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. OnJuly 1, 2020 , GSWC completed the transfer of the electric utility assets and liabilities from its electric division to 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 six months of 2019 and 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 third quarter and year-to-date 2019 results to help facilitate comparisons of Registrant'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 the water and electric gross margins, and earnings per share by 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, 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 Third Quarter Results by Segment" and "Summary of Year-to-Date 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 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 the Big Bear area ofSan 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:
Water GRC for years 2022 - 2024:
On
Water
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The final decision also allowed for water gross margin increases in 2020 and
2021, subject to an earnings test. Effective
Issuance of Senior Unsecured Notes at GSWC:
On
Final Decision on Low-Income Affordability Rulemaking:
On
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.
Electric Segment
32 -------------------------------------------------------------------------------- Table of Contents 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 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$0.03 per share for the six months endedJune 30, 2019 , and$0.04 per share for the full year endedDecember 31, 2018 had the new 2018 and 2019 rates been in place at those times. 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, and ASUS have continued their operations given that their water, wastewater, and electric utility services are deemed essential. The Company's responses to the COVID-19 pandemic take into account the guidance provided by federal, state, and local health authorities and other government officials. The response of GSWC and BVESI has included: (i) suspending, throughApril 2021 , service disconnections for nonpayment pursuant to CPUC orders; (ii) increasing the number of employees telecommuting; and (iii) delaying some capital improvement projects at the 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. Thus far, the COVID-19 pandemic has not had a material impact on ASUS's operations. The pandemic has caused significant volatility in 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 and BVESI have increased their allowance for doubtful accounts as ofSeptember 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. ThroughSeptember 30, 2020 , AWR has recorded approximately$1.4 million in the CEMA regulatory asset accounts related to bad debt expense in excess of GSWC's and BVESI'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. 33
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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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