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, and ASUS and its subsidiaries), and
AWR (parent) where applicable. The subsidiaries of ASUS are collectively
referred to as the "Military Utility Privatization Subsidiaries".
Included in the following analysis is a discussion of AWR's operations in terms
of earnings per share by business segment and AWR (parent), which equals each
business segment's earnings divided by AWR's weighted average number of diluted
common shares. Furthermore, the gains and losses generated on the investments
held to fund one of the Company's retirement plans during the three and nine
months ended September 30, 2022 and 2021 have been excluded when communicating
the results to help facilitate comparisons of AWR's performance from period to
period. Also, the retroactive impact of new 2022 water rates not yet recorded
due to the delay in receiving a final decision from the CPUC, which will be
retroactive to January 1, 2022 when approved, have been included when
communicating AWR's consolidated and its water segment's results for the three
and nine months ended September 30, 2022 to help facilitate comparisons of AWR's
performance from period to period. All of these measures 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) in the United States. These items constitute "non-GAAP
financial measures" under the Securities and Exchange Commission rules, which
supplement our GAAP disclosures but should not be considered as an alternative
to the respective GAAP measures. Furthermore, the non-GAAP financial measures
may not be comparable to similarly titled non-GAAP financial measures of other
registrants.
AWR uses earnings per share by business segment as an important measure in
evaluating its operating results and believes it provides investors with clarity
surrounding the performance of its segments. AWR reviews this measurement
regularly and compares it to historical periods and to its operating budget. A
reconciliation to AWR's consolidated diluted earnings per share prepared in
accordance with GAAP is included in the discussion under the section 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 ended December 31, 2021 filed with the SEC.
Water and Electric Segments:
GSWC's and BVESI's revenues, operating income, and cash flows are earned
primarily through delivering potable water to homes and businesses in California
and electricity in the Big Bear area of San 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
substantially higher levels than depreciation expense. When necessary, GSWC and
BVESI may obtain funds from external sources in the capital markets and through
bank borrowings.
General Rate Case Filings and Other Matters:
Water General Rate Case for the years 2022-2024:
In July 2020, GSWC filed a general rate case application for all of its water
regions and its general office. This general rate case will determine new water
rates for the years 2022 - 2024. In November 2021, GSWC and the Public Advocates
Office at the CPUC ("Public Advocates") filed with the CPUC a joint motion to
adopt a settlement agreement between GSWC and Public Advocates on this general
rate case application. The settlement agreement, if approved, resolves all
issues related to the 2022 annual revenue requirement in the general rate case
application, leaving only three unresolved issues. Among other things, the
settlement authorizes GSWC to invest approximately $404.8 million in capital
infrastructure over the three-year cycle. The settlement also authorizes GSWC to
complete certain advice letter capital projects approved in the last general
rate case, which have recently been completed for a total capital investment of
$9.4 million. The additional annual revenue requirements generated from these
capital investments total $1.2 million and became effective February 15, 2022.
Advice letter projects are filed for revenue recovery only when the projects are
completed.
Excluding the advice letter project revenues, the amounts included in the
settlement agreement would increase the 2022 adopted revenues by approximately
$30.3 million, or $0.59 per share, as compared to the 2021 adopted revenues, and
increase the 2022 adopted supply costs by $9.7 million, or $0.19 per share, as
compared to the 2021 adopted supply costs, which combined is $0.40 per share.
The settlement agreement also allows for the potential of additional increases
in adopted revenues for 2023 and 2024 subject to an earnings test and changes to
the forecasted inflationary index values.
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The three remaining unresolved issues relate to GSWC's requests for: (i) a
medical insurance cost balancing account, (ii) a general liability insurance
cost balancing account, and (iii) the consolidation of two of GSWC's customer
service areas. GSWC and Public Advocates have filed briefs with the CPUC on
these unsettled issues. A proposed decision will address the three unresolved
issues along with the settlement agreement filed by GSWC and Public Advocates.
Pending a final decision on this general rate case application, GSWC filed with
the CPUC for interim rates that will make the new 2022 rates, once approved in a
CPUC final decision, effective January 1, 2022. In October 2022, the CPUC issued
a decision approving an extension of the statutory deadline for a final decision
in the water general rate case proceeding to February 14, 2023.
Due to the delay in finalizing the water general rate case, water revenues
billed and recorded for the first nine months of 2022 were based on 2021 adopted
rates, pending a final decision by the CPUC. When approved, the new rates will
be retroactive to January 1, 2022 and cumulative adjustments will be recorded in
the quarter in which the new rates are approved by the CPUC. Had the new 2022
water rates been approved and effective January 1, 2022 consistent with the
settlement agreement between GSWC and Public Advocates, for the three months
ended September 30, 2022, GSWC would have recorded additional revenues of $8.7
million, or $0.17 per share, and additional water supply costs of $3.4 million,
or $0.07 per share, which together is $0.10 per share higher than what was
actually recorded for the third quarter of 2022. For the nine months
ended September 30, 2022, GSWC would have recorded additional revenues of $22.7
million, or $0.44 per share, and additional water supply costs of $7.7 million,
or $0.15 per share, which together is $0.29 per share higher than what was
actually recorded for the first nine months of 2022.
Final Decision in the First Phase of the Low-Income Affordability Rulemaking:
In August 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
discontinued 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 other
California water utilities after August 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. 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 revenue and supply costs.
As a result of the August 2020 decision, the discontinuation of the WRAM and
MCBA for GSWC would be effective for years after 2024. However, on September 30,
2022, the governor of California signed Senate Bill ("SB") 1469. Effective
January 1, 2023, SB 1469 allows Class A water utilities, including GSWC, to
continue requesting the use of the WRAM in their next general rate case. With
the passage of SB 1469, GSWC will be able to request the continued use of the
WRAM in its next general rate case to be filed in 2023 that will establish new
rates for the years 2025 - 2027. GSWC's request to continue using the WRAM in
its next general rate case will be subject to CPUC approval.
In October 2020, GSWC, three other investor-owned water utilities ("IOWUs")
operating in California, and the California Water Association ("CWA") filed
applications with the CPUC for rehearing on the discontinuation of the WRAM and
MCBA, which the CPUC denied in September 2021. GSWC, the three other IOWUs and
CWA each separately filed a petition with the California Supreme Court ("Court")
to review the CPUC's decision revoking prior authorization of the WRAM and MCBA.
In May 2022, the Court granted the petition for writ of review. The Court has
ordered GSWC, along with the other IOWUs and CWA, to file opening briefs, which
were filed on September 1. The CPUC's answer to the opening brief is due by
November 15 and reply briefs are due by December 15. However, as a result of SB
1469, in October 2022 the CPUC filed a motion to dismiss the IOWUs and CWA's
petition with the Court, and also requested that the Court suspend the
proceeding schedule until it rules on the motion to dismiss. The Court granted
the CPUC's request to suspend the proceeding schedule. There is no timeline for
the Court to complete their review. At this time, management cannot predict the
final outcome of this matter.
Final Decision in the Second Phase of the Low-Income Affordability Rulemaking:
On July 15, 2021, the CPUC issued a final decision in the second phase of the
Low-Income Affordability Rulemaking. The final decision requires that amounts
tracked in GSWC's COVID-19 Catastrophic Event Memorandum Account ("CEMA")
account for unpaid customer bills be first offset by any (i) federal or state
relief for customers' utility bill debt, and (ii) customer payments through
payment-plan arrangements prior to receiving recovery from customers at large.
In January 2022, GSWC received $9.5 million of relief funding from the state of
California for customers' unpaid water bills incurred during the pandemic, which
it applied to its delinquent customers' eligible balances.
In August 2021, GSWC, in addition to three other parties, filed separate
applications to the CPUC for rehearing on certain aspects of this final
decision, which the CPUC denied in May 2022. In March 2022, CWA filed a petition
for writ of review to the California Supreme Court, urging the Court to review
the CPUC's final decision on the second phase of the Low-
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Income Affordability Rulemaking. CWA amended its petition to reflect the CPUC's
decision denying the requests for rehearing. In September 2022, the Supreme
Court denied CWA's amended petition for writ of review.
Cost of Capital Proceeding:
Investor-owned water utilities serving California are required to file their
cost of capital applications on a triennial basis. GSWC filed a cost of capital
application with the CPUC in May 2021 currently pending approval, which
requested a capital structure of 57% equity and 43% debt, a return on equity of
10.5%, an embedded cost of debt of 5.1%, and a return on rate base of 8.18%.
Hearings on this proceeding occurred in May 2022 and briefs were filed in June
2022. Based on management's analysis of this regulatory proceeding and
associated accounting to date, for the three and nine months ended September 30,
2022, GSWC reduced revenues by $1.9 million and $5.0 million, respectively, and
recorded a corresponding regulatory liability for revenues subject to refund
based on its best estimate at this time, which includes the impact of GSWC's
lower cost of debt requested in its application. However, management cannot
predict the ultimate outcome of the cost of capital application and the
associated impact on 2022 revenues. Changes in estimates will be made, if
necessary, as more information in this proceeding becomes available. The lower
cost of debt of 5.1% is expected to lower 2022 adopted water revenues by
approximately $7.5 million, or $0.15 per share, as compared to 2021 adopted
water revenues at the currently authorized cost of debt of 6.6% that is
presently being billed to water customers until a final decision is issued in
this proceeding.
In the pending cost of capital proceeding, GSWC requested authorization to
continue the Water Cost of Capital Mechanism ("WCCM"). The WCCM adjusts return
on equity and rate of return on rate base between the three-year cost of capital
proceedings only if there is a positive or negative change of more than 100
basis points in the average of the Moody's Aa utility bond rate as measured over
the period October 1 through September 30. If there is a positive or negative
change of more than 100 basis points, the return on equity is adjusted by one
half of the difference. For the period from October 1, 2021 through September
30, 2022, the Moody's rate increased by more than 100 basis points from the
benchmark, which triggered the WCCM adjustment. The WCCM is expected to be
addressed by the CPUC in the pending proposed decision.
Electric General Rate Cases:
On August 15, 2019, the CPUC issued a final decision on the electric general
rate case that set new rates for the years 2018 - 2022. Among other things, the
decision increased adopted electric revenues by $1.0 million in 2022 not subject
to an earnings test. The decision also allowed BVESI 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. The decision authorized a return on equity for the electric
segment of 9.6% and included a capital structure and a debt cost that are
consistent with those approved by the CPUC in March 2018 in connection with
GSWC's water segment cost of capital proceeding.
On August 30, 2022, BVESI filed a general rate case application that will
determine new electric rates for the years 2023 - 2026. Among other things,
BVESI requested (i) capital budgets of approximately $62 million for the
four-year rate cycle, and another $6.2 million for a large line replacement
capital project to be filed for revenue recovery through an advice letter when
the project is completed, and (ii) a capital structure for BVESI of 61.8% equity
and 38.2% debt, a return on equity of 11.25%, an embedded cost of debt of 5.1%,
and a return on rate base of 9.05%. Furthermore, included in the general rate
case application is a request for recovery of all capital expenditures and other
costs incurred over the last few years in connection with BVESI's wildfire
mitigation plans that are currently not in customer rates. These costs will be
subject to review by the CPUC during the general rate case proceeding. A
pre-hearing conference has been scheduled for December 16, 2022 at which time
the scope of issues and schedule for the proceeding will be determined. On
November 2, 2022, BVESI filed a motion to request a general rate case memorandum
account that would make the new 2023 rates, once approved in a CPUC final
decision, effective and retroactive to January 1, 2023.
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 for 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 annual economic price adjustments, and new construction
activities under contract modifications with the U.S. government or agreements
with other third-party prime contractors.
Entering into contracts with the U.S. government subjects ASUS to potential
government audits or investigations of its business practices and compliance
with government procurement statutes and regulations. ASUS is currently under a
civil government investigation over bidding and estimating practices used in
certain capital upgrade projects. ASUS is cooperating fully with the
investigation and management does not currently believe that the investigation
will have a material adverse effect on its consolidated results of operations,
financial condition, or liquidity. However, at this time, management cannot
predict the final outcome or recommendations that may result from the
investigation or determine the amount, if any, of penalties and damages that may
be assessed.
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COVID-19:
GSWC, BVESI and ASUS have continued their operations throughout the COVID-19
pandemic given that their water, wastewater and electric utility services are
deemed essential. AWR and its subsidiaries continue to monitor the guidance
provided by federal, state, and local health authorities and other government
officials. While continuing to monitor transmission rates and other variables,
employees have returned to company offices. Thus far, the COVID-19 pandemic has
not had a material impact on ASUS's current operations.
During 2022, GSWC and BVESI continue to experience delinquent customer accounts
receivable due to the lingering effects of the COVID-19 pandemic, resulting in
both GSWC and BVESI increasing their allowance for doubtful accounts during the
nine months ended September 30, 2022. 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 incurred as a result of the
pandemic in COVID-19 emergency-related memorandum accounts, which GSWC and BVESI
intend to file with the CPUC for future recovery. As of September 30, 2022, GSWC
and BVESI had approximately $5.1 million and $454,000, respectively, in
regulatory asset accounts related to bad debt expense in excess of their revenue
requirements, the purchase of personal protective equipment, additional incurred
printing costs, and other incremental COVID-19-related costs. Emergency-type
memorandum accounts are well-established cost recovery mechanisms authorized 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 emergency-related memorandum accounts have not impacted GSWC's or
BVESI's earnings.
In January 2022, GSWC received $9.5 million in COVID relief funds through the
California Water and Wastewater Arrearage Payment Program to provide assistance
to customers for their water debt accrued during the COVID-19 pandemic by
remitting federal funds that the state received from the American Rescue Plan
Act of 2021 to the utility on behalf of eligible customers. GSWC applied these
funds to its delinquent customers' eligible balances. In February 2022, BVESI
received $321,000 from the state of California for similar customer relief
funding for unpaid electric customer bills incurred during the pandemic.
The CPUC requires that amounts tracked in GSWC's and BVESI's COVID-19 memorandum
accounts for unpaid customer bills be first offset by any (i) federal and state
relief for water or electric utility bill debt, and (ii) customer payments
through payment plan arrangements, prior to receiving recovery from customers at
large. After these offsets are made, GSWC will file with the CPUC for recovery
of the remaining balance. BVESI intends to include the remaining balance in its
COVID-19 memorandum account for recovery once all alternative sources of funding
have been exhausted and credited to eligible customer accounts.
The CPUC's moratoriums on service disconnections for nonpayment for water and
electric customers have ended. As a result, service disconnections due to
nonpayment have resumed with disconnections for delinquent residential customers
having resumed in June 2022.
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