for both monthly and bi-monthly customers. The CPUC granted GSWC the authority to implement revenue decoupling mechanisms through the adoption of the WRAM and the BRRAM. With the adoption of these alternative revenue programs, GSWC adjusts revenues in the WRAM and BRRAM for the difference between what is billed to its regulated customers and that which is authorized by the CPUC. As required by the accounting guidance for alternative revenue programs, GSWC is required to collect its WRAM and BRRAM balances within 24 months following the year in which they are recorded. The CPUC has set the recovery period for under-collected balances that are up to 15% of adopted annual revenues at 18 months or less. For net WRAM under-collected balances greater than 15%, the recovery period is 19 to 36 months. As a result of the accounting guidance and CPUC-adopted recovery periods, Registrant must estimate if any WRAM and BRRAM revenues will be collected beyond the 24-month period, which can affect the timing of when such revenues are recognized. ASUS's 50-year firm fixed-price contracts with theU.S. government are considered service concession arrangements under ASC 853 Service Concession Arrangements. Accordingly, the services under these contracts are accounted for under Topic 606 Revenue from Contracts with Customers and the water and/or wastewater systems are not recorded as Property, Plant and Equipment on Registrant's balance sheet. Revenues for ASUS's operations and maintenance contracts are recognized when services have been rendered to theU.S. government pursuant to 50-year contracts. Revenues from construction activities are recognized based on either the percentage-of-completion or cost-plus methods of accounting. In accordance with GAAP, revenue recognition under these methods requires management to estimate the progress toward completion on a contract in terms of efforts, such as costs incurred. This approach is used because management considers it to be the best available measure of progress on these contracts. Changes in job performance, job conditions, change orders and estimated profitability, including those arising from any contract penalty provisions, and final contract settlements may result in revisions to costs and income, and are recognized in the period in which the revisions are determined. Unbilled receivables from theU.S. 36
--------------------------------------------------------------------------------
Table of Contents
government represent amounts to be billed for construction work completed and/or for services rendered pursuant to the 50-year contracts with theU.S government, which are not presently billable but which will be billed under the terms of the contracts. Income Taxes - Registrant's income tax calculations require estimates due principally to the regulated nature of the operations of GSWC, the multiple states in which Registrant operates, and potential future tax rate changes. Registrant uses the asset and liability method of accounting for income taxes under which 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. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. Changes in regulatory treatment, or significant changes in tax-related estimates, assumptions or law, could have a material impact on the financial position and results of operations of Registrant. As a regulated utility, GSWC treats certain temporary differences as flow-through adjustments in computing its income tax expense consistent with the income tax approach approved by the CPUC for ratemaking purposes. Flow-through adjustments increase or decrease tax expense in one period, with an offsetting decrease or increase occurring in another period. Giving effect to these temporary differences as flow-through adjustments typically results in a greater variance between the effective tax rate and the statutory federal income tax rate in any given period than would otherwise exist if GSWC were not required to account for its income taxes as a regulated enterprise. As ofDecember 31, 2019 , Registrant's total amount of unrecognized tax benefits was zero. Pension Benefits - Registrant's pension benefit obligations and related costs are calculated using actuarial concepts within the framework of accounting guidance for employers' accounting for pensions and post-retirement benefits other than pensions. Two critical assumptions, the discount rate and the expected return on plan assets, are important elements of expense and/or liability measurement. We evaluate these critical assumptions annually. Other assumptions include employee demographic factors such as retirement patterns, mortality, turnover and rate of compensation increase. The discount rate enables Registrant to state expected future cash payments for benefits as a present value on the measurement date. The guideline for setting this rate is a high-quality, long-term corporate bond rate. Registrant's discount rates were determined by considering the average of pension yield curves constructed using a large population of high-quality corporate bonds. The resulting discount rates reflect the matching of plan liability cash flows to the yield curves. A lower discount rate increases the present value of benefit obligations and increases periodic pension expense. Conversely, a higher discount rate decreases the present value of benefit obligations and decreases periodic pension expense. To determine the expected long-term rate of return on the plan assets, Registrant considers the current and expected asset allocation, as well as historical and expected returns on each plan asset class. A lower expected rate of return on plan assets will increase pension expense. The long-term expected return on the pension plan's assets was 6.50% in both 2019 and 2018. For the pension plan obligation, Registrant decreased the discount rate to 3.43% as ofDecember 31, 2019 from 4.43% as ofDecember 31, 2018 to reflect market interest-rate conditions atDecember 31, 2019 . A hypothetical 25-basis point decrease in the assumed discount rate would have increased total net periodic pension expense for 2019 by approximately$761,000 , or 17.1%, and would have increased the projected benefit obligation ("PBO") and accumulated benefit obligation ("ABO") atDecember 31, 2019 by a total of$8.8 million , or 3.8%. A 25-basis point further decrease in the long-term return on pension-plan-asset assumption would have increased 2019 pension cost by approximately$399,000 , or 9.0%. In addition, changes in the fair value of plan assets will impact future pension cost and the Plan's funded status. Volatile market conditions can affect the value of plan assets held to fund its future long-term pension benefits. Any reductions in the value of plan assets will result in increased future expense, an increase in the underfunded position and increased future contributions. The CPUC has authorized GSWC to maintain two-way balancing accounts to track differences between the forecasted annual pension expenses adopted in rates and the actual annual expense to be recorded by GSWC in accordance with the accounting guidance for pension costs. As ofDecember 31, 2019 , GSWC has a$2.7 million over-collection in the two-way pension balancing accounts, consisting of a$1.5 million over-collection related to the general office and water regions, and a$1.2 million over-collection related to BVES. Funding requirements for qualified defined benefit pension plans are determined by government regulations. In establishing the contribution amount, Registrant has considered the potential impact of funding-rule changes under the Pension Protection Act of 2006. Registrant contributes the minimum required contribution as determined by government regulations or the forecasted annual pension cost authorized by the CPUC and included in customer rates, whichever is higher. In accordance with this funding policy, for 2020 the pension contribution is expected to be approximately$3.3 million . Any differences between the forecasted annual pension costs in rates and the actual pension costs are included in the two-way pension balancing accounts. Additionally, market factors can affect assumptions we use in determining funding requirements with respect to our pension plan. For example, a relatively modest change in our assumptions regarding discount rates can materially affect our 37
--------------------------------------------------------------------------------
Table of Contents
calculation of funding requirements. To the extent that market data compels us to reduce the discount rate used in our assumptions, our benefit obligations could materially increase. Changes in demographics, including increased numbers of retirees or increases in life expectancy assumptions may also increase the funding requirements of our obligations related to the pension and other postretirement benefit plans. Mortality assumptions are a critical component of benefit obligation amounts and a key factor in determining the expected length of time for annuity payments. Assuming no changes in actuarial assumptions or plan amendments, the costs over the long term are expected to decrease due to the closure of Registrant's defined benefit pension plan to new employees as ofJanuary 1, 2011 . Employees hired or rehired afterDecember 31, 2010 are eligible to participate in a defined contribution plan. 38
--------------------------------------------------------------------------------
Table of Contents
Liquidity and Capital Resources
AWR
Registrant's regulated business is capital intensive and requires considerable capital resources. A portion of these capital resources is provided by internally generated cash flows from operations. AWR anticipates that interest expense will increase in future periods due to the need for additional external capital to fund its construction program and as market interest rates increase. AWR believes that costs associated with capital used to fund construction at GSWC will continue to be recovered through water and electric rates charged to customers. AWR funds its operating expenses and pays dividends on its outstanding Common Shares primarily through dividends from its wholly owned subsidiaries. The ability of GSWC to pay dividends to AWR is restricted byCalifornia law. Under these restrictions, approximately$257.4 million was available for GSWC to pay dividends to AWR onDecember 31, 2019 . Approximately$62.1 million was available for ASUS to pay dividends to AWR as ofDecember 31, 2019 to the extent that the subsidiaries of ASUS are able to pay dividends in that amount to ASUS under applicable state laws. When necessary, Registrant obtains funds from external sources in the capital markets and through bank borrowings. Access to external financing on reasonable terms depends on the credit ratings of AWR and GSWC and current business conditions, including that of the water utility industry in general, as well as conditions in the debt and equity capital markets. AWR borrows under a credit facility, which expires inMay 2023 , and provides funds to its subsidiaries, GSWC and ASUS, in support of their operations. The interest rate charged to GSWC and ASUS is sufficient to cover AWR's interest expense under the credit facility. InMarch 2019 , AWR amended this credit facility to increase its borrowing capacity from$150.0 million to$200.0 million , and inOctober 2019 further amended the credit facility to temporarily increase its borrowing capacity to$225.0 million , effective untilJune 30, 2020 . InFebruary 2020 , AWR received a binding commitment from its lender for the option to revise the temporary increase of the credit facility to$260.0 million through the end of 2020. When needed, AWR will be able to exercise this commitment and have immediate access to the additional funds. OnDecember 31, 2020 , the borrowing capacity will revert to$200.0 million . As ofDecember 31, 2019 , there was$205.0 million outstanding under this facility. Management intends to seek additional financing in 2020 through the issuance of long-term debt at GSWC. GSWC intends to use the proceeds from any additional long-term debt to reduce its intercompany borrowings and to partially fund capital expenditures. AWR parent intends to use any financing proceeds from GSWC to pay down the amounts outstanding under its credit facility. InDecember 2019 , Standard and Poor's Global Ratings ("S&P") affirmed an A+ credit rating with a stable outlook on both AWR and GSWC. S&P's debt ratings range fromAAA (highest possible) to D (obligation is in default). InMay 2019 , Moody's Investors Service ("Moody's") affirmed its A2 rating with a revised outlook from positive to stable for GSWC. Securities ratings are not recommendations to buy, sell or hold a security, and are subject to change or withdrawal at any time by the rating agencies. Registrant believes that AWR's sound capital structure and A+ credit rating, combined with its financial discipline, will enable AWR to access the debt and equity markets. However, unpredictable financial market conditions in the future may limit its access or impact the timing of when to access the market, in which case Registrant may choose to temporarily reduce its capital spending. AWR's ability to pay cash dividends on its Common Shares outstanding depends primarily upon cash flows from its subsidiaries. AWR intends to continue paying quarterly cash dividends in the future, on or aboutMarch 1 ,June 1 ,September 1 andDecember 1 , subject to earnings and financial conditions, regulatory requirements and such other factors as the Board of Directors may deem relevant. Registrant has paid dividends on its Common Shares for over 80 consecutive years. OnJanuary 28, 2020 , AWR's Board of Directors approved a first quarter dividend of$0.305 per share on AWR's Common Shares. Dividends on the Common Shares will be paid onMarch 2, 2020 to shareholders of record at the close of business onFebruary 14, 2020 . Cash Flows from Operating Activities: Cash flows from operating activities have generally provided sufficient cash to fund operating requirements, including a portion of construction expenditures at GSWC, construction expenses at ASUS and dividend payments. Registrant's future cash flows from operating activities are expected to be affected by a number of factors, including utility regulation; changes in tax law and deferred taxes; maintenance expenses; inflation; compliance with environmental, health and safety standards; production costs; customer growth; per-customer usage of water and electricity; weather and seasonality; conservation efforts; compliance with local governmental requirements, including mandatory restrictions on water use; and required cash contributions to pension and post-retirement plans. Future cash flows from contracted services subsidiaries will depend on new business activities, existing operations, the construction of new and/or replacement infrastructure at military bases, timely economic price and equitable adjustment of prices and timely collection of payments from theU.S. government and other prime contractors operating at the military bases. 39
--------------------------------------------------------------------------------
Table of Contents
The lower federal tax rate and the elimination of bonus depreciation brought
about by the 2017 Tax Cuts and Jobs Act ("Tax Act") have and are expected to
continue to reduce Registrant's cash flows from operating activities and result
in higher financing costs arising from an increased need to borrow and/or issue
equity securities more frequently. Pursuant to a CPUC directive, the 2018 impact
of the Tax Act on the water adopted revenue requirement was tracked in a
memorandum account effective January 1, 2018 . On July 1, 2018 , new lower water
rates, which incorporated the new federal income tax rate, were implemented for
all water ratemaking areas. As a result of receiving the May 2019 CPUC final
decision on the water general rate case, in the third quarter of 2019 GSWC
refunded to water customers approximately $7.2 million of over-collections
recorded in this memorandum account as a one-time surcredit.
ASUS funds its operating expenses primarily through internal operating sources,
which include U.S. government funding under 50-year contracts for operations and
maintenance costs and construction activities, as well as investments by, or
loans from, AWR. ASUS, in turn, provides funding to its subsidiaries. ASUS's
subsidiaries may also from time to time provide funding to ASUS or its
subsidiaries.
Cash flows from operating activities are primarily generated by net income,
adjusted for non-cash expenses such as depreciation and amortization. Cash
generated by operations varies during the year. Net cash provided by operating
activities was $116.9 million for the year ended December 31, 2019 as compared
to $136.8 million for the year ended December 31, 2018 . There was a decrease in
cash receipts in 2019 due to lower water customer usage, delays in receiving
decisions on the water and electric general rate cases and also the refunding of
$7.2 million to water customers during the third quarter related to the Tax Act.
The decrease in water customer usage increases the under-collection balance in
the WRAM regulatory asset, which is filed annually for recovery. These decreases
in cash flows were partially offset by an increase in cash resulting from the
timing in billing of and cash receipts for construction work at military bases
during 2019. The billings (and cash receipts) for construction work at our
contracted services segment generally occur at completion of the work or in
accordance with a billing schedule contractually agreed to with the U.S.
government and/or other prime contractors. Thus, cash flow from
construction-related activities may fluctuate from period to period with such
fluctuations representing timing differences of when the work is being performed
and when the cash is received for payment of the work. The timing of cash
receipts and disbursements related to other working capital items also affected
the change in net cash provided by operating activities.
Cash Flows from Investing Activities:
Net cash used in investing activities was $153.2 million for the year ended
December 31, 2019 as compared to $128.0 million used in 2018. The increase in
cash used in investing activities during 2019 was due to an increase in capital
expenditures as compared to 2018. Cash used for other investments consists
primarily of cash invested in a trust for a retirement benefit plan.
Registrant invests capital to provide essential services to its regulated
customer base and has an opportunity to earn a fair rate of return on
investments in infrastructure. Registrant's infrastructure investment plan
consists of both infrastructure renewal programs, where infrastructure is
replaced as needed, and major capital investment projects, where new water
treatment and delivery facilities are constructed. GSWC may also be required
from time to time to relocate existing infrastructure in order to accommodate
local infrastructure improvement projects. Projected capital expenditures and
other investments are subject to periodic review and revision.
Cash Flows from Financing Activities:
Registrant's financing activities include primarily: (i) the sale proceeds from
the issuance of Common Shares and stock option exercises and the repurchase of
Common Shares; (ii) the issuance and repayment of long-term debt and notes
payable to banks; and (iii) the payment of dividends on Common Shares. In order
to finance new infrastructure, Registrant also receives customer advances (net
of refunds) for, and contributions in aid of, construction. Short-term
borrowings are used to fund capital expenditures until long-term financing is
arranged.
Net cash provided by financing activities was $30.5 million for the year ended
December 31, 2019 as compared to net cash used of $1.8 million for the same
period in 2018. The increase in cash provided by financing activities in 2019
was due largely to increased borrowings on Registrant's credit facility to
partially fund capital expenditures, as well as repay $40 million in GSWC debt,
which became due in 2019.
GSWC
GSWC funds its operating expenses, payments on its debt, dividends on its
outstanding common shares and a portion of its construction expenditures through
internal sources. Internal sources of cash flow are provided primarily by
retention of a portion of earnings from operating activities. Internal cash
generation is influenced by factors such as weather patterns, conservation
efforts, environmental regulation, litigation, changes in tax law and deferred
taxes, changes in supply costs and regulatory decisions affecting GSWC's ability
to recover these supply costs, timing of rate relief, increases in maintenance
expenses and capital expenditures, surcharges authorized by the CPUC to enable
GSWC to recover expenses previously incurred from customers and CPUC
requirements to refund amounts previously charged to customers.
40--------------------------------------------------------------------------------
Table of Contents
GSWC may, at times, utilize external sources, including equity investments and borrowings from AWR, and long-term debt to help fund a portion of its construction expenditures. In addition, GSWC receives advances and contributions from customers, homebuilders and real estate developers to fund construction necessary to extend service to new areas. Advances for construction are generally refundable at a rate of 2.5% in equal annual installments over 40 years. Amounts that are no longer subject to refund are reclassified to contributions in aid of construction. Utility plant funded by advances and contributions is excluded from rate base. Generally, GSWC amortizes contributions in aid of construction at the same composite rate of depreciation for the related property. As is often the case with public utilities, GSWC's current liabilities may at times exceed its current assets. Management believes that internally generated funds, along with the proceeds from the issuance of long-term debt, borrowings from AWR and common share issuances to AWR, will be adequate to provide sufficient capital to enable GSWC to maintain normal operations and to meet its capital and financing requirements pending recovery of costs in rates. The CPUC requires GSWC to completely pay down all intercompany borrowings from AWR within a 24-month period. The end of the next 24-month period in which GSWC is required to completely pay down its intercompany borrowings will be inNovember 2020 . As a result, GSWC's intercompany borrowings of$158.8 million as ofDecember 31, 2019 have been classified as a current liability on GSWC's balance sheet. GSWC intends to use the proceeds from any new long-term debt to reduce its intercompany borrowings and to partially fund capital expenditures. AWR parent intends to use any financing proceeds from GSWC to pay down the amounts outstanding under its credit facility. Cash Flows from Operating Activities: Net cash provided by operating activities was$96.6 million for the year endedDecember 31, 2019 as compared to$120.4 million for the same period in 2018. The decrease in cash receipts in 2019 as compared to 2018 was due to lower water customer usage, delays in receiving decisions on the water and electric general rate cases and also the refunding of$7.2 million to water customers during the third quarter of 2019 related to the Tax Act. The decrease in water customer usage increases the under-collection balance in the WRAM regulatory asset, which is filed annually for recovery. The timing of cash receipts and disbursements related to other working capital items also affected the change in net cash provided by operating activities. Cash Flows from Investing Activities: Net cash used in investing activities was$144.2 million for the year endedDecember 31, 2019 as compared to$117.9 million for the same period in 2018. The increase in cash used in investing activities during 2019 was due to an increase in capital expenditures as compared to 2018. During the years endedDecember 31, 2019 and 2018, cash paid for capital expenditures was$142.9 million and$116.4 million , respectively. Capital expenditures incurred in 2019 and 2018 were consistent with GSWC's capital investment program. GSWC expects 2020 company-funded capital expenditures to be between$120 and$135 million . Cash Flows from Financing Activities: Net cash provided by financing activities was$43.8 million for 2019 as compared to net cash used of$1.4 million for 2018. The increase in net cash provided by financing activities during 2019 was due to an increase in intercompany borrowings as compared to 2018. These proceeds were used to partially fund capital expenditures and to repay$40.0 million of GSWC debt, which matured in 2019. There was also a decrease in dividends paid by GSWC to AWR parent in 2019 as compared to 2018. 41
--------------------------------------------------------------------------------
Table of Contents
Contractual Obligations, Commitments and Off-Balance-Sheet Arrangements Registrant has various contractual obligations which are recorded as liabilities in the consolidated financial statements. Other items, such as certain purchase commitments and operating leases, are not recognized as liabilities in the consolidated financial statements but are required to be disclosed. In addition to contractual maturities, Registrant has certain debt instruments that contain annual sinking funds or other principal payments. Registrant believes that it will be able to refinance debt instruments at their maturity through public issuance or private placement of debt or equity. Annual payments to service debt are generally made from cash flows from operations. The following table reflects Registrant's contractual obligations and commitments to make future payments pursuant to contracts as ofDecember 31, 2019 . The table reflects only financial obligations and commitments. Therefore, performance obligations associated with our 50-year firm, fixed-price contracts with theU.S. government at our contracted services segment are not included in the amounts below. All obligations and commitments are obligations and commitments of GSWC unless otherwise noted.
Payments/Commitments Due by Period (1)
Less than 1
($ in thousands) Total Year 1-3 Years 4-5 Years After 5 Years
Notes/Debentures (2) $ 187,000 $ - $ - $ - $ 187,000
Private Placement Notes (3) 83,000 - - - 83,000
Tax-Exempt Obligations (4) 11,293 156 348 378 10,411
Other Debt Instruments (5) 3,406 188 409 453 2,356
Total AWR Long-Term Debt $ 284,699 $ 344 757 $ 831 $ 282,767
Interest on Long-Term Debt (6) $ 234,813 $ 18,890 $ 37,721 $ 37,648 $ 140,554
Advances for Construction (7) 67,350 3,361 6,708 6,660 50,621
Renewable Energy Credit Agreement (8) 2,323 465 1,858 - -
Purchased Power Contracts (9) 26,347 6,224 11,157 8,966 -
Capital Expenditures (10) 50,878 50,878 - - -
Water Purchase Agreements (11) 4,116 417 834 834 2,031
Operating Leases (12) 15,983 2,709 4,750 3,278 5,246
Employer Contributions (13) 6,469 3,326 3,143 - -
SUB-TOTAL $ 408,279 $ 86,270 $ 66,171 $ 57,386 $ 198,452
Other Commitments (14) 214,802
TOTAL $ 907,780
(1) Excludes dividends and facility fees.
(2) The notes and debentures have been issued by GSWC under an Indenture dated
September 1, 1993 , as amended in December 2008 . The notes and debentures do not
contain any financial covenants that Registrant believes to be material or any
cross-default provisions.
(3) GSWC issued private placement notes in 1991 in the amount of $28 million
pursuant to the terms of note purchase agreements with substantially similar
terms. These agreements contain restrictions on the payment of dividends,
minimum interest coverage requirements, a maximum debt-to-capitalization ratio,
and a negative pledge. Pursuant to the terms of these agreements, GSWC must
maintain a minimum interest coverage ratio of two times interest expense. In
addition, a senior note in the amount of $40 million was issued by GSWC in
October 2005 to CoBank, ACB. A senior note in the amount of $15 million was
issued to The Prudential Insurance Company of America in December 2014 . Under
the terms of these senior notes, GSWC may not incur any additional debt or pay
any distributions to its shareholders if, after giving effect thereto, it would
have a debt to capitalization ratio in excess of 0.6667-to-1 or a debt to
earnings before interest, taxes, depreciation and amortization ratio of more
than 8-to-1. GSWC is in compliance with these covenant provisions as of
December 31, 2019 . GSWC does not currently have any outstanding mortgages or
other liens on indebtedness on its properties.
(4) Consists of obligations at GSWC related to (i) a loan agreement supporting
$7.7 million in outstanding debt issued by the California Pollution Control
Financing Authority , and (ii) $3.6 million of obligations with respect to GSWC's
500 acre-foot entitlement to water from the State Water Project ("SWP"). These
obligations do not contain any financial covenants
42--------------------------------------------------------------------------------
Table of Contents
believed to be material to Registrant or any cross-default provisions. In regard to its SWP entitlement, GSWC has entered into agreements with various developers for a portion of its 500 acre-foot entitlement to water from the SWP. (5) Consists of the outstanding debt portion of funds received under the American Recovery and Reinvestment Act for reimbursements of capital costs related to the installation of meters for conversion of non-metered service to metered service inGSWC's Arden-Cordova District . (6) Consists of expected interest expense payments based on the assumption that GSWC's long-term debt remains outstanding until maturity. (7) Advances for construction represent contract refunds by GSWC to developers for the cost of water systems paid for by the developers. The advances are generally refundable in equal annual installments over 40-year periods. (8) Consists of an agreement by GSWC to purchase renewable energy credits through 2023. These renewable energy credits are used by GSWC's electric division to meetCalifornia's renewables portfolio standard. (9) Consists of BVES fixed-cost purchased power contracts executed inSeptember 2019 withExelon Generation Company, LLC andMorgan Stanley Capital Group Inc. (10) Consists primarily of capital expenditures estimated to be required under signed contracts at GSWC as ofDecember 31, 2019 . (11) Water purchase agreements consist of (i) a remaining amount of$2.1 million under an agreement expiring in 2028 to use water rights from a third party, and (ii) an aggregate amount of$2.0 million of other water purchase commitments with other third parties, which expire through 2038. (12) Reflects future minimum payments under noncancelable operating leases for both GSWC and ASUS. (13) Consists of expected contributions to Registrant's defined benefit pension plan for the years 2020 through 2021. Contribution to the pension plan are expected to be the higher of the minimum required contribution under the Employee Retirement Income Security Act ("ERISA") or the amounts that are recovered in customer rates and approved by the CPUC. These amounts are estimates and are subject to change based on, among other things, the limits established for federal tax deductibility (pension plan) and the significant impact that returns on plan assets and changes in discount rates have on such amounts. (14) Other commitments consist primarily of (i) a$225 million revolving credit facility, of which$205.0 million was outstanding as ofDecember 31, 2019 ; (ii) a$8.9 million asset retirement obligation of GSWC that reflects the retirement of wells by GSWC, which by law need to be properly capped at the time of removal; (iii) an irrevocable letter of credit in the amount of$340,000 for the deductible in Registrant's business automobile insurance policy; (iv) an irrevocable letter of credit issued on behalf of GSWC in the amount of$585,000 as security for the purchase of power by BVES under an energy scheduling agreement with Automated Power Exchange; and (v) a$15,000 irrevocable letter of credit issued on behalf of GSWC pursuant to a franchise agreement with theCity of Rancho Cordova . InFebruary 2020 , AWR received a binding commitment from its lender for the option to temporarily increase the revolving credit facility to$260.0 million through the end of 2020. When needed, AWR will be able to exercise this commitment and have immediate access to the additional funds. OnDecember 31, 2020 , the borrowing capacity will revert to$200.0 million . All of the letters of credit are issued pursuant to the revolving credit facility. The revolving credit facility contains restrictions on prepayments, disposition of property, mergers, liens and negative pledges, indebtedness and guaranty obligations, transactions with affiliates, minimum interest coverage requirements, a maximum debt-to-capitalization ratio, and a minimum debt rating. Pursuant to the credit agreement, AWR must maintain a minimum interest coverage ratio of 3.25 times interest expense, a maximum total funded debt ratio of 0.65-to-1.00 and a minimum debt rating from Moody's or S&P of Baa3 or BBB-, respectively. As ofDecember 31, 2019 , AWR was in compliance with these covenants with an interest coverage ratio of 6.89 times interest expense, a debt ratio of 0.45-to-1.00 and debt ratings of A+ and A2. Off-Balance-Sheet Arrangements Registrant has various contractual obligations that are recorded as liabilities in the consolidated financial statements. Other items, such as certain purchase commitments, are not recognized as liabilities in the consolidated financial statements but are required to be disclosed. Except for those disclosed above in the table, Registrant does not have any other off-balance-sheet arrangements. 43
--------------------------------------------------------------------------------
Table of Contents
Effects of Inflation The rates of GSWC are established to provide recovery of costs and a fair return on shareholders' investment. Recovery of the effects of inflation through higher water rates is dependent upon receiving adequate and timely rate increases; however, authorized rates charged to customers are usually based on a forecast of expenses and capital costs for GSWC. Rates may lag increases in costs caused by unanticipated inflation. During periods of moderate to low inflation, as has been experienced for the last several years, the effects of inflation on operating results have not been significant. Furthermore, the CPUC approves projections for a future test year in general rate cases which reduces the impact of inflation to the extent that GSWC's inflation forecasts are accurate. For the Military Utility Privatization Subsidiaries, under the terms of the contracts with theU.S. government, the contract price is subject to an economic price adjustment on an annual basis. ASUS has experienced delays in some of its economic price adjustments. However, when adjustments are finalized, they are implemented retroactively to the effective date of the economic price adjustment. Climate Change Water - GSWC considers the potential impacts of climate change in its water supply portfolio planning and its overall infrastructure replacement plans. In addition, GSWC considers the impacts of greenhouse gas emissions and other environmental concerns in its operations and infrastructure investments. Electric -California has established a cap-and-trade program applicable to greenhouse gas emissions. While BVES's power-plant emissions are below the reporting threshold, as a "Covered Entity" BVES has an obligation to file a report in June of each year under the Greenhouse Gas Mandatory Reporting Regulation. TheState of California and the CPUC have also established renewable energy procurement targets. BVES has entered into a CPUC-approved ten-year contract for renewable energy credits. Because of this agreement, BVES believes it will comply through at least 2023 withCalifornia's renewable energy statutes that address this issue. BVES is also required to comply with the CPUC's greenhouse gas emission performance standards. Under these standards, BVES must file an annual attestation with the CPUC stating that BVES is in compliance. Specifically, BVES must attest to having no new ownership investment in generation facilities exceeding the emission performance standards and no long-term commitments for generation exceeding the standards. InFebruary 2020 , BVES filed an attestation that BVES complied with the standards for 2019. At this time, management cannot estimate the impact, if any, that these regulations may have on future costs over BVES's power plant operations or the cost of BVES's purchased power from third party providers. BVES Power-Supply Arrangements BVES began taking power pursuant to purchased power contracts approved by the CPUC effective in the fourth quarter of 2019 at a fixed cost over three and five-year terms depending on the amount of power and period during which the power is purchased under the contracts. In addition to the purchased power contracts, BVES buys additional energy to meet peak demand as needed and sells surplus power when necessary. The average price per MWh, including fixed costs, decreased to$75.47 per MWh in 2019 from$79.90 per MWh for the year endedDecember 31, 2018 . BVES's average energy costs are impacted by pricing fluctuations on the spot market. However, BVES has implemented an electric-supply-cost balancing account, as approved by the CPUC, to alleviate any impacts to earnings. Construction Program GSWC maintains an ongoing water distribution main replacement program throughout its customer service areas based on the age and type of distribution-system materials, priority of leaks detected, remaining productive life of the distribution system and an underlying replacement schedule. In addition, GSWC upgrades its electric and water supply facilities in accordance with industry standards, local and CPUC requirements, and new legislation. InSeptember 2018 , theCalifornia legislature enacted Senate Bill (SB) 901 mandating investor-owned electric utilities to submit an annual wildfire mitigation plan to the CPUC for approval. SB 901 requires all electric utilities to prepare plans on constructing, maintaining, and operating their electrical lines and equipment to minimize the risk of catastrophic wildfire. As ofDecember 31, 2019 , GSWC has unconditional purchase obligations for capital projects of approximately$50.9 million . During the years endedDecember 31, 2019 , 2018 and 2017, GSWC had capital expenditures of$140.8 million ,$125.1 million and$115.3 million , respectively. A portion of these capital expenditures was funded by developers through contributions in aid of construction, which are not required to be repaid, and refundable advances. During the years endedDecember 31, 2019 , 2018 and 2017, capital expenditures funded by developers were$4.7 million ,$4.1 million and$3.5 million , respectively. During 2020, GSWC's company-funded capital expenditures are estimated to be approximately$120 -$135 million . 44
--------------------------------------------------------------------------------
Table of Contents
Contracted Services
Under the terms of the current and future utility privatization contracts with theU.S. government, each contract's price is subject to an economic price adjustment ("EPA") on an annual basis. In the event that ASUS (i) is managing more assets at specific military bases than were included in theU.S. government's request for proposal, (ii) is managing assets that are in substandard condition as compared to what was disclosed in the request for proposal, (iii) prudently incurs costs not contemplated under the terms of the utility privatization contract, and/or (iv) becomes subject to new regulatory requirements, such as more stringent water-quality standards, ASUS is permitted to file, and has filed, requests for equitable adjustment ("REA"). The timely filing for and receipt of EPAs and/or REAs continues to be critical in order for the Military Utility Privatization Subsidiaries to recover increasing costs of operating, maintaining, renewing, and replacing the water and/or wastewater systems at the military bases it serves. Under the Budget Control Act of 2011 (the "2011 Act"), substantial automatic spending cuts, known as "sequestration," have impacted the expected levels ofDepartment of Defense budgeting. The Military Utility Privatization Subsidiaries have not experienced any earnings impact to their existing operations and maintenance and renewal and replacement services, as utility privatization contracts are an "excepted service" within the 2011 Act. While the ongoing effects of sequestration have been mitigated through the passage of the Bipartisan Budget Act of 2018 for fiscal years 2018 and 2019, similar issues may arise as part of fiscal uncertainty and/or future debt-ceiling limits imposed byCongress . However, any future impact on ASUS and its operations through the Military Utility Privatization Subsidiaries will likely be limited to (a) the timing of funding to pay for services rendered, (b) delays in the processing of EPAs and/or REAs, (c) the timing of the issuance of contract modifications for new construction work not already funded by theU.S. government, and/or (d) delays in the solicitation for and/or awarding of new contracts under theDepartment of Defense utility privatization program. Furthermore, fromDecember 22, 2018 untilJanuary 25, 2019 , theU.S. government shutdown impacted non-essential government employees due to the lack of an approved appropriations bill to fund the operations of the federal government for fiscal year 2019. However, the shutdown did not have any meaningful impact on ASUS due to the fact that funding for military operations (including military bases) is provided by theDepartment of Defense , which is fully funded for fiscal year 2019 and was not part of the government shutdown. There were no further shutdowns during the remainder of 2019 and the start of 2020 as two continuing resolutions and a spending package were passed allowing the federal government funding to continue for 2020. At times, the DCAA and/or the DCMA may, at the request of a contracting officer, perform audits/reviews of contractors for compliance with certain government guidance and regulations, such as the Federal Acquisition Regulations and Defense Federal Acquisition Regulation Supplements. Certain audit/review findings, such as system deficiencies for government-contract-business-system requirements, may result in delays in the resolution of filings submitted to and/or the ability to file new proposals with theU.S. government. Below is a summary of current and projected EPA filings for price adjustments to operations and maintenance fees and renewal and replacement fees for the Military Utility Privatization Subsidiaries in fiscal 2020. Military Base EPA period Filing Date October 2019 - Third Quarter Fort Bliss (FBWS) September 2020 2019 February 2020 - Fourth Andrews Air Force Base (TUS) January 2021 Quarter 2019 February 2020 - Fourth Fort Lee (ODUS) January 2021 Quarter 2019 Joint BaseLangley Eustis and Joint Expeditionary Base Little Creek Fort Story April 2020 - First Quarter (ODUS) March 2021 of 2020 February 2020 - Fourth Fort Jackson (PSUS) January 2021 Quarter 2019 March 2020 - First Quarter Fort Bragg (ONUS) February 2021 2020 June 2020 - May Second Eglin Air Force Base (ECUS) 2021 Quarter 2020 July 2020 - June Second Fort Riley (FRUS) 2021 Quarter 2020
ASUS assumed the operation of the water distribution and wastewater collection
and treatment facilities at
45--------------------------------------------------------------------------------
Table of Contents
Regulatory Matters
Certificates of Public Convenience and Necessity
GSWC holds Certificates of Public Convenience and Necessity ("CPCN") granted by
the CPUC in each of the ratemaking areas it serves. ASUS is regulated, if
applicable, by the state in which it primarily conducts water and/or wastewater
operations. FBWS holds a CPCN from the Public Utilities Commission of Texas .
The Virginia State Corporation Commission exercises jurisdiction over ODUS as a
public service company. The Maryland Public Service Commission approved the
right of TUS to operate as a water and wastewater utility at Joint Base Andrews,
Maryland , based on certain conditions. The South Carolina Public Service
Commission exercises jurisdiction over PSUS as a public service company. ONUS
is regulated by the North Carolina Public Service Commission . ECUS and FRUS are
not subject to regulation by their respective states' utility commissions.
Rate Regulation
GSWC is subject to regulation by the CPUC which has broad authority over service
and facilities, rates, classification of accounts, valuation of properties, the
purchase, disposition and mortgaging of properties necessary or useful in
rendering public utility service, the issuance of securities, the granting of
certificates of public convenience and necessity as to the extension of services
and facilities and various other matters.
Rates that GSWC is authorized to charge are determined by the CPUC in general
rate cases and are derived using rate base, cost of service and cost of capital,
as projected for a future test year. Rates charged to customers vary according
to customer class and rate jurisdiction and are generally set at levels allowing
for recovery of prudently incurred costs, including a fair return on rate base.
Rate base generally consists of the original cost of utility plant in service,
plus certain other assets, such as working capital and inventory, less
accumulated depreciation on utility plant in service, deferred income tax
liabilities and certain other deductions.
GSWC is required to file a water general rate case application every three years
according to a schedule established by the CPUC. General rate cases typically
include an increase in the first test year with inflation-rate adjustments for
expenses for the second and third years of the rate case cycle. For capital
projects, there are two test years. Rates are based on a forecast of expenses
and capital costs for each test year. Electric general rate cases are typically
filed every four years. Rates may also be increased by offsets for certain
expense increases, including, but not limited to, supply-cost offset and
balancing-account amortization, advice letter filings related to certain plant
additions and other operating cost increases.
Neither the operations nor rates of AWR and ASUS are directly regulated by the
CPUC. The CPUC does, however, regulate certain transactions between GSWC and
ASUS and between GSWC and AWR.
General Rate Case Filings
Water Segment:
In July 2017 , GSWC filed a general rate case application for all of its water
regions and the general office to determine new rates for the years 2019 - 2021.
On May 30, 2019 , the CPUC issued a final decision on GSWC's water general rate
case with rates retroactive to January 1, 2019 . Among other things, the final
decision approves in its entirety an August 2018 settlement agreement that had
been entered into between GSWC and the CPUC's Public Advocates Office. As a
result, the final decision authorizes GSWC to invest approximately $334.5
million over the rate cycle. The $334.5 million of infrastructure investment
includes $20.4 million of capital projects to be filed for revenue recovery
through advice letters when those projects are completed.
Excluding the advice letter project revenues, the new rates approved increased
the adopted water gross margin for 2019 by approximately $7.1 million , adjusted
for updated inflation index values since the August 2018 settlement, as compared
to the 2018 adopted water gross margin. The 2019 water revenue requirement has
been reduced to reflect a decrease of approximately $7.0 million in depreciation
expense, compared to the adopted 2018 depreciation expense, due to a reduction
in the overall composite depreciation rates based on a revised study filed in
the general rate case. The decrease in depreciation expense lowers the water
gross margin and is offset by a corresponding decrease in depreciation expense,
resulting in no impact to net earnings. In addition, the 2019 water revenue
requirement includes a decrease of approximately $2.2 million for excess
deferred tax refunds as a result of the 2017 Tax Cuts and Jobs Act ("Tax Act"),
with a corresponding decrease in income tax expense also resulting in no impact
to net earnings. Had depreciation remained the same as the 2018 adopted amount
and there were no excess deferred tax refunds that lowered the 2019 revenue
requirement, the water gross margin for 2019 would have increased by
approximately $16.3 million .
As a result of the May 2019 CPUC final decision, GSWC implemented new water
rates on June 8, 2019 . The final decision also allowed for a water gross margin
increase of approximately $10.4 million from new customer rates for 2020, which
were effective January 1, 2020 , as well as an additional increase of
approximately $11.4 million in 2021, subject to the results of an earnings test
and changes to the forecasted inflationary index values.
46--------------------------------------------------------------------------------
Table of Contents
Electric Segment: InMay 2017 , GSWC filed its electric general rate case application with the CPUC to determine new electric rates for the years 2018 through 2021. InNovember 2018 , GSWC and the Public Advocates Office filed a joint motion to adopt a settlement agreement between the two parties resolving all issues in connection with the general rate case. OnAugust 15, 2019 , the CPUC issued a final decision on this general rate case, adopting the settlement agreement in its entirety. Among other things, the decision (i) extends the rate cycle by one year (new rates will be effective for 2018 - 2022); (ii) increases the adopted electric gross margin for 2018 by approximately$2.3 million compared to the 2017 adopted electric gross margin, adjusted for Tax Act changes; (iii) authorizes BVES to construct all the capital projects requested in its application, which are dedicated to improving system safety and reliability and total approximately$44 million over the 5-year rate cycle; and (iv) increases the adopted electric gross margin by$1.2 million for each of the years 2019 and 2020, by$1.1 million in 2021, and by$1.0 million in 2022. The rate increases for 2019 - 2022 are not subject to an earnings test. The decision authorizes a return on equity for GSWC's electric segment of 9.60%, as compared to its previously authorized return of 9.95% and includes a capital structure and debt cost that is consistent with those approved by the CPUC inMarch 2018 in connection with GSWC's water segment cost of capital proceeding. Cost of Capital Proceedings InMarch 2018 , the CPUC issued a final decision in the cost of capital proceeding for GSWC and three other water utilities servingCalifornia for the years 2018 - 2020. Among other things, the final decision adopted for GSWC's water segment a return on equity of 8.90%, with a return on rate base of 7.91%. The previously authorized return on equity for GSWC's water segment was 9.43%, with a return on rate base of 8.34%. Investor-owned water utilities servingCalifornia are required to file their cost of capital applications on a triennial basis with the next scheduled filing to take place onMay 1, 2020 effective for the years 2021 - 2023. InJanuary 2020 , GSWC, along with the three other water utilities, requested an extension of the date by which each of them must file its 2020 cost of capital applications. If approved, the request would postpone this filing date by one year untilMay 1, 2021 , with a corresponding effective date ofJanuary 1, 2022 . As part of this request, the joint parties agreed to leave the current Water Cost of Capital Mechanism in place, but that there will be no changes to the respective costs of capital during the one-year extension, regardless of what the mechanism might otherwise indicate. The joint parties are currently awaiting the CPUC's response to the joint request. Other Regulatory Matters Application to Transfer Electric Utility Operations to New Subsidiary: GSWC filed applications with the CPUC and theFERC inDecember 2018 andJuly 2019 , respectively, to transfer the assets and liabilities of the BVES division of GSWC toBear Valley Electric Service, Inc. , a newly created separate legal entity and stand-alone subsidiary of AWR. Due to the differences in operations, regulations, and risks, management believes a separate electric legal entity and stand-alone subsidiary of AWR is in the best interests of customers, employees, and the communities served. TheFERC and CPUC approved GSWC's application for reorganization in October and December of 2019, respectively. The reorganization plan is pending the completion of certain closing procedures to effectuate the transfer of assets and liabilities including, among other things, an additionalFERC approval for tariffs. When completed, the reorganization plan is not expected to result in a substantive change to AWR's operations and business segments. Wildfire Mitigation Plan and New California Legislation: InSeptember 2018 , theCalifornia legislature enacted Senate Bill (SB) 901 mandating investor-owned electric utilities to submit an annual wildfire mitigation plan (WMP) to the CPUC for approval. SB 901 requires all electric utilities to prepare plans on constructing, maintaining, and operating their electrical lines and equipment to minimize the risk of catastrophic wildfire. InFebruary 2019 BVES filed its first WMP, which was subsequently approved by the CPUC inJune 2019 . Among other things, the WMP approves capital projects and programs dedicated to improving system safety and reliability and, specifically, aimed at reducing the possibility of wildfires. Upon approval inJune 2019 , BVES commenced executing its WMP immediately. BVES filed its second WMP with the CPUC onFebruary 7, 2020 . Additionally, theCalifornia legislature enacted Assembly Bill (AB) 1054 inJuly 2019 , which among other things, changed the burden of proof applicable in CPUC proceedings in which an electric utility with a valid safety certification seeks to recover wildfire costs. Traditionally, an electric utility seeking to recover costs has the burden to prove that it acted reasonably. Under AB 1054, if an electric utility has a valid safety certification, it will be presumed to have acted reasonably unless a party to the relevant proceeding creates a "serious doubt" as to the reasonableness of the utility's conduct. BVES received its initial safety certification from the CPUC onFebruary 4, 2020 . 47
--------------------------------------------------------------------------------
Table of Contents
AB 1054 also establishes aWildfire Fund to pay eligible claims arising from a covered wildfire under certain circumstances.The Wildfire Fund is expected to be funded partially by electrical corporation shareholders, and partly by ratepayers.California's three largest electric utilities are participating in theWildfire Fund . Other investor-owned electric utilities (referred to as "regional" utilities), including GSWC's BVES division have decided not to participate. It is highly unlikely that theWildfire Fund will have any financial value for regional utilities such as BVES because withdrawals by a regional utility are capped per wildfire at three times the regional utility's aggregate initial and annual contributions and withdrawals may only be made if and to the extent that the amount of the claims against the utility (which must be settled or finally adjudicated) in a given year exceed the greater of the amount of the utility's insurance or$1 billion dollars . It is remote that claims within BVES's service territory from a wildfire will reach the$1 billion minimum, and if they did, the claims would likely exceed the amount that the electric division would be able to access from theWildfire Fund .Solar Energy Project : BVES is subject to theCalifornia renewables portfolio standard ("RPS") law, which requires BVES to meet certain targets for purchases of energy from qualified renewable energy resources. BVES has purchased renewable energy credits from sources outside its service territory, which are being used towards meeting the RPS requirements. However, to ensure local area reliability and help meet its RPS requirements over the long-term, inDecember 2019 , BVES filed an application with the CPUC for the development of a turn-key solar project within its service territory. BVES has selected a 7.9-megawatt solar generation project that will be constructed by a third party and will be connected directly with BVES's existing distribution system, which will help in achievingCalifornia's energy and environmental goals. BVES estimates the total cost of this solar project to be approximately$14.3 million . InDecember 2019 , BVES filed a joint motion to adopt a settlement agreement between BVES and theCPUC's Public Advocates Office for approval to acquire, own and operate the solar generation project upon completion. The CPUC is scheduled to issue a proposed decision in this proceeding during the second quarter of 2020. For more information regarding significant regulatory matters, see Note 3 of "Notes to Financial Statements" included in Part II, Item 8, in Financial Statements and Supplementary Data. Environmental Matters AWR's subsidiaries are subject to stringent environmental regulations. GSWC is required to comply with the safe drinking water standards established by theU.S. Environmental Protection Agency ("U.S. EPA") and theDivision of Drinking Water ("DDW"), under theState Water Resources Control Board ("SWRCB"). TheU.S. EPA regulates contaminants that may have adverse health effects that are known or likely to occur at levels of public health concern, and the regulation of which will provide a meaningful opportunity for health risk reduction. The DDW, acting on behalf of theU.S. EPA , administers theU.S. EPA's program inCalifornia . Similar state agencies administer these rules in the other states in which Registrant operates. GSWC currently tests its water supplies and water systems according to, among other things, requirements listed in the Federal Safe Drinking Water Act ("SDWA"). GSWC works proactively with third parties and governmental agencies to address issues relating to known contamination threatening GSWC water sources. GSWC also incurs operating costs for testing to determine the levels, if any, of the constituents in its sources of supply and additional expense to treat contaminants in order to meet the federal and state maximum contaminant level standards and consumer demands. GSWC expects to incur additional capital costs as well as increased operating costs to maintain or improve the quality of water delivered to its customers in light of anticipated stress on water resources associated with watershed and aquifer pollution, as well as to meet future water quality standards and consumer expectations. The CPUC ratemaking process provides GSWC with the opportunity to recover prudently incurred capital and operating costs in future filings associated with achieving water quality standards. Management believes that such incurred and expected future costs should be authorized for recovery by the CPUC. Matters Relating to Environmental Cleanup GSWC has been involved in environmental remediation and cleanup at a plant site ("Chadron Plant") that contained an underground storage tank that was used to store gasoline for its vehicles. This tank was removed from the ground inJuly 1990 along with the dispenser and ancillary piping. Since then, GSWC has been involved in various remediation activities at this site. As ofDecember 31, 2019 , the total spent to cleanup and remediate GSWC's plant facility was approximately$6.3 million , of which$1.5 million has been paid by theState of California Underground Storage Tank Fund . Amounts paid by GSWC have been included in rate base and approved by the CPUC for recovery. As ofDecember 31, 2019 , GSWC has a regulatory asset and an accrued liability for the estimated additional cost of$1.3 million to complete the cleanup at the site. The estimate includes costs for continued activities of groundwater cleanup and monitoring, future soil treatment, and site closure related activities. The ultimate cost may vary as there are many unknowns in remediation of underground gasoline spills and this is an estimate based on currently available information. Management also believes it is probable that the estimated additional costs will be approved for inclusion in rate base by the CPUC. 48
--------------------------------------------------------------------------------
Table of Contents
Drinking Water Notification and Response Levels InJuly 2018 , DDW issued drinking water notification levels for certain fluorinated organic chemicals used to make certain fabrics and other materials, and used in various industrial processes. These chemicals were also present in certain fire suppression agents. These chemicals are referred to as perfluoroalkyl substances (PFAS). Notification levels are health-based advisory levels established for contaminants in drinking water for which maximum contaminant levels have not been established. The US EPA has also established health advisory levels for these compounds. Notification to consumers and stakeholders is required when the advisory levels or notification levels are exceeded. Assembly Bill 756, signed into law inJuly 2019 and effective inJanuary 2020 , requires, among other things, additional notification requirements for water systems detecting levels of PFAS above response levels. GSWC is in the process of collecting and analyzing samples for PFAS under the direction of DDW. GSWC has removed some wells from service, and expects to incur additional treatment costs to treat impacted wells. GSWC has provided customers with information regarding PFAS detections, and provided updated information via its website. InFebruary 2020 , DDW established new response levels for two of the PFAS compounds: 10 parts per trillion for perfluorooctanoic acid (PFOA) and 40 parts per trillion for perfluorooctanesulfonic acid (PFOS). Lead Testing in Schools InJanuary 2017 , theCalifornia State Water Resources Control Board -Division of Drinking Water (DDW) issued a permit amendment that required all community water systems to test the schools in their service area for lead, if sampling is requested in writing by the institution's officials. In addition, theCalifornia Assembly passed Assembly Bill 746 inOctober 2017 , which required all community water systems that serve a school site of a local educational agency with a building constructed beforeJanuary 1, 2010 , to test for lead in the potable water system of the school site on or beforeJuly 1, 2019 . GSWC worked extensively with the schools in its service areas. As a result of concerted outreach to the schools, GSWC completed lead sampling at all schools that were subject to Assembly Bill 746 in its service area in 2019. Matters Relating to Military Privatization Contracts Each of the Military Utility Privatization Subsidiaries is responsible for testing the water and wastewater systems on the military bases on which it operates in accordance with applicable law. Each of the Military Utility Privatization Subsidiaries has the right to seek an equitable adjustment to its contract in the event that there are changes in environmental laws, a change in the quality of water used in providing water service or wastewater discharged by theU.S. government, or contamination of the air or soil not caused by the fault or negligence of the Military Utility Privatization Subsidiary. These changes can impact operations and maintenance and renewal and replacement costs under the contracts. TheU.S. government is responsible for environmental contamination due to its fault or negligence and for environmental contamination that occurred prior to the execution of a contract. Security Issues GSWC has security systems and infrastructure in place intended to prevent unlawful intrusion, service disruption and cyber-attacks. GSWC utilizes a variety of physical security measures to protect its facilities. GSWC also considers advances in security and emergency preparedness technology and relevant industry developments in developing its capital-improvement plans. GSWC intends to seek approval of the CPUC to recover any additional costs that it incurs in enhancing the security, reliability and resiliency of its water and electric systems. The Military Utility Privatization Subsidiaries operate facilities within the boundaries of military bases, which provide limited access to the general public. To further enhance security, in prior years, certain upgrades were completed at various military bases through contract modifications funded by theU.S. government. Registrant has evaluated its cyber-security systems and continues to address identified areas of improvement with respect toU.S. government regulations regarding cyber-security of government contractors. These improvements include the physical security at all of the office and employee facilities it operates. Registrant believes it is in compliance with these regulations. Despite its efforts, Registrant cannot guarantee that intrusions, cyber-attacks or other attacks will not cause water or electric system problems, disrupt service to customers, compromise important data or systems or result in unintended release of customer or employee information. 49
--------------------------------------------------------------------------------
Table of Contents
GSWC's Water Supply
During 2019, GSWC delivered approximately 59.5 million hundred cubic feet
("ccf") of water to its customers, which is an average of about 374 acre-feet
per day (an acre-foot is approximately 435.6 ccf or 326,000 gallons).
Approximately 53% of GSWC's supply came from groundwater production wells
situated throughout GSWC's service areas. GSWC supplemented its groundwater
production with wholesale purchases from Metropolitan Water District ("MWD")
member agencies and regional water suppliers (roughly 44% of total demand) and
with authorized diversions from rivers (roughly 3%) under contracts with the
United States Bureau of Reclamation ("Bureau") and the Sacramento Municipal
Utility District ("SMUD"). GSWC also utilizes recycled water supplies to serve
recycled water customers in several service areas. GSWC continually assesses its
water rights and groundwater storage assets.
Groundwater
GSWC has a diverse water supply portfolio which includes adjudicated groundwater
rights, surface water rights, and a number of unadjudicated water rights to help
meet supply requirements. The productivity of GSWC's groundwater resources
varies from year to year depending upon a variety of factors, including natural
replenishment from snow-melt or rainfall, the availability of imported
replenishment water, the amount of water previously stored in groundwater
basins, natural or man-made contamination, legal production limitations, and the
amount and seasonality of water use by GSWC's customers and others. GSWC
actively participates in efforts to protect groundwater basins from over-use and
from contamination. In some periods, these efforts may require reductions in
groundwater pumping and increased reliance on alternative water resources. GSWC
also participates in implementation of California's Sustainable Groundwater
Management Act.
From time to time, GSWC may purchase or temporarily use water rights from others
for delivery to customers. GSWC has contracts to purchase water or water rights
for an aggregate amount of $4.1 million as of December 31, 2019 . Included in
the $4.1 million is a remaining commitment of $2.1 million under an agreement
with the City of Claremont ("the City") to lease water rights that were ascribed
to the City as part of the Six Basins adjudication. The initial term of the
agreement expires in 2028. GSWC may exercise an option to renew this agreement
for 10 additional years. The remaining $2.0 million is for commitments for
purchased water with other third parties, which expire through 2038.
Imported Water
GSWC also manages a portfolio of water supply arrangements with water
wholesalers who may import water from outside the immediate service area. For
example, GSWC has contracts with various governmental entities (principally MWD
member agencies) and other parties to purchase water through a total of 58
connections for distribution to customers, in addition to numerous emergency
connections. MWD is a public agency organized and managed to provide a
supplemental, imported supply to its member public agencies. There are 26 such
member agencies, consisting of 14 cities, 11 municipal water districts and one
county water authority. GSWC has 45 connections to MWD's water distribution
facilities and those of member agencies. GSWC purchases MWD water through six
separate member agencies aggregating 49,973 acre-feet annually. MWD's principal
source of water is the SWP and the Colorado River via the Colorado River
Aqueduct.
Drought Impact
In May 2018 , the California Legislature passed two bills that provide a
framework for long-term water-use efficiency standards and drought planning and
resiliency. The initial steps in implementation of this legislation has been
laid out in a summary document by the California Department of Water Resources
("DWR") and State Water Resources Control Board ("SWQCB"). Over the next several
years, State agencies, water suppliers and other entities will be working to
meet the requirements and timelines of plan implementation. A notable milestone
is the establishment of indoor water use standard of 55 gallons per capita per
day (gpcd) until 2025 at which time the standard may be reduced to 52.5 gpcd or
a new standard as recommend by DWR.
California's recent period of multi-year drought resulted in reduced recharge to
the state's groundwater basins. GSWC utilizes groundwater from numerous
groundwater basins throughout the state. Several of these basins, especially
smaller basins, experienced lower groundwater levels because of the drought.
Several of GSWC's service areas rely on groundwater as their only source of
supply. Given the critical nature of the groundwater levels in California's
Central Coast area, GSWC implemented mandatory water restrictions in certain
service areas, in accordance with CPUC procedures. In the event of water supply
shortages beyond the locally available supply, GSWC would need to transport
additional water from other areas, increasing the cost of water supply.
The 2018-2019 water year was a normal year, with rainfall in northern California
being above normal levels. Precipitation to date in 2020 has been slightly below
normal levels with statewide snowpack at about 75% of average. As of February
18, 2020 , the U.S. Drought Monitor reported that approximately 10% of California
was considered in a "Moderate Drought" as compared to approximately 4% one year
ago. If dry conditions continue or get worse, the SWQCB or other regulatory
agencies may impose emergency drought actions. Due to local conditions,
water-use restrictions and allocations
50--------------------------------------------------------------------------------
Table of Contents
remain in place for customers in some of GSWC's service areas. GSWC continues assessing water supply conditions and water-use restrictions in these service areas and will make appropriate adjustments as needed. Military Utility Privatization Subsidiaries TheU.S. government is responsible for providing the source of supply for all water on each of the bases served by the Military Utility Privatization Subsidiaries at no cost to the Military Utility Privatization Subsidiaries. Once received from theU.S. government, ASUS is responsible for ensuring the continued compliance of the provided source of supply with all federal, state and local regulations. New Accounting Pronouncements Registrant is subject to newly issued accounting requirements as well as changes in existing requirements issued by theFinancial Accounting Standards Board . See Note 1 of Notes to Consolidated Financial Statements. 51
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source
