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 its subsidiaries (GSWC, BVESI, andASUS and its subsidiaries), and AWR (parent) where applicable. Included in the following analysis is a discussion about "operating revenues less supply costs" at AWR's water and electric segments. Operating revenues less supply costs are computed by subtracting water supply costs from water operating revenues, and by subtracting electric supply costs from electric operating revenues. Registrant believes these measures are useful supplemental data in that they remove the effects of pass-through supply costs that, due to regulatory mechanisms in place, do not impact the profitability of GSWC or BVESI. The discussions and tables included in the following analysis also present Registrant's operations in terms of diluted earnings per share by business segment, which equals each business segment's net income divided by Registrant's weighted average number of diluted shares. Furthermore, the gains generated on the investments held to fund one of the Company's retirement plans during the three-and nine-month periods endedSeptember 30, 2021 and 2020 have been excluded when communicating the results to help facilitate comparisons of the Company's performance from period to period. All of these items are derived from consolidated financial information but are not presented in our financial statements that are prepared in accordance with Generally Accepted Accounting Principles (GAAP) inthe United States . These items constitute "non-GAAP financial measures" under theSecurities and Exchange Commission rules. Registrant believes that the disclosures of "operating revenues less supply costs" for its water and electric segments, and diluted earnings per share by each business segment provide investors with clarity surrounding the performance of its segments. Registrant reviews these measurements regularly and compares them to historical periods and to its operating budget. However, these measures are not presented in accordance with GAAP and may not be comparable to similarly titled measures used by other entities and, therefore, should not be considered as an alternative to "operating revenues" or "fully diluted earnings per common share", which are determined in accordance with GAAP and presented in Registrant's consolidated statements of income. Registrant has provided the computations and reconciliations of its non-GAAP measures to the most directly comparable GAAP measures. Calculations of "operating revenues less supply costs" for the water and electric segments are included in the tables under the sections titled "Operating Expenses: Supply Costs." A computation and reconciliation of diluted earnings per share from the measure of operating income by business segment (as disclosed in this Form 10-Q in Note 10 to the Unaudited Consolidated Financial Statements), to AWR's consolidated fully diluted earnings per common share is included in the discussion under the sections titled "Summary of Third Quarter Results by Segment" and "Summary of Year-to-Date Results by Segment." Overview Factors affecting our financial performance are summarized under "Risk Factors" in our Form 10-K for the period endedDecember 31, 2020 filed with theSEC . Water and Electric Segments: GSWC's and BVESI's revenues, operating income, and cash flows have been earned primarily through delivering potable water to homes and businesses inCalifornia and electricity in theCity of Big Bear Lake and surrounding areas inSan Bernardino County, California , respectively. Rates charged to GSWC and BVESI 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 and BVESI plan to continue seeking 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 and BVESI are expected to remain at higher levels than depreciation expense. When necessary, GSWC and BVESI are able to obtain funds from external sources in the capital markets and through bank borrowings. General Rate Case Filings and Other Matters: WaterGeneral Rate Case for the years 2022 - 2024: OnJuly 15, 2020 , GSWC filed a general rate case application for all its water regions and the general office. This general rate case will determine new water rates for the years 2022 - 2024. Among other things, GSWC requested capital budgets in this application of approximately$450.6 million for the three-year rate cycle, and another$11.4 million of capital projects to be filed for revenue recovery only through advice letters when those projects are completed. GSWC and the Public Advocates Office at the CPUC have reached a settlement in principle on nearly all of the items in this general rate case application. The unsettled matters are GSWC's requests for: (i) a medical cost balancing account, (ii) a general liability insurance cost balancing account, and (iii) the consolidation of two of GSWC's customer service areas. The date to file a Joint Motion for Approval of Settlement Agreement to the CPUC has been proposed forNovember 23, 2021 . As a result of this proposed timing, a final decision from the CPUC on this general rate case application is not expected by the end of 2021. For a final decision issued after 2021, new rates adopted in the case will be effective retroactively toJanuary 1, 2022 . 27 -------------------------------------------------------------------------------- Table of Contents WaterGeneral Rate Case for the years 2019 - 2021: InMay 2019 , the CPUC issued a final decision in GSWC's water general rate case 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 included$20.4 million of capital projects to be filed for revenue recovery through advice letters when those projects are completed. Due to changes in circumstances, not all the anticipated advice letter projects have been completed during this rate cycle. The final decision also allowed for increases in water's operating revenues less water supply costs ("RLWSC") for 2020 and 2021, subject to an earnings test. The full second-year step increases generated an additional$10.4 million in water's RLWSC for 2020. EffectiveJanuary 1, 2021 , the CPUC also approved all third-year rate increases, which GSWC achieved as a result of passing the earnings test. The third-year rate increases are expected to generate an additional increase in water's RLWSC of approximately$11.1 million in 2021 as compared to 2020. Final Decision in the First Phase of the Low-Income Affordability Rulemaking: OnAugust 27, 2020 , the CPUC issued a final decision in the first phase of the CPUC's Order Instituting Rulemaking evaluating the low income ratepayer assistance and affordability objectives contained in the CPUC's 2010 Water Action Plan. This decision also addressed other issues, including the continued use of the Water Revenue Adjustment Mechanism ("WRAM") and the Modified Cost Balancing Account ("MCBA"). The MCBA is a full-cost balancing account used to track the difference between adopted and actual water supply costs (including the effects of changes in both rates and volume). Based on the final decision, any general rate case application filed by GSWC and the otherCalifornia water utilities afterAugust 27, 2020 may not include a proposal to continue the use of the WRAM or MCBA, but may instead include a proposal to use a limited price adjustment mechanism and an incremental supply cost balancing account. The final decision will not have any impact on GSWC's WRAM or MCBA balances during the current rate cycle (2019 - 2021). InFebruary 2021 , the assigned administrative law judge in the pending general rate case proceeding confirmed that GSWC may continue using the WRAM and MCBA through the year 2024. GSWC's next general rate case application will be filed in 2023 to establish new rates for the years 2025 - 2027, which may not include the WRAM or MCBA for those years. Since its implementation in 2008, the WRAM and MCBA have helped mitigate fluctuations in GSWC's earnings due to changes in water consumption by its customers or changes in water supply mix. Replacing them with mechanisms recommended in the final decision will likely result in more volatility in GSWC's future earnings and could result in less than, or more than, full recovery of its authorized RLWSC. InOctober 2020 , GSWC, certain otherCalifornia water utilities, and theCalifornia Water Association filed separate applications for rehearing on this matter. Due to the delay in the CPUC issuing a decision on any of these applications for rehearing, GSWC filed a petition for writ of review to theCalifornia Supreme Court inMay 2021 , requesting the Court to review the CPUC's final decision on this matter. In response, the CPUC requested that the Court hold the case, pending a CPUC decision on theOctober 2020 applications for rehearing, and the Court granted the request. InSeptember 2021 , the CPUC issued a decision denying all theOctober 2020 applications for rehearing. InOctober 2021 , GSWC re-filed its writ of review to theCalifornia Supreme Court , requesting the Court to review the CPUC's final decision on this matter. Certain otherCalifornia water utilities, and theCalifornia Water Association also filed separate writs of review with the Court. Management cannot currently predict the final outcome of this matter. Final Decision in the Second Phase of the Low-Income Affordability Rulemaking: OnJuly 15, 2021 , the CPUC issued a final decision in the second phase of the Low-Income Affordability Rulemaking. Among other things, the decision extended the suspension of water-service disconnection implemented during the COVID-19 pandemic due to non-payment of past-due amounts billed to residential customers until the earlier ofFebruary 1, 2022 or pursuant to further CPUC guidance on this matter. The final decision also requires that amounts tracked in GSWC's COVID-19 Catastrophic Event Memorandum Account ("CEMA") account for unpaid customer bills be offset by any (i) federal and state relief for water utility bill debt, and (ii) customer payments through payment plan arrangements, prior to receiving recovery from customers. InAugust 2021 , GSWC, in addition to three other parties, filed separate applications to the CPUC for rehearing on certain aspects of this final decision. Cost of Capital Proceeding: Investor-owned water utilities servingCalifornia are required to file their cost of capital applications on a triennial basis. GSWC filed a cost of capital application with the CPUC inMay 2021 requesting a capital structure of 57% equity and 43% debt, a return on equity of 10.5%, and a return on rate base of 8.18%. A final decision on this proceeding is expected during the first half of 2022, with an effective date retroactive toJanuary 1, 2022 . GSWC's current authorized rate of return on rate base of 7.91% will remain in effect throughDecember 31, 2021 . Electric SegmentGeneral Rate Case : OnAugust 15, 2019 , the CPUC issued a final decision in the electric general rate case. Among other things, the decision (i) extended the rate cycle by one year to include 2022; (ii) increased electric's operating revenues less electric supply costs ("RLESC") for 2018 by approximately$2.3 million compared to its 2017 adopted RLESC, adjusted for tax reform changes; 28 -------------------------------------------------------------------------------- Table of Contents (iii) allows the electric segment to construct capital projects of approximately$44 million over the 5-year rate cycle, all of which are dedicated to improving system safety and reliability; and (iv) increased electric's RLESC by$1.2 million for each of the years 2019 and 2020, by$1.1 million for 2021, and by$1.0 million for 2022. The rate increases for 2019 - 2022 are not subject to an earnings test. The decision authorized a return on equity for the electric segment of 9.6% and included 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. The rate case decision continues to apply to BVESI. 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: GSWC, BVESI andASUS have continued their operations throughout the COVID-19 pandemic given that their water, wastewater and electric utility services are deemed essential. AWR's responses take into account orders issued by the CPUC, and the guidance provided by federal, state, and local health authorities and other government officials for the COVID-19 pandemic. Some of the actions taken by GSWC and BVESI continue to include suspending service disconnections for nonpayment pursuant to CPUC and state orders, and telecommuting by employees. The suspension of water-service disconnections at GSWC was implemented in response to an executive order from the governor ofCalifornia . OnJuly 15, 2021 , the CPUC issued a final decision in the second phase of the Low-Income Affordability Rulemaking which, among other things, extended the moratorium on water-service disconnections due to non-payment of past-due amounts billed to residential customers until the earlier ofFebruary 1, 2022 or pursuant to further CPUC guidance on the matter. OnJune 24, 2021 , the CPUC issued a final decision to extend the moratorium on electric customer service disconnections untilSeptember 30, 2021 . Under the terms of CPUC-adopted payment plans, actual electric-service disconnections for non-payment will occur no earlier thanDecember 1, 2021 The pandemic has caused volatility in financial markets resulting in fluctuations in the fair value of plan assets in GSWC's pension and other retirement plans. Furthermore, as discussed above, GSWC's and BVESI's response to the pandemic required the suspension of service disconnections for nonpayment, which has significantly increased the amount of delinquent customer accounts receivable during the COVID-19 pandemic. Due to the expected future credit losses on utility customer bills, GSWC and BVESI have increased their allowance for doubtful accounts as ofSeptember 30, 2021 for past due customer receivables. The CPUC has authorized GSWC and BVESI to track incremental costs, including bad debt expense, in excess of what is included in their respective revenue requirements in COVID-19-related memorandum accounts, which is to be filed with the CPUC for future recovery. ThroughSeptember 30, 2021 , AWR has recorded approximately$8.5 million in these COVID-19-related memorandum accounts related to bad debt expense, personal protective equipment, printing costs, and other incremental costs in excess of GSWC's and BVESI's revenue requirements. By tracking these costs in memorandum accounts, utilities can later request authorization from the CPUC for recovery of them. Emergency-type memorandum accounts are well-established cost recovery mechanisms authorized by the CPUC as a result of a state/federal declared emergency, and are therefore recognized as regulatory assets for future recovery. As a result, the amounts recorded in the COVID-19-related memorandum accounts have not impacted GSWC's and BVESI's earnings. Thus far, the COVID-19 pandemic has not had a material impact onASUS's operations. OnSeptember 9, 2021 , the president ofthe United States issued orders and instructions on mandatory COVID-19 vaccination of all federal employees, federal contractors and employees of companies with 100 or more employees. The effects of mandatory vaccination on Registrant's workforce are unknown given that federal vaccine-mandate guidance has yet to be issued. The CPUC requires that amounts tracked in GSWC's and BVESI's COVID-19 memorandum accounts for unpaid customer bills be offset by any (i) federal and state relief for water utility bill debt, and (ii) customer payments through payment plan arrangements, prior to receiving recovery from customers. After these offsets are made, GSWC will file with the CPUC for future recovery of the remaining balance. BVESI intends to include the remaining balance in its COVID-19 memorandum account in its next general rate case application expected to be filed in 2022. OnJuly 12, 2021 , the governor ofCalifornia approved SB-129 Budget Act of 2021, which includes almost$1 billion in relief funding for overdue water customer bills, and almost$1 billion in relief funding for overdue electric customer bills. The water utility relief funding is being managed by theState Water Resources Control Board through the California Water and Wastewater Arrearage Payment Program to provide direct assistance to community water systems to credit customer accounts for water debt accrued during the COVID-19 pandemic. The electric utility relief funding is being managed by theCalifornia Department of Community Services and Development through the California Arrearage Payment Program. Both GSWC and BVESI intend to seek recovery of overdue amounts from all available funding sources. Funds for both water and electric utility relief are expected to be distributed to utilities during the fourth quarter of 2021 or the first quarter of 2022. 29
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Table of Contents Summary of Third Quarter Results by Segment The table below sets forth the third quarter diluted earnings per share by business segment:
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