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. On July 1, 2020, GSWC completed the transfer of the electric utility assets and liabilities from its electric division to Bear Valley Electric Service, Inc. ("BVESI") in exchange for common shares of BVESI. GSWC then immediately distributed all of BVESI's common shares to AWR, whereupon BVESI became wholly owned directly by AWR. The reorganization is not expected to result in any substantive changes to AWR's operations or business segments. 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 and BVESI. 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 common shares. Furthermore, the retroactive impact related to the first quarter of 2019 resulting from the CPUC's final decision on the water general rate case issued in May 2019 has been excluded when communicating the water segment's second quarter 2019 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) in the United States. These items constitute "non-GAAP financial measures" under the Securities and Exchange Commission rules. 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 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 Second Quarter Results by Segment" and "Summary of Year-to-Date Results by Segment."


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Overview


Factors affecting our financial performance are summarized under Forward-Looking
Information and under "Risk Factors" in our Form 10-K for the period ended
December 31, 2019.
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 in California
and the delivery of 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 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 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 ("GRC") Filings and Other Matters:
Water Segment GRC:
In May 2019, the CPUC issued a final decision on GSWC's water general rate case,
which determined new rates for the years 2019 - 2021 with rates retroactive to
January 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 quarter of 2019 were based on 2018
adopted rates, pending a final decision. As a result of the May 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. Effective January 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 also allows 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 GRC:
In August 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; (iii) authorized GSWC's
electric division 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) increased
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 authorized a
return on equity for GSWC's electric segment of 9.60% and included a capital
structure and debt cost that is consistent with those approved by the CPUC in
March 2018 in connection with GSWC's water segment cost of capital proceeding.
The rate case decision continues to apply for BVESI.
Due to the delay in finalizing the electric general rate case, electric revenues
recognized during the first six months of 2019 were based on 2017 adopted rates.
Because the August 2019 CPUC final decision was retroactive to January 1, 2018,
the cumulative retroactive earnings impact of the decision was included in the
third quarter results of 2019, including approximately $0.03 per share related
to the six months ended June 30, 2019, of which $0.01 per share related to the
second quarter of 2019, had the new 2018 and 2019 rates been in place at that
time.
Issuance of Senior Unsecured Notes at GSWC:
On July 8, 2020, GSWC completed the issuance of unsecured private placement
notes totaling $160 million. In connection with this financing, GSWC issued $85
million in 2.17% senior notes which mature in 2030, and $75 million in
2.90% senior notes which mature in 2040. GSWC used the proceeds from the notes
to pay down a majority of its intercompany borrowings from AWR. AWR used these
proceeds from GSWC to pay down amounts outstanding under its credit facility. In
March 2020, AWR had amended its credit facility to temporarily increase the
borrowing capacity to $260 million. Following the issuance of GSWC's notes,
effective July 15, 2020 AWR reduced the aggregate borrowing capacity back down
to $200 million pursuant to the terms of the revolving credit facility
agreement.
Proposed Decision on Low-Income Affordability Rulemaking:
On July 3, 2020, the CPUC issued a proposed decision related to the low income
ratepayer assistance and affordability objectives contained in the CPUC's 2010
Water Action Plan, which also addressed other issues including matters
associated with

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the continued use of the water revenue adjustment mechanism ("WRAM").  If
approved, California water utilities that use full decoupling WRAM accounts,
including GSWC, would be required to replace their WRAM accounts with a limited
price adjustment mechanism (the Monterey-Style Water Revenue Adjustment
Mechanisms) in their next general rate case filing.  This proposed decision may
be on the Commission's agenda for a vote as early as August 6, 2020.  Management
believes the proposed decision, if approved, should not have any impact on
GSWC's WRAM balances during the current rate cycle (2019 through 2021).
Since its implementation in 2008, the WRAM has helped mitigate fluctuations in
GSWC's revenues due to changes in water consumption by its customers.  Replacing
the WRAM with the mechanism recommended in the proposed decision would undo the
current decoupling mechanism, which could result in more volatility in GSWC's
future revenues and prevent full recovery of its authorized revenues.  GSWC
filed comments to the proposed decision.  At this time, management cannot
predict the outcome of this matter including its potential impact to the water
general rate case application filed in July 2020, which will set new rates for
the years 2022 - 2024.
Cost of Capital Proceeding:
Investor-owned water utilities serving California are required to file their
cost of capital applications on a triennial basis, with the next scheduled
filing required to have taken place on May 1, 2020 and to be effective for the
years 2021 - 2023. In January 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. In March 2020, the CPUC approved the
request, postponing the filing date by one year until May 1, 2021, with a
corresponding effective date of January 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 through December 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 the U.S. government or agreements with other third-party prime contractors.
COVID-19:
GSWC and BVESI continue to operate as its water and electric utility services
are deemed essential services, and continue to monitor the guidance provided by
federal, state, and local health authorities and other government officials.
GSWC's response to the COVID-19 outbreak has included: (i) suspending through
April 2021 service disconnections for nonpayments pursuant to CPUC orders, which
will remain in effect over other existing requirements governing disconnections;
(ii) the temporary closing of customer service offices; (iii) increasing the
number of employees telecommuting; and (iv) delaying some capital improvement
projects at its water utility services business. At this time, neither GSWC nor
BVESI is able to predict the financial impact this situation may have on the
remainder of 2020. However, the pandemic has caused significant volatility on
financial markets, resulting in significant fluctuations in the fair value of
plan assets in GSWC'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 of June 30,
2020. However, 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 COVID-19 pandemic
in a Catastrophic Event Memorandum Account ("CEMA") to be filed with the CPUC
for future recovery. Through June 30, 2020, we have recorded approximately
$669,000 in the CEMA regulatory asset account related to bad debt expense in
excess of GSWC's revenue requirement, personal protective equipment, printing
costs and other incremental miscellaneous costs. By tracking these costs in a
CEMA, utilities can later ask for recovery of these costs from the CPUC. 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.

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Summary of Second Quarter Results by Segment The table below sets forth the second quarter diluted earnings per share by business segment:

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