General
The following discussion and analysis provides information on AWR's consolidated operations and assets and includes specific references to AWR's individual segments and/or its subsidiaries (GSWC and ASUS and its subsidiaries), and AWR (parent) where applicable. 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, which equals each business segment's earnings divided by Registrant's weighted average number of diluted shares. Registrant believes that the disclosure of the water and electric gross margins and earnings per share by business segment provide investors with clarity surrounding the performance of its different services. 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 accounting principles generally accepted inthe United States of America ("GAAP"), may not be comparable to similarly titled measures used by other entities 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." A reconciliation to AWR's diluted earnings per share is included in the discussion under the sections titled "Summary of First Quarter Results by Segment." Overview Factors affecting our financial performance are summarized under Forward-Looking Information and under "Risk Factors" in our Form 10-K for the period endedDecember 31, 2019 . 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: InMay 2019 , the CPUC issued a final decision on GSWC's water general rate case, which determines new rates for the years 2019 - 2021 with rates retroactive toJanuary 1, 2019 . Among other things, the final decision authorized 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. Due to the delay in receiving a final CPUC decision on the water general rate case, billed water revenues for the first three months of 2019 were based on 2018 adopted rates, pending a final decision. As a result of theMay 2019 CPUC final decision, GSWC recorded the impact of the final decision in the second quarter of 2019, including earnings of$0.08 per share that related to the first quarter of 2019. The final decision also allowed for a water gross margin increase in 2020 and 2021, subject to an earnings test. EffectiveJanuary 1, 2020 , GSWC received its full second-year step increase, which it achieved because of passing the earnings test at all of its ratemaking areas. The full step increase is expected to generate an additional$10.4 million in water gross margin for 2020. The final decision will also allow for a potential additional increase in the water gross margin 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: InAugust 2019 , the CPUC issued a final decision on the electric general rate case. Among other things, the decision (i) extended the rate cycle by one year (new rates were effective for 2018 - 2022); (ii) increased the electric gross margin for 2018 by approximately$2.3 million compared to the 2017 adopted electric gross margin, adjusted for Tax Act changes; 26
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(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% 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 the first three months of 2019 were based on 2017 adopted rates. Because theAugust 2019 CPUC final decision was retroactive toJanuary 1, 2018 , the cumulative retroactive earnings impact of the decision was included in the third quarter results of 2019, including approximately$0.02 per share related to the first quarter of 2019 had the new 2018 and 2019 rates been in place at that time. Cost of Capital Proceeding: Investor-owned water utilities servingCalifornia are required to file their cost of capital applications on a triennial basis, with the next scheduled filing required to have taken place onMay 1, 2020 and to be 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 application. InMarch 2020 , the CPUC approved the request, postponing the filing date by one year untilMay 1, 2021 , with a corresponding effective date ofJanuary 1, 2022 . The CPUC also approved the joint parties' request to leave the current Water Cost of Capital Mechanism in place, but there will be no changes to the companies' rate of return on rate base during the one-year extension, regardless of what the mechanism might otherwise indicate. GSWC's current authorized rate of return on rate base is 7.91%, based on its weighted cost of capital, which will continue in effect throughDecember 31, 2021 . The 7.91% return on rate base includes a return on equity of 8.9%, an embedded cost of debt of 6.6%, and a capital structure with 57% equity and 43% debt. 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. COVID-19: Recently, the outbreak of novel coronavirus (COVID-19) has become a global pandemic. GSWC continues to operate as its water and electric utility services are deemed essential services. GSWC's response to the COVID-19 outbreak continues to rapidly evolve and has included: (i) suspending throughApril 2021 service disconnections for nonpayments pursuant to CPUC orders, which will remain in effect over other existing requirements governing disconnections; (ii) waiving reconnection or facilities fees for affected customers and suspending deposit requirements for affected customers who must reconnect to the system; (iii) the temporary closing of customer service offices; (iv) increasing the number of employees telecommuting; and (v) delaying some capital improvement projects at its water utility services business. The effects of the continuing pandemic on the Company are still emerging, but among other things, it has caused significant negative impacts on financial markets. This has resulted in significant fluctuations in the fair value of plan assets in the Company's pension and other retirement plans, which are likely to continue. Furthermore, due to expected future credit losses on utility customer bills, GSWC has increased its allowance for doubtful accounts as ofMarch 31, 2020 and expects to increase intercompany borrowings as well as borrowings from outside sources due to the associated potential decrease in liquidity. Thus far, the COVID-19 pandemic has not had a material impact on ASUS's operations, as the water and wastewater services performed on the military bases are deemed essential services. The extent to which COVID-19 may materially impact GSWC's results is uncertain but will depend on future developments, which cannot be predicted at this time. However, the CPUC has approved GSWC to track incremental costs, including bad debt expense in excess of what is included in GSWC's revenue requirement, incurred as a result of the COVID-19 pandemic in a Catastrophic Event Memorandum Account ("CEMA") to be filed with the CPUC for future recovery. 27
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Summary of First Quarter Results by Segment The table below sets forth the first quarter diluted earnings per share by business segment:
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