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(Registrant’s
Telephone Number, Including Area Code)
Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate
by check mark whether Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or such shorter period that the Registrant was required to submit and post such files).
American States Water Company
iYes
x
No
¨
Golden
State Water Company
iYes
x
No
¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
American States Water Company
iLarge
accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
i☐
Emerging
growth company
i☐
Golden State Water Company
Large accelerated filer
¨
Accelerated
filer
¨
iNon-accelerated filer
x
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.¨
Indicate by check mark whether the Registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act)
American States Water Company
Yes
i☐
No
x
Golden
State Water Company
Yes
i☐
No
x
As of November 1, 2019,
the number of Common Shares outstanding of American States Water Company was i36,839,301 shares. As of November 1, 2019, all of the i165
outstanding Common Shares of Golden State Water Company were owned by American States Water Company.
Golden State Water Company meets the conditions set forth in General Instruction (H)(1)(a) and (b) of Form 10-Q and is therefore filing this Form, in part, with the reduced disclosure format for Golden State Water Company.
The basic financial statements included herein have been prepared by Registrant, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments consisting of normal recurring items and estimates necessary for a fair statement
of results for the interim period have been made.
It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto in the latest Annual Report on Form 10-K of American States Water Company and its wholly owned subsidiary, Golden State Water Company.
Filing Format
American States Water Company (“AWR”) is the parent company of Golden State Water Company (“GSWC”) and American States Utility Services, Inc. and its subsidiaries ("ASUS").
This quarterly report on Form 10-Q is a combined report being filed by two separate Registrants: AWR and GSWC. For more information, please see Note 1 of the Notes to Consolidated Financial Statements and the heading entitled "General" in "Item 2. Management’s Discussion and Analysis
of Financial Condition and Results of Operations." References in this report to “Registrant” are to AWR and GSWC collectively, unless otherwise specified. GSWC makes no representations as to the information contained in this report other than with respect to itself.
Forward-Looking Information
This Form 10-Q and the documents incorporated herein contain forward-looking statements intended to qualify for the “safe harbor” from liability established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on current estimates, expectations and projections about future events and assumptions regarding these events and include statements regarding management’s goals, beliefs, plans or current expectations, taking into account the information currently available to management. Forward-looking statements are not statements of
historical facts. For example, when we use words such as “anticipate,”“believe,”“plan,”“estimate,”“expect,”“intend,”“may” and other words that convey uncertainty of future events or outcomes, we are making forward-looking statements. We are not able to predict all the factors that may affect future results. We caution you that any forward-looking statements made by us are not guarantees of future performance and the actual results may differ materially from those in our forward-looking statements. Some of the factors that could cause future results to differ materially from those expressed or implied by our forward-looking statements or from historical results, include, but are not limited to:
•
the outcome
of pending and future regulatory, legislative or other proceedings, investigations or audits, including decisions in GSWC's general rate cases and the results of independent audits of GSWC's construction contracting procurement practices or other independent audits of our costs;
•
changes in the policies and procedures of the California Public Utilities Commission ("CPUC");
•
timeliness of CPUC action on GSWC rates;
•
availability
of GSWC's water supplies, which may be adversely affected by increases in the frequency and duration of droughts, changes in weather patterns, contamination, and court decisions or other governmental actions restricting the use of water from the Colorado River, the California State Water Project, and/or pumping of groundwater;
•
liabilities of GSWC associated with the inherent risks of damage to private property and injuries to employees and the public if our or their property should come into contact with electrical current or equipment;
•
the
potential of strict liability for damages caused by GSWC's property or equipment, even if GSWC was not negligent in the operation and maintenance of that property or equipment, under a doctrine known as inverse condemnation;
•
the impact of storms, high winds, earthquakes, floods, mudslides, drought, wildfires and similar natural disasters, contamination or acts of terrorism or vandalism, that affect water quality and/or supply, affect customer demand, that damage or disrupt facilities, operations or information technology systems owned by us, our customers or third parties on whom we rely or that damage the property of our customers or other third parties or cause bodily injury resulting in
liabilities that we may be unable to recover from insurance, other third parties and/or the U.S. government or that the CPUC or the courts do not permit us to recover from ratepayers;
•
the impact on water utility operations during high fire threat conditions as a result of the Public Safety Power Shutdown program authorized by the CPUC and implemented by the electric utilities that serve GSWC facilities throughout the state and our ability to get full cost recovery in rates for costs incurred in preparation of and during a Public Safety Power Shutdown event;
•
liabilities
of GSWC for wildfires caused by GSWC’s electrical equipment if GSWC is unable to recover the costs and expenses associated with such liabilities from insurance or from ratepayers on a timely basis, if at all;
•
penalties which may be assessed by the CPUC if GSWC shuts down power to its customers during high threat conditions under the Public Safety Power Shutdown program authorized by the CPUC if the CPUC determines that the shutdown was not reasonably necessary or excessive in the circumstance;
•
costs incurred, and
the ability to recover such costs from customers, associated with service disruptions as the result of a Public Safety Power Shutdown program;
•
increases in the cost of obtaining insurance or in uninsured losses that may not be recovered in rates, or under our contracts with the U.S. government, including increases due to difficulties in obtaining insurance for certain risks, such as wildfires and earthquakes in California;
•
increases in costs to reduce the risks associated with the increasing frequency of severe weather,
including to improve the resiliency and reliability of our water production and delivery facilities and systems, and our electric transmission and distribution lines;
•
increases in service disruptions if severe weather and wildfires or threats of wildfire become more frequent as predicted by some scientists who study climate change;
•
our ability to efficiently manage GSWC capital expenditures and operating and maintenance expenses within CPUC authorized levels and timely recover our costs through rates;
•
the
impact of opposition to GSWC rate increases on our ability to recover our costs through rates, including costs associated with construction and costs associated with damages to our property and that of others and injuries to persons arising out of more extreme weather events;
•
the impact of opposition by GSWC customers to conservation rate design, including more stringent water-use restrictions if drought in California persists due to climate change, as well as future restrictions on water use mandated in California, which may decrease adopted usage and increase customer rates;
•
the
impact of condemnation actions on future GSWC revenues and other aspects of our business if we do not receive adequate compensation for the assets taken, or recovery of all charges associated with the condemnation of such assets, as well as the impact on future revenues if we are no longer entitled to any portion of the revenues generated from such assets;
•
our ability to forecast the costs of maintaining GSWC’s aging water and electric infrastructure;
•
our ability to recover increases in permitting costs and costs
associated with negotiating and complying with the terms of our franchise agreements with cities and counties and other demands made upon us by the cities and counties in which GSWC operates;
•
changes in accounting valuations and estimates, including changes resulting from our assessment of anticipated recovery of GSWC's regulatory assets, settlement of liabilities and revenues subject to refund or regulatory disallowances and the timing of such recovery, and the amounts set aside for uncollectible accounts receivable, inventory obsolescence, pension and post-retirement liabilities, taxes and uninsured losses and claims, including general liability and workers' compensation claims;
•
changes
in environmental laws, health and safety laws, and water and recycled water quality requirements, and increases in costs associated with complying with these laws and requirements, including costs associated with GSWC's upgrading and building new water treatment plants, GSWC's disposing of residuals from our water treatment plants, more stringent rules regarding pipeline repairs and installation, handling and storing hazardous chemicals, upgrading electrical equipment to make it more resistant to extreme weather events, removal of vegetation near power lines, compliance-monitoring activities and GSWC's securing alternative water supplies when necessary;
changes
in laboratory detection capabilities and drinking water notification levels for certain fluorinated organic perfluoroalkyl substances (e.g. PFOA and PFAS) used to make certain fabrics and other materials, used in certain fire suppression agents and also used in various industrial processes;
•
our ability to obtain adequate, reliable and cost-effective supplies of chemicals, electricity, fuel, water and other raw materials that are needed for our water and wastewater operations;
•
our ability to attract, retain, train,
motivate, develop and transition key employees;
•
our ability to recover the costs associated with any contamination of GSWC’s groundwater supplies from parties responsible for the contamination or through the ratemaking process, and the time and expense incurred by us in obtaining recovery of such costs;
•
adequacy of GSWC's electric division's power supplies and the extent to which we can manage and respond to the volatility of electricity and natural gas prices;
•
GSWC's
electric division's ability to comply with the CPUC’s renewable energy procurement requirements;
•
changes in GSWC's long-term customer demand due to changes in customer usage patterns as a result of conservation efforts, regulatory changes affecting demand such as mandatory restrictions on water use, new landscaping or irrigation requirements, recycling of water by customers or purchase of recycled water supplied by other parties, unanticipated population growth or decline, changes in climate conditions, general economic and financial market conditions and cost increases, which may impact our long-term operating revenues if we are unable to secure rate increases in an amount sufficient to offset reduced demand;
•
changes
in accounting treatment for regulated utilities;
•
effects of changes in, or interpretations of, tax laws, rates or policies;
•
changes in estimates used in ASUS’s cost-to-cost method for revenue recognition of certain construction activities;
•
termination, in whole or in part, of one or more
of ASUS's military utility privatization contracts to provide water and/or wastewater services at military bases for the convenience of the U.S. government or for default;
•
suspension or debarment of ASUS for a period of time from contracting with the government due to violations of laws or regulations in connection with military utility privatization activities;
•
delays by the U.S. government in making timely payments to ASUS for water and/or wastewater services or construction activities at military bases because
of fiscal uncertainties over the funding of the U.S. government or otherwise;
•
delays in ASUS obtaining economic price or equitable adjustments to our prices on one or more of our contracts to provide water and/or wastewater services at military bases;
•
disallowance of costs on any of ASUS's contracts to provide water and/or wastewater services at military bases because of audits, cost reviews or investigations by contracting agencies;
•
inaccurate
assumptions used by ASUS in preparing bids in our contracted services business;
•
failure of wastewater systems that ASUS operates on military bases resulting in untreated wastewater or contaminants spilling into nearby properties, streams or rivers, a risk which may increase if flooding and rainfall become more frequent or severe as a result of climate change;
•
failure to comply with the terms of our military privatization contracts;
•
failure
of any of our subcontractors to perform services for ASUS in accordance with the terms of our military privatization contracts;
•
competition for new military privatization contracts;
•
issues with the implementation, maintenance or upgrading of our information technology systems;
•
general economic
conditions which may impact our ability to recover infrastructure investments and operating costs from customers;
explosions, fires, accidents, mechanical breakdowns, the disruption of information technology and telecommunication systems, human error and similar events that may occur while operating and maintaining water and electric systems in California or operating and maintaining water and wastewater systems on military bases under varying geographic conditions;
•
potential
costs, lost revenues, or other consequences resulting from misappropriation of assets or sensitive information, corruption of data, or operational disruption due to a cyber-attack or other cyber incident;
•
restrictive covenants in our debt instruments or changes to our credit ratings on current or future debt that may increase our financing costs or affect our ability to borrow or make payments on our debt; and
•
our ability to access capital markets and other sources of credit in a timely manner on acceptable terms.
Please
consider our forward-looking statements in light of these risks (which are more fully disclosed in our 2018 Annual Report on Form 10-K) as you read this Form 10-Q. We qualify all our forward-looking statements by these cautionary statements.
Note
1 — iSummary of Significant Accounting Policies
Nature of Operations: American States Water Company (“AWR”) is the parent company of Golden State Water Company (“GSWC”) and American States Utility Services, Inc. (“ASUS”) (and its subsidiaries, Fort Bliss Water Services Company (“FBWS”), Terrapin Utility Services, Inc. (“TUS”), Old Dominion Utility Services, Inc. (“ODUS”), Palmetto State Utility Services, Inc. (“PSUS”), Old North
Utility Services, Inc. (“ONUS”), Emerald Coast Utility Services, Inc. ("ECUS"), and Fort Riley Utility Services, Inc. ("FRUS")). The subsidiaries of ASUS are collectively referred to as the “Military Utility Privatization Subsidiaries.” AWR, through its wholly owned subsidiaries, serves over ione million people in inine
states.
GSWC is a public utility engaged principally in the purchase, production, distribution and sale of water in California serving approximately i261,000 customer connections. GSWC also distributes electricity in several San Bernardino County mountain communities in California serving approximately i24,000
customer connections through its Bear Valley Electric Service (“BVES”) division. The California Public Utilities Commission (“CPUC”) regulates GSWC’s water and electric businesses in matters including properties, rates, services, facilities and transactions by GSWC with its affiliates. GSWC filed applications with the CPUC and the Federal Energy Regulatory Commission ("FERC") in December 2018 and July 2019, respectively, to transfer the assets and liabilities of the BVES division of GSWC to Bear Valley Electric Service, Inc., a newly created separate legal entity and stand-alone subsidiary of AWR. This reorganization plan is subject to regulatory approvals and, if approved, is not expected to result in a substantive change to AWR's operations and business segments. On October 11, 2019, the FERC approved GSWC's application for reorganization. The CPUC is scheduled to issue a final decision by
the end of 2019.
ASUS, through its wholly owned subsidiaries, operates, maintains and performs construction activities (including renewal and replacement capital work) on water and/or wastewater systems at various U.S. military bases pursuant to i50-year firm fixed-price contracts. These contracts are subject to annual economic
price adjustments and modifications for changes in circumstances, changes in laws and regulations and additions to the contract value for new construction of facilities at the military bases.
There is no direct regulatory oversight by the CPUC over AWR or the operations, rates or services provided by ASUS or any of its wholly owned subsidiaries.
iBasis of Presentation: The consolidated financial statements and notes thereto are presented in a combined report filed by itwo
separate Registrants: AWR and GSWC. References in this report to “Registrant” are to AWR and GSWC, collectively, unless otherwise specified. /
AWR owns all of the outstanding common shares of GSWC and ASUS. ASUS owns all of the outstanding common stock of the Military Utility Privatization Subsidiaries. The consolidated financial statements of AWR include the accounts of AWR and its subsidiaries, all of which are wholly owned. These financial statements are prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). Intercompany transactions and balances have been eliminated in the AWR consolidated financial statements.
The consolidated financial statements included herein have been prepared by
Registrant, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The December 31, 2018 condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by GAAP. The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, all adjustments consisting of normal, recurring items and estimates necessary for a fair statement of the results for the interim periods have been made. It is suggested
that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Form 10-K for the year ended December 31, 2018 filed with the SEC.
iRelated Party Transactions: GSWC and ASUS provide and/or receive various support services to and from their parent, AWR, and among themselves. GSWC also allocates certain corporate office administrative
and general costs to its affiliate, ASUS, using allocation factors approved by the CPUC. GSWC allocated corporate office administrative and general costs to ASUS of approximately $i1.2 million during each of the three month periods ended September 30, 2019 and 2018,
and approximately $i3.5 million and $i3.2
million during the nine months ended September 30, 2019 and 2018, respectively. /
AWR borrows under a credit facility, which expires in May 2023, and provides funds to its subsidiaries, GSWC and ASUS, in support of their operations. The interest
rate charged to GSWC and ASUS is sufficient to cover AWR’s interest expense under the credit facility. In March 2019, AWR amended this credit facility to increase its borrowing capacity from $i150.0 million to $i200.0
million. As of September 30, 2019, there was $194.5 million outstanding under this facility. On October 31, 2019, AWR further amended its credit facility to temporarily increase its borrowing capacity by $i25.0
million, from $i200.0 million to $i225.0
million, effective through June 30, 2020. Management intends to obtain additional financing during 2020 by issuing long- term debt at GSWC. GSWC intends to use the proceeds from any new long-term debt to reduce its intercompany borrowings and to partially fund capital expenditures. AWR parent intends to use any financing proceeds from GSWC to pay down the amounts outstanding under its credit facility.
The CPUC requires GSWC to completely pay down all intercompany borrowings from AWR within a i24-month
period. In November 2018, GSWC paid down its intercompany borrowings owed to AWR. The next i24-month period in which GSWC is required to completely pay down its intercompany borrowings ends in November 2020. As a result, GSWC’s intercompany borrowings of $i151.2
million as of September 30, 2019 have been classified as a long-term liability on GSWC’s balance sheet.
i
GSWC Long-Term Debt:In March 2019, GSWC repaid $i40.0
million of its i6.70% senior note, which matured in that month. GSWC increased its intercompany borrowings from AWR parent to fund the repayment of this note.
/i
Recently
Issued Accounting Pronouncements:
Accounting Pronouncements Adopted in 2019
In February 2016, the Financial Accounting Standards Board ("FASB") issued a new lease accounting standard, Leases (Accounting Standards Codification ("ASC") 842), which replaces the prior lease guidance, (ASC 840). Under the new standard, lessees will recognize a right-of-use asset and a lease liability for virtually all leases (other than leases that meet the definition of a short-term lease). For income statement purposes, leases will be classified as either operating or finance. Operating leases will result in straight-line expense while finance leases will result in a front-loaded expense pattern. Registrant adopted the new lease accounting standard as of January 1,
2019 and did not adjust comparative periods for it. There was ino cumulative-effect impact to the opening balance of retained earnings as a result of this adoption. Registrant elected the practical expedient under ASU 2018-01 Land Easement Practical Expedient for Transition to Topic 842 and did not review existing easements entered into prior to January 1, 2019. Leases with terms of twelve months or less were not recorded on the
balance sheet. The adoption of the new lease guidance did not have a material impact on Registrant's results of operations or liquidity, but resulted in the recognition of operating lease liabilities and operating lease right-of-use assets on its balance sheets. The adoption of this guidance as of January 1, 2019 resulted in the recognition of $i7.6 million in right-of-use assets and $i8.0
million in operating lease liabilities (see Note 10).
In August 2018, the FASB issued Accounting Standards Update ("ASU") 2018-15-Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. Under this ASU, entities that enter into cloud computing service arrangements are required to apply existing internal-use software guidance to determine which implementation costs are eligible for capitalization. Under that guidance, implementation costs are capitalized or expensed depending on the nature of the costs and the project stage during which they are incurred. Registrant adopted this guidance effective January 1, 2019. The adoption of this accounting standard did not
have a significant impact on Registrant's financial statements.
Accounting Pronouncements to be Adopted in Future Periods
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and issued further guidance in November 2018 and May 2019, related to the impairment of financial instruments, effective January 1, 2020. The new guidance provides an impairment model, known as the current expected credit loss model, which is based on expected credit losses rather than incurred losses over the remaining life of most financial assets measured at amortized cost, including trade and other receivables. Registrant is currently evaluating the impact of this new guidance and does not expect
the adoption of the guidance to have a material impact on its financial statements.
In August 2018, the FASB issued ASU 2018-14-Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans. This ASU removes disclosures to pension plans and other post-retirement benefit plans that no longer are considered cost beneficial, clarifies the specific disclosure requirements and adds disclosure requirements deemed relevant. This ASU is effective for fiscal years ending after December 15, 2020 and will be applied by Registrant on a retrospective basis to all periods presented. Registrant is still evaluating the ASU and has not yet determined the effect on the Company's financial statements and disclosures.
Most of Registrant's revenues are derived from contracts with customers, including tariff-based revenues from its regulated utilities. ASUS's i50-year
firm fixed-price contracts with the U.S. government are considered service concession arrangements under ASC 853 Service Concession Arrangements. Accordingly, the services under these contracts are accounted for under Topic 606 Revenue from Contracts with Customers and the water and/or wastewater systems are not recorded as Property, Plant and Equipment on Registrant’s balance sheet.
Although GSWC has a diversified base of residential, commercial, industrial and other customers, revenues derived from residential and commercial customers generally account for more than i90%
of total water and electric revenues. The vast majority of ASUS's revenues are from the U.S. government. iFor the three and nine months ended September 30, 2019 and 2018, disaggregated revenues from contracts with customers by segment were as follows:
Three
Months Ended September 30,
Nine Months Ended September 30,
(dollar in thousands)
2019
2018
2019
2018
Water:
Tariff-based
revenues
$
i89,050
$
i87,204
$
i225,501
$
i223,230
Surcharges
(cost-recovery activities)
i1,900
i937
i2,954
i2,458
Other
i555
i486
i1,475
i1,381
Water
revenues from contracts with customers
i91,505
i88,627
i229,930
i227,069
WRAM
under (over)-collection (alternative revenue program)
i3,744
(i938
)
i18,182
i1,765
Total
water revenues
i95,249
i87,689
i248,112
i228,834
Electric:
Tariff-based
revenues
i9,729
i8,207
i28,693
i26,021
Surcharges
(cost-recovery activities)
i51
i62
i148
i172
Electric
revenues from contracts with customers
i9,780
i8,269
i28,841
i26,193
BRRAM
under (over)-collection (alternative revenue program)
i2,216
(i394
)
i1,192
(i645
)
Total
electric revenues
i11,996
i7,875
i30,033
i25,548
Contracted
services:
Water
i13,797
i16,909
i41,772
i44,134
Wastewater
i13,454
i11,709
i40,959
i27,295
Contracted
services revenues from contracts with customers
i27,251
i28,618
i82,731
i71,429
Total
revenues
$
i134,496
$
i124,182
$
i360,876
$
i325,811
i
The
opening and closing balances of the receivable from the U.S. government, contract assets and contract liabilities from contracts with customers, which related entirely to ASUS, were as follows:
Contract
Assets - Contract assets are those of ASUS and consist of unbilled revenues recognized from work-in-progress construction projects, where the right to payment is conditional on something other than the passage of time. The classification of this asset as current or noncurrent is based on the timing of when ASUS expects to bill these amounts.
Contract Liabilities - Contract liabilities are those of ASUS and consist of billings in excess of revenue recognized. The classification of this liability as current or noncurrent is based on the timing of when ASUS expects to recognize revenue.
Revenue for the three
and nine months ended September 30, 2019, which were included in contract liabilities at the beginning of the period were $i5.9 million and $i7.3
million, respectively. Contracted services revenues recognized during the three and nine months ended September 30, 2019 from performance obligations satisfied in previous periods were not material.
As of September 30, 2019, Registrant's aggregate remaining performance obligations, which are entirely for the contracted services segment, were $i3.2
billion. Registrant expects to recognize revenue on these remaining performance obligations over the remaining term of each of the i50-year contracts, which range from i35
to i49 years. Each of the contracts with the U.S. government is subject to termination, in whole or in part, prior to the end of its i50-year
term for convenience of the U.S. government.
Note 3 — iRegulatory Matters
In accordance with accounting principles for rate-regulated enterprises, Registrant records regulatory assets, which represent probable future recovery of costs from customers through the ratemaking process, and regulatory liabilities, which represent probable future refunds that are to
be credited to customers through the ratemaking process. At September 30, 2019, Registrant had approximately $i53.4 million of regulatory liabilities, net of regulatory assets, not accruing carrying costs. Of this amount, (i) $i80.3
million of regulatory liabilities are excess deferred income taxes arising from the lower federal income tax rate due to the Tax Cuts and Jobs Act ("Tax Act") enacted in December 2017 that are expected to be refunded to customers, (ii) $i14.0 million of regulatory liabilities are from flowed-through deferred income taxes, (iii) $i35.0
million of regulatory assets relates to the underfunded position in Registrant's pension and other post-retirement obligations (not including the two-way pension balancing accounts), and (iv) $i3.0 million of regulatory assets relates to a memorandum account authorized by the CPUC to track unrealized gains and losses on BVES's purchase power contracts over the term of the contracts. The remainder
of regulatory assets relates to other items that do not provide for or incur carrying costs.
Regulatory assets represent costs incurred by GSWC for which it has received or expects to receive rate recovery in the future. In determining the probability of costs being recognized in other periods, GSWC considers regulatory rules and decisions, past practices, and other facts or circumstances that would indicate if recovery is probable. If the CPUC determines that a portion of GSWC’s assets are not recoverable in customer rates, GSWC must determine if it has suffered an asset impairment that requires it to write down the asset's value. Regulatory assets are offset against regulatory liabilities within each ratemaking area. Amounts expected to be collected or refunded in the next twelve months have been classified as current assets and current liabilities by ratemaking area. iRegulatory
assets, less regulatory liabilities, included in the consolidated balance sheets are as follows:
Water
Revenue Adjustment Mechanism and Modified Cost Balancing Account
$
i29,228
$
i17,763
Costs
deferred for future recovery on Aerojet case
i8,663
i9,516
Pensions
and other post-retirement obligations (Note 8)
i32,222
i33,124
Derivative
unrealized loss (Note 5)
i3,022
i311
Low
income rate assistance balancing accounts
i538
i2,784
General
rate case memorandum accounts
i6,014
i5,054
Excess
deferred income taxes
(i80,303
)
(i81,465
)
Flow-through
taxes, net
(i14,037
)
(i15,273
)
Other
regulatory assets
i17,310
i15,656
Tax
Cuts and Jobs Act memorandum accounts
i—
(i8,293
)
Various
refunds to customers
(i7,921
)
(i7,517
)
Total
$
(i5,264
)
$
(i28,340
)
Regulatory
matters are discussed in the consolidated financial statements and the notes thereto included in the Form 10-K for the year ended December 31, 2018 filed with the SEC. The discussion below focuses on significant matters and developments since December 31, 2018.
Alternative-Revenue Programs:
GSWC records the difference between what it bills its water customers and that which is authorized by the CPUC using the Water Revenue Adjustment Mechanism ("WRAM") and Modified Cost Balancing Account (“MCBA”) accounts approved by the CPUC. The over- or under-collection of the WRAM is aggregated with the MCBA over- or under-collection for the corresponding ratemaking area and bears interest
at the current i90-day commercial paper rate.
As required by the accounting guidance for alternative revenue programs, GSWC is required to collect its WRAM balances, net of
its MCBA, within i24 months following the year in which an under-collection is recorded in order to recognize such amounts as revenue. The recovery periods for the majority of GSWC's WRAM/MCBA balances are primarily within i12
to i24 months. GSWC has implemented surcharges to recover its WRAM/MCBA balances as of December 31, 2018. For the three months ended September 30, 2019 and 2018,
surcharges (net of surcredits) of approximately $i5.5 million and $i7.7
million, respectively, were billed to customers to recover previously incurred under-collections in the WRAM/MCBA accounts. For the nine months ended September 30, 2019 and 2018, surcharges (net of surcredits) of approximately $i9.1
million and $i17.5 million, respectively, were billed to customers to recover previously incurred under-collections in the WRAM/MCBA accounts. During the nine months ended September 30, 2019,
GSWC recorded additional net under-collections in the WRAM/MCBA accounts of approximately $i20.5 million due to lower-than-adopted water usage, as well as higher-than-adopted supply costs currently in billed customer rates. As of September 30, 2019, GSWC had an aggregated
regulatory asset of $i29.2 million, which is comprised of a $i19.1
million under-collection in the WRAM accounts and a $i10.1 million under-collection in the MCBA accounts.
General Rate Case Filings:
Water Segment:
In July 2017, GSWC filed a general rate case application for all of its water regions and the general office
to determine new rates for the years 2019 - 2021. On May 30, 2019, the CPUC issued a final decision on GSWC's water general rate case with rates retroactive to January 1, 2019. Among other things, the final decision approves in its entirety a settlement agreement that had been entered into between GSWC and the CPUC’s Public Advocates Office in August 2018. As a result, the final decision authorizes GSWC to invest approximately $i334.5
million in capital expenditures over the rate cycle. The $i334.5 million of infrastructure investment includes $i20.4
million of capital projects to be filed for revenue recovery through advice letters when those projects are completed.
As a result of the May 2019 CPUC decision, GSWC implemented new water rates on June 8, 2019. Due to the delay in receiving a final decision by the CPUC, billed water revenues up to June 8, 2019 were based on 2018 adopted rates. The new rates are retroactive to January 1, 2019 and, as a result, the cumulative retroactive impact of the CPUC decision was recorded during the second quarter of 2019, primarily affecting water revenues, supply costs and depreciation expense. Accordingly, GSWC added approximately $i5.6
million to the general rate case memorandum accounts regulatory asset representing the rate difference between interim rates and final rates authorized by the CPUC retroactive to January 1, 2019. Surcharges were implemented in September 2019 to recover the retroactive rate difference over approximately i12 - i24
months. The final decision also approved the recovery of previously incurred costs that were being tracked in CPUC-authorized memorandum accounts, which resulted in a reduction to administrative and general expense of approximately $i1.1 million, which was also recorded during the second quarter of 2019.
In December 2017, the Tax Cuts and Jobs Act ("Tax Act") was signed into federal law. The
provisions of this major tax reform were generally effective January 1, 2018. The most significant provisions of the Tax Act impacting GSWC was the reduction of the federal corporate income tax rate from 35% to 21% and the elimination of bonus depreciation for regulated utilities. Pursuant to a CPUC directive, the 2018 impact of the Tax Act on the water adopted revenue requirement was tracked in a memorandum account effective January 1, 2018. On July 1, 2018, new lower water rates, which incorporated the new federal income tax rate, were implemented for all water ratemaking areas. As a result of receiving the May 2019 CPUC final decision on the water general rate case, in the third quarter of 2019 GSWC refunded approximately $i7.2
million of over-collections recorded in this memorandum account as a one-time surcredit to water customers.
Electric Segment:
In May 2017, GSWC filed its electric general rate case application with the CPUC to determine new electric rates for the years 2018 through 2021. In November 2018, GSWC and the Public Advocates Office filed a joint motion to adopt a settlement agreement between the itwo parties resolving all issues in connection with the general rate case. On
August 15, 2019, the CPUC issued a final decision, adopting the settlement agreement which, among other things, extends the rate cycle by an additional year (new rates will be effective for 2018 - 2022) and is retroactive to January 1, 2018. Because of the delay in finalizing the electric general rate case, billed electric revenues during the first two quarters of 2019, and all of 2018, were based on 2017 adopted rates pending a final decision by the CPUC in the rate case application. As a result, a $i2.3
million retroactive increase to revenues related to the full year of 2018 was recorded during the third quarter of 2019 with a corresponding increase to GSWC's regulatory assets for future recovery from customers.
In accordance with the accounting guidance for participating securities and earnings per share (“EPS”), Registrant uses the “two-class” method of computing EPS. The “two-class” method is an earnings allocation formula that determines EPS for each class of common stock and participating security. AWR has participating securities related to restricted stock units that earn dividend equivalents on an equal basis with AWR’s Common Shares, and that have been issued under AWR's stock incentive plans for employees and the non-employee directors stock plans. In applying the “two-class” method, undistributed earnings are allocated to both common shares and participating securities.
The following is a reconciliation of Registrant’s net income and weighted average Common Shares outstanding used for calculating basic net income per
share:
i
Basic:
For
The Three Months Ended September 30,
For the Nine Months Ended September 30,
(in thousands, except per share amounts)
2019
2018
2019
2018
Net
income
$
i28,006
$
i22,952
$
i67,642
$
i50,082
Less:
(a) Distributed earnings to common shareholders
i11,234
i10,102
i31,466
i28,831
Distributed
earnings to participating securities
i50
i54
i137
i151
Undistributed
earnings
i16,722
i12,796
i36,039
i21,100
(b) Undistributed
earnings allocated to common shareholders
i16,647
i12,727
i35,882
i20,991
Undistributed
earnings allocated to participating securities
i75
i69
i157
i109
Total
income available to common shareholders, basic (a)+(b)
$
i27,881
$
i22,829
$
i67,348
$
i49,822
Weighted
average Common Shares outstanding, basic
i36,835
i36,737
i36,804
i36,728
Basic
earnings per Common Share
$
i0.76
$
i0.62
$
i1.83
$
i1.36
/
Diluted
EPS is based upon the weighted average number of Common Shares, including both outstanding shares and shares potentially issuable in connection with stock options and restricted stock units granted under AWR’s stock incentive plans for employees and the non-employee directors stock plans, and net income. At September 30, 2019 and 2018, there were i8,556
and i47,792 options outstanding, respectively, under these plans. At September 30, 2019 and 2018, there were also i165,783
and i198,613 restricted stock units outstanding, respectively, including performance shares awarded to officers of the Registrant.
i
The
following is a reconciliation of Registrant’s net income and weighted average Common Shares outstanding for calculating diluted net income per share:
Diluted:
For The Three Months Ended September 30,
For The Nine Months
Ended September 30,
(in thousands, except per share amounts)
2019
2018
2019
2018
Common shareholders earnings, basic
$
i27,881
$
i22,829
$
i67,348
$
i49,822
Undistributed
earnings for dilutive stock-based awards
i75
i69
i157
i109
Total
common shareholders earnings, diluted
$
i27,956
$
i22,898
$
i67,505
$
i49,931
Weighted
average common shares outstanding, basic
i36,835
i36,737
i36,804
i36,728
Stock-based
compensation (1)
i161
i213
i156
i207
Weighted
average common shares outstanding, diluted
(1)In applying the treasury stock method of reflecting the dilutive effect of outstanding stock-based compensation in the calculation of diluted EPS, i8,556
and i47,792 stock options at September 30, 2019 and 2018, respectively, were deemed to be outstanding in accordance with accounting guidance on earnings per share. All of the i165,783
and i198,613 restricted stock units at September 30, 2019 and 2018, respectively, were included in the calculation
of diluted EPS for the three and nine months ended September 30, 2019 and 2018.
iNo stock options outstanding at
September 30, 2019 had an exercise price greater than the average market price of AWR’s Common Shares for the three and nine months ended September 30, 2019. There were ino
stock options outstanding at September 30, 2019 or 2018 that were anti-dilutive.
During the nine months ended September 30, 2019 and 2018, AWR issued i81,459
and i64,245 common shares, for approximately $i416,000 and
$i348,000, respectively, under Registrant’s Common Share Purchase and Dividend Reinvestment Plan, the 401(k) Plan, the stock incentive plans for employees, and the non-employee directors stock plans.
During the nine months ended September 30, 2019 and 2018,
AWR paid $i1.6 million and $i1.2
million, respectively, to taxing authorities on employees' behalf for shares withheld related to net share settlements. During the nine months ended September 30, 2019 and 2018, GSWC paid $i1.3
million and $i1.1 million, respectively, to taxing authorities on employees' behalf for shares withheld related to net share settlements. These payments are included in the stock-based compensation caption of the statements of equity.
During the three months ended September 30,
2019 and 2018, AWR paid quarterly dividends of approximately $i11.2 million, or $i0.305
per share, and $i10.1 million, or $i0.275 per share, respectively. During
the nine months ended September 30, 2019 and 2018, AWR paid quarterly dividends of approximately $i31.5 million, or $i0.855
per share, and $i28.8 million, or $i0.785 per share, respectively.
During
the three months ended September 30, 2019, GSWC did not pay a dividend to AWR. Instead, during the three months ended September 30, 2019, ASUS paid a $i11.3 million dividend to AWR. During the three
months ended September 30, 2018, GSWC paid dividends of $i10.1 million, to AWR. During the nine months ended September 30, 2019 and 2018, GSWC paid dividends of $i20.2
million and $i28.9 million respectively, to AWR.
Note 5 — iDerivative
Instruments
GSWC's electric division, BVES, purchases power under long-term contracts at a fixed cost depending on the amount of power and the period during which the power is purchased under such contracts. In August 2019, the CPUC approved an application that allowed BVES to enter into new long-term purchased power contracts with energy providers, which BVES executed in September 2019. BVES will begin taking power under these long-term contracts during the fourth quarter of 2019 to replace existing expiring contracts. The new contracts provide power at a fixed cost over approximately three- and five-year terms depending on the amount of power and period during which the power is purchased under the contracts.
These purchase power contracts are subject to the accounting guidance for derivatives and require mark-to-market derivative accounting. Among other things, the
CPUC also authorized BVES to use a regulatory asset and liability memorandum account to offset the mark-to-market entries required by the accounting guidance. Accordingly, all unrealized gains and losses generated from the purchased power contracts are deferred on a monthly basis into a non-interest bearing regulatory memorandum account that tracks the changes in fair value of the derivative throughout the terms of the contracts. As a result, these unrealized gains and losses do not impact GSWC’s earnings. As of September 30, 2019, there was a $i3.0
million unrealized loss recorded as a regulatory asset in the memorandum account for the purchased power contracts. As of September 30, 2019, GSWC's commitment under BVES's purchased power contracts totaled approximately $i28.0 million. The notional volume of derivatives remaining
under these long-term contracts as of September 30, 2019 was i674,961 megawatt hours.
The accounting guidance for fair value measurements applies to all financial assets and financial liabilities that are measured and reported on a fair value basis. Under the accounting guidance, GSWC makes fair value measurements that are classified and disclosed in one of the following
three categories:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2: Quoted prices in markets that are not active or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; or
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
To value the contracts, Registrant applies the Black-76 model, utilizing various inputs that include quoted market prices for energy over the duration of the
contracts. The market prices used to determine the fair value for this derivative instrument
were estimated based on independent sources such as broker quotes and publications that are not observable in or corroborated by the market. When such inputs have a significant impact on the measurement of fair value, the instruments are categorized as Level 3. Accordingly, the valuation of the derivatives on Registrant’s purchased power contract has been classified as Level 3 for all periods presented.
i
The
following table presents changes in the fair value of GSWC’s Level 3 derivatives for the three and nine months ended September 30, 2019 and 2018:
For
The Three Months Ended September 30,
For The Nine Months Ended September 30,
(dollars in thousands)
2019
2018
2019
2018
Fair value
at beginning of the period
$
(i267
)
$
(i1,710
)
$
(i311
)
$
(i2,941
)
Unrealized
gain (loss) on purchased power contracts
(i2,755
)
i567
(i2,711
)
i1,798
Fair
value at end of the period
$
(i3,022
)
$
(i1,143
)
$
(i3,022
)
$
(i1,143
)
/
Note
6 — iFair Value of Financial Instruments
For cash and cash equivalents, accounts receivable, accounts payable and short-term debt, the carrying amount is assumed to approximate fair value due to the short-term nature of these items.
Investments held in a Rabbi Trust for the supplemental executive retirement plan ("SERP") are measured at fair value and totaled $i18.8
million as of September 30, 2019. All equity investments in the Rabbi Trust are Level 1 investments in mutual funds. The investments held in the Rabbi Trust are included in "Other Property and Investments" on Registrant's balance sheets.
i
The table below estimates the fair
value of long-term debt held by GSWC. The fair values as of September 30, 2019 and December 31, 2018 were determined using rates for similar financial instruments of the same duration utilizing Level 2 methods and assumptions. The interest rates used for the September 30, 2019 valuation decreased as compared to December 31, 2018, increasing the fair value of long-term debt as of September 30, 2019 after taking into account the repayment of $i40.0
million of GSWC's i6.70% senior note in March 2019. Changes in the assumptions will produce different results.
(1) Excludes
debt issuance costs and redemption premiums.
Note 7 — iIncome Taxes
On December 22, 2017, the Tax Act was signed into federal law. The provisions of this major tax reform were generally effective January 1, 2018. Among its significant provisions, the Tax
Act reduced the federal corporate income tax rate from 35% to 21% and eliminated bonus depreciation for regulated utilities. AWR's effective income tax rate (“ETR”) was i25.1% and i23.2%
for the three months ended September 30, 2019 and 2018, respectively, and was i23.3% and i21.7%
for the nine months ended September 30, 2019 and 2018, respectively. GSWC's ETR was i26.4% and i23.2%
for the three months ended September 30, 2019 and 2018, respectively, and was i24.1% and i22.5%
for the nine months ended September 30, 2019 and 2018, respectively.
The AWR and GSWC effective tax rates differ from the federal statutory tax rate primarily due to (i) state taxes, (ii) permanent differences, including the excess tax benefits from share-based payments, which were reflected in the income statements and resulted in a reduction to income tax expense during the three and nine months ended September 30, 2019 and 2018, (iii) the continuing amortization
of the excess deferred income tax liability that commenced upon the lowering of the federal tax rate, and (iv) differences between book and taxable income that are treated as flow-through adjustments in accordance with regulatory requirements (principally from plant, rate-case, and compensation expenses). As a regulated utility, GSWC treats certain temporary differences as flow-through in computing its income tax expense consistent with the income tax method used in its CPUC-jurisdiction ratemaking. Flow-through items either increase or decrease tax expense and thus impact the ETR.
The components of net periodic benefit costs for Registrant’s pension plan, postretirement
plan and SERP for the three and nine months ended September 30, 2019 and 2018 were as follows:
For
The Three Months Ended September 30,
Pension Benefits
Other
Postretirement
Benefits
SERP
(dollars in thousands)
2019
2018
2019
2018
2019
2018
Components
of Net Periodic Benefits Cost:
Service
cost
$
i1,110
$
i1,335
$
i53
$
i48
$
i298
$
i274
Interest
cost
i2,132
i1,912
i80
i75
i267
i222
Expected
return on plan assets
(i2,594
)
(i2,793
)
(i112
)
(i123
)
i—
i—
Amortization
of prior service cost
i109
i—
i—
i—
i—
i—
Amortization
of actuarial (gain) loss
i355
i314
(i150
)
(i212
)
i118
i262
Net
periodic benefits costs under accounting standards
i1,112
i768
(i129
)
(i212
)
i683
i758
Regulatory
adjustment - deferred
(i160
)
i—
i—
i—
i—
i—
Total
expense (benefit) recognized, before surcharges and allocation to overhead pool
$
i952
$
i768
$
(i129
)
$
(i212
)
$
i683
$
i758
For
The Nine Months Ended September 30,
Pension Benefits
Other
Postretirement
Benefits
SERP
(dollars in thousands)
2019
2018
2019
2018
2019
2018
Components
of Net Periodic Benefits Cost:
Service
cost
$
i3,330
$
i4,005
$
i159
$
i162
$
i894
$
i822
Interest
cost
i6,396
i5,736
i240
i219
i801
i666
Expected
return on plan assets
(i7,782
)
(i8,379
)
(i336
)
(i369
)
i—
i—
Amortization
of prior service cost
i327
i—
i—
i—
i—
i—
Amortization
of actuarial (gain) loss
i1,065
i942
(i450
)
(i576
)
i354
i786
Net
periodic benefits costs under accounting standards
i3,336
i2,304
(i387
)
(i564
)
i2,049
i2,274
Regulatory
adjustment - deferred
(i502
)
i—
i—
i—
i—
i—
Total
expense (benefit) recognized, before surcharges and allocation to overhead pool
$
i2,834
$
i2,304
$
(i387
)
$
(i564
)
$
i2,049
$
i2,274
/
During
the third quarter of 2019, Registrant contributed approximately $i3.9 million to its pension plan.
As authorized by the CPUC in the water and electric general rate case decisions, GSWC utilizes two-way balancing accounts for its water and electric regions and the general office to track differences between the forecasted annual pension
expenses in rates, or expected to be in rates, and the actual annual expense recorded by GSWC in accordance with the accounting guidance for pension costs. During the three and nine months ended September 30, 2019, GSWC's actual pension expense was higher than the amounts included in water customer rates by $i160,000
and $i502,000 , respectively. As of September 30, 2019, GSWC had a $i2.8
million net over-collection in the two-way pension balancing accounts included as part of the pension regulatory asset (Note 3).
Note 9 — iContingencies
Environmental Clean-Up and Remediation:
GSWC has been involved in environmental remediation and cleanup at a plant site
("Chadron Plant") that contained an underground storage tank which was used to store gasoline for its vehicles. This tank was removed from the ground in July 1990 along with the dispenser and ancillary piping. Since then, GSWC has been involved in various remediation activities at this site. Analysis indicates that off-site monitoring wells may be necessary to document effectiveness of remediation.
As of September 30, 2019, the total amount spent to clean up and remediate GSWC’s plant facility was approximately $i6.2
million, of which $i1.5 million has been paid by the State of California Underground Storage Tank Fund. Amounts paid by GSWC have been included in rate base and approved by the CPUC for recovery. As of September 30, 2019, GSWC has a regulatory asset and an accrued liability for the estimated additional cost of $i1.3
million to complete the cleanup at the site. The estimate includes costs for two years of continued activities of groundwater cleanup and monitoring, future soil treatment and site-closure-related activities. The ultimate cost may vary as there are many unknowns in remediation of underground gasoline spills and this is an estimate based on currently available information. Management also believes it is probable that the estimated additional costs will be approved in rate base by the CPUC.
Other Litigation:
Registrant is also subject to other ordinary routine litigation incidental to its business, some of which may include claims for compensatory and punitive damages. Management believes that rate recovery, proper insurance coverage and reserves are in place to insure against, among other things, property, general liability,
employment, and workers’ compensation claims incurred in the ordinary course of business. Insurance coverage may not cover certain claims involving punitive damages. However, Registrant does not believe the outcome from any pending suits or administrative proceedings will have a material effect on Registrant's consolidated results of operations, financial position or cash flows.
Note 10 — iLeases
The
adoption of the new lease guidance (see Note 1) effective January 1, 2019 did not have a material impact on Registrant's results of operations or liquidity but resulted in the recognition of operating lease liabilities and operating lease right-of-use assets on its balance sheets. Right-of-use ("ROU") assets represent the right to use an underlying asset for the lease term, and lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets and liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term. As of September 30, 2019, Registrant has right-of-use assets of $i13.0
million, short-term operating lease liabilities of $i1.8 million and long-term operating lease liabilities of $i11.5
million.
Significant assumptions and judgments made as part of the adoption of this new lease standard include determining (i) whether a contract contains a lease, (ii) whether a contract involves an identified asset, and (iii) which party to the contract directs the use of the asset. The discount rates used to calculate the present value of lease payments were determined based on hypothetical borrowing rates available to Registrant over terms similar to the lease terms.
Registrant’s leases consist of real estate and equipment leases. Most of these are GSWC's leases. Most of Registrant's leases require fixed lease payments. Some real estate leases have escalation payments which depend on an index. Variable lease costs have not been material. Lease terms used to measure the lease liability include options to extend the lease if the option is reasonably
certain to be exercised. Lease and non-lease components were combined to measure lease liabilities. Registrant also has a real estate lease that have not yet commenced as of September 30, 2019. This lease will increase operating right-of-use assets and operating lease liabilities by approximately $i806,000 upon possession of the office space later in 2019.
GSWC's
long-term debt includes $i28.0 million of i9.56%
private placement notes, which require GSWC to maintain a total indebtedness to capitalization ratio of less than i0.6667-to-1. The indebtedness, as defined in the note agreement, includes any lease liabilities required to be recorded under GAAP. As of September 30, 2019, GSWC had a total indebtedness (including GSWC's lease liabilities) to capitalization
ratio of i0.4377-to-1. None of the other covenants or restrictions contained in Registrant's long-term debt agreements were affected by the adoption of the new lease standard.
i
Registrant's
supplemental lease information for the three and nine months ended September 30, 2019 is as follows (in thousands, except for weighted average data):
During the three months ended September 30, 2019 and 2018, Registrant’s consolidated rent expense was approximately $i683,000 and $i569,000,
respectively, and was approximately $i2.0 million and $i1.7 million for the nine months ended September 30,
2019 and 2018, respectively. Registrant has entered into several new office leases during 2019. iRegistrant’s future minimum payments under long-term non-cancelable operating leases are as follows (in thousands):
There
is no material difference between the consolidated operations of AWR and the operations of GSWC in regard to the future minimum payments under long-term non-cancelable operating leases.
AWR has ithree reportable segments, water, electric and contracted services, whereas GSWC has itwo
segments, water and electric. On a stand-alone basis, AWR has no material assets other than its equity investments in its subsidiaries and note receivables therefrom, and deferred taxes.
All activities of GSWC, a rate-regulated utility, are geographically located within California. Activities of ASUS and its subsidiaries are conducted in California, Georgia, Florida, Kansas, Maryland, New Mexico, North Carolina, South Carolina, Texas and Virginia. Each of ASUS’s wholly owned subsidiaries is regulated, if applicable, by the state in which the subsidiary primarily conducts water and/or wastewater operations. Fees charged for operations and maintenance and renewal and replacement services are based upon the terms of the contracts with the U.S. government, which have been filed, as appropriate, with the commissions in the states in which ASUS’s subsidiaries are incorporated.
iThe
tables below set forth information relating to GSWC’s operating segments, ASUS and its subsidiaries and other matters. Total assets by segment are not presented below, as certain of Registrant’s assets are not tracked by segment. The utility plant amounts are net of respective accumulated provisions for depreciation. Capital additions reflect capital expenditures paid in cash, excluding U.S. government- and third-party contractor-funded capital expenditures for ASUS and property installed by developers and conveyed to GSWC.
(1)Depreciation computed on GSWC’s transportation equipment is recorded in other operating expenses and totaled $i80,000
and $i58,000
for the three months ended September 30, 2019 and 2018, respectively, and $i234,000 and $i179,000
for the nine months ended September 30, 2019 and 2018, respectively.
i
The following table reconciles total utility plant (a key figure for ratemaking) to total consolidated assets (in thousands):
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 the company’s weighted average number of diluted 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 in August 2019, has been excluded when communicating that segment's quarterly and year-to-date results to help facilitate comparisons of the company’s performance from period to period.
Registrant believes that the disclosure of the water and electric gross margins, earnings per share by business segment, and the adjustment to the electric
segment's earnings for earnings related to prior periods, 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 in the 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 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 ended December 31, 2018.
Water and Electric Segments:
GSWC's revenues, operating income and cash flows are 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. 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:
In July 2017, GSWC filed a general rate case application for all of its
water regions and the general office to determine new rates for the years 2019 – 2021. On May 30, 2019, the CPUC issued a final decision on GSWC's water general rate case with rates retroactive to January 1, 2019. Among other things, the final decision approves in its entirety an August 2018 settlement agreement that had been entered into between GSWC and the CPUC’s Public Advocates Office. As a result, the final decision authorizes 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.
Excluding the advice letter project revenues, the new rates approved will increase the water gross margin for 2019 by approximately $7.1 million, adjusted
for updated inflation index values since the August 2018 settlement, as compared to the 2018 adopted water gross margin. The 2019 water revenue requirement has been reduced to reflect a decrease of approximately $7.0 million in depreciation expense, compared to the adopted 2018 depreciation expense, due to a reduction in the overall composite depreciation rates based on a revised study filed in the general rate case. The decrease in depreciation expense lowers the water gross margin and is offset by a corresponding decrease in depreciation expense, resulting in no impact to net earnings. In addition, the 2019 water revenue requirement includes a decrease of approximately $2.2 million for excess deferred tax refunds as a result of the 2017 Tax Cuts and Jobs Act ("Tax Act"), with a corresponding decrease in income tax expense also resulting in
no impact to net earnings. Had depreciation remained the same as the 2018 adopted amount and there were no excess deferred tax refunds that lowered the 2019 revenue requirement, the water gross margin for 2019 would have increased by approximately $16.3 million.
As a result of the May 2019 CPUC final decision, GSWC implemented new water rates on June 8, 2019. The CPUC in the final decision also approved the recovery of previously incurred costs that were being tracked in CPUC-authorized memorandum accounts. This resulted in a reduction to administrative and general expense of approximately $1.1 million, or $0.02 per share, which was recorded during the second quarter of 2019. The final decision also allows for potential additional water revenue increases in 2020 and 2021 of approximately
$9.1 million (based on current inflationary index values) and $12.0 million, respectively, subject to the results of an earnings test and changes to the forecasted inflationary index values.
Electric Segment:
In May 2017, GSWC filed its electric general rate case application with the CPUC to determine new electric rates for the years 2018 through 2021. In November 2018, GSWC and the Public Advocates Office filed a joint motion to adopt a settlement agreement between the two parties resolving all issues in connection with the general rate case.
On August 15, 2019, the CPUC issued a final decision on this general rate case, adopting the settlement agreement in its entirety. Among other things, the decision authorizes a new return on equity for GSWC's electric segment
of 9.60%, as compared to its previously authorized return of 9.95%. The decision also includes 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. Furthermore, the decision (i) extends the rate cycle by one year (new rates will be effective for 2018 – 2022); (ii) increases the electric gross margin for 2018 by approximately $2.0 million compared to the 2017 adopted electric gross margin, adjusted for Tax Act changes; (iii) authorizes BVES to construct all the capital projects requested in its application and provides additional funding for the fifth year added to the rate cycle, which total approximately $44 million of capital projects 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.
Due to the delay in finalizing the electric general rate case, electric revenues recognized during 2018 and the first six months of 2019 were based on 2017 adopted rates. Because the CPUC final decision is retroactive to January 1, 2018, the cumulative retroactive earnings impact of the decision is included in the third quarter results of 2019, including approximately $0.03 per share related to the first six months of 2019, and $0.04 per share relating to the full year ended December 31, 2018.
California Assembly Bill No. 1054:
On July 12, 2019, the governor of California signed Assembly Bill No. 1054 (“AB 1054”), the provisions of which took effect
immediately. Among other things, AB 1054 provides a framework for electrical corporations to recover costs and expenses arising from a covered wildfire, as defined, and to allow cost recovery from ratepayers in particular circumstances. The bill also establishes a Wildfire Fund to pay eligible claims arising from a covered wildfire under certain circumstances. The Wildfire Fund is expected to be funded partially by electrical corporation shareholders, and partly by ratepayers. California's three largest electric utilities are participating in the Wildfire Fund. Other investor-owned electric utilities (referred to as “regional” utilities), including GSWC's BVES division have decided not to participate. It is highly unlikely that the Wildfire Fund will have any financial value for regional utilities such as BVES because withdrawals by a regional utility are capped per wildfire at three times the regional utility’s aggregate initial and annual contributions
and withdrawals may only be made if and to the extent that the amount of the claims against the utility (which must be settled or finally adjudicated) in a given year exceed the greater of the amount of the utility’s insurance or $1 billion dollars. It is remote that claims from a wildfire will reach the $1 billion minimum, and if they did, the claims would likely exceed the amount that the electric division would be able to access from the Wildfire Fund.
AB 1054 also requires the CPUC, when determining whether an electric utility may recover costs and expenses arising from a wildfire from ratepayers, to allow cost recovery if the costs and expenses are determined to be just and reasonable based on reasonable conduct by the electric utility. The electric utility has the burden of proof based on a preponderance of the evidence that its conduct was reasonable unless it has a valid safety certification for the time period in
which the wildfire occurred or the plaintiff establishes reasonable doubt that GSWC acted reasonably. At this time, GSWC intends to seek a safety certification from the CPUC in accordance with the current procedures adopted by the CPUC. The bill also authorizes an electric utility to file an application requesting the CPUC to authorize the recovery of costs and expenses determined to be reasonable through the issuance of bonds secured by a rate component.
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.
Fort Riley:
On July 1, 2018, ASUS assumed the operation, maintenance and construction management of the water distribution and wastewater collection and treatment facilities at Fort Riley, a United States Army installation located in Kansas, after completing
a transition period and a detailed inventory study. The 50-year contract is subject to annual economic price adjustments.
Summary of Third Quarter Results by Segment
The table below sets forth the third quarter diluted earnings per share by business segment:
Diluted Earnings per Share
Three Months Ended
9/30/2019
9/30/2018
CHANGE
Water
$
0.53
$
0.47
$
0.06
Electric
(excluding retroactive impact of CPUC decision on general rate case)
0.03
0.02
0.01
Contracted services
0.12
0.13
(0.01
)
AWR
(parent)
0.01
—
0.01
Consolidated diluted earnings per share, adjusted
0.69
0.62
0.07
Retroactive
impact of CPUC decision in the electric general rate case for first six months of 2019 and full year of 2018
0.07
—
0.07
Consolidated diluted earnings per share, as reported
$
0.76
$
0.62
$
0.14
Water
Segment:
Diluted earnings per share from the water segment for the three months ended September 30, 2019 increased by $0.06 per share as compared to the same period in 2018. The following items affected the comparability between the two periods (excluding the impact of billed surcharges, which have no impact to net earnings):
•
An increase in the water gross margin increased earnings by approximately $0.06 per share largely as a result of the May 2019 CPUC decision on the general rate
case, which approved new water rates and adopted supply costs for 2019. As previously discussed, the 2019 water revenue requirement has also been reduced to reflect a decrease in depreciation expense, due to a reduction in the overall composite depreciation rates based on a revised study filed in the general rate case. The decrease in depreciation expense lowers the water gross margin, and is offset by a corresponding decrease in depreciation expense as discussed below, resulting in no impact to net earnings.
•
An overall decrease in operating expenses (excluding supply costs), which positively impacted earnings by $0.02 per share mostly due to lower depreciation and administrative and general expenses. As discussed above, the lower depreciation
expense is reflected in the new revenue requirement approved in the general rate case. The decrease in administrative and general expenses was due, in large part, to timing differences related to the recognition of stock-based compensation expense. These decreases were partially offset by higher maintenance expense, and property and other taxes.
•
A decrease in the gains generated during the three months ended September 30, 2019 on Registrant's investments held to fund a retirement benefit plan due to market conditions as well as an increase in interest expense, decreased water earnings by approximately
$0.01 per share, as compared to the same period of 2018.
•
Changes in the effective income tax rate resulting from certain flow-through taxes and permanent items for the three months ended September 30, 2019 as compared to the same period in 2018, decreased earnings at the water segment by approximately $0.01 per share.
Electric Segment:
In August 2019, the CPUC issued a final decision on the electric general rate case, which sets new rates for the years 2018 through 2022. Since the new rates were
retroactive to January 1, 2018, the impact of the new electric rates for the first six months of 2019 and all of 2018 are reflected in the results for the third quarter of 2019. Of the electric segment's $0.10 recorded earnings per share for the three months ended September 30, 2019, approximately $0.03 per share relates to the first six months of 2019, and $0.04 per share relates to the full year ended December 31, 2018, for a total of $0.07 per share, which is shown on a separate line in the table above.
Excluding this retroactive impact, forthe three months ended September 30, 2019, diluted earnings from the electric segment were $0.03 per share as compared to $0.02 per share for the same period in 2018. There was an increase in the electric gross margin as a result of new rates authorized by the CPUC's August final decision, partially offset by an increase in the effective income tax rate as compared to the same period in 2018 resulting from certain flow-through taxes.
Contracted
Services Segment:
For the three months ended September 30, 2019, diluted earnings from the contracted services segment were $0.12 per share as compared to $0.13 per share for the same period in 2018. The decrease was largely due to differences in the timing of construction work performed in 2019 as compared to 2018.
AWR (parent):
For the three months ended September 30, 2019, diluted earnings at AWR (parent) increased $0.01
per share due primarily to lower state unitary taxes.
Summary of Year-to-Date Results by Segment
The table below sets forth the year-to-date diluted earnings per share by business segment.
Diluted Earnings per Share
Nine Months Ended
9/30/2019
9/30/2018
CHANGE
Water
$
1.33
$
1.02
$
0.31
Electric
(excluding retroactive impact of CPUC decision on general rate case)
0.11
0.08
0.03
Contracted services
0.34
0.24
0.10
AWR
(parent)
0.01
0.01
—
Consolidated diluted earnings per share, adjusted
1.79
1.35
0.44
Retroactive
impact of CPUC decision in the electric general rate case related to the full year of 2018
0.04
—
0.04
Consolidated diluted earnings per share, as reported
$
1.83
$
1.35
$
0.48
Water
Segment:
Diluted earnings per share from the water segment for the nine months ended September 30, 2019 increased by $0.31 per share as compared to the same period in 2018 largely due to the approval of the water general rate case in May 2019. Also, included in the earnings for the nine months ended September 30, 2019 was a $1.1 million reduction to administrative and general expense, positively impacting earnings by $0.02 per share, to reflect the CPUC's approval for recovery of costs previously expensed as incurred and tracked in memorandum accounts. Excluding
this $0.02 per share impact, diluted earnings per share from the water segment for the nine months ended September 30, 2019 increased by $0.29 per share due to the following items (excluding billed surcharges):
•
An increase in the water gross margin of $0.17 per share, as a result of new rates authorized by the CPUC's final decision on the water general rate case and retroactive to January 1, 2019.
•
An
overall decrease in operating expenses (excluding supply costs), positively impacting earnings by $0.08 per share due, in large part, to lower depreciation expense resulting from lower authorized composite rates recently approved in the water general rate case. The decrease in depreciation expense from lower adopted composite rates also lowers the adopted water gross margin, resulting in no impact to net earnings. There was also a decrease in maintenance expense, which is expected to increase during the remainder of 2019.
•
An increase in interest and other income, net of interest expense, of $0.02 per share due to higher gains generated during the nine months ended September 30,
2019 on Registrant's investments held to fund a retirement benefit plan, as compared to the same period of 2018 due to market conditions.
•
Changes in the effective income tax rate resulting from certain flow-through taxes and permanent items for the nine months ended September 30, 2019 as compared to the same period in 2018, increased earnings at the water segment by approximately $0.02 per share.
The CPUC's August 2019 final decision on the electric general rate case set new rates for 2018 through 2022 and is retroactive to January 1, 2018. As a result, the retroactive impact of the new electric rates for all of fiscal 2018 is reflected in the results for the nine months ended September 30, 2019. Of the electric segment's $0.15 earnings per share for the nine months ended September 30, 2019, approximately $0.04 per share relates to the full year
ended December 31, 2018, which is shown on a separate line in the table above.
Excluding this retroactive impact, forthe nine months ended September 30, 2019, diluted earnings from the electric segment were $0.11 per share as compared to $0.08 per share for the same period in 2018. The increase was due to a higher electric gross margin as a result of new rates authorized by the CPUC's August final decision, partially offset by a higher effective income tax rate as compared to the nine months ended September 30,
2018 due to changes in certain flow-through taxes.
Contracted Services Segment:
For the nine months ended September 30, 2019, diluted earnings per share from the contracted services segment were $0.34 per share as compared to $0.24 per share for the same period in 2018 due, in part, to the commencement of operations at Fort Riley in July 2018. There was also an increase in management fees and construction revenues at several other military bases due to the successful resolution of various price adjustments and an overall increase in construction activity compared to the same period
in 2018, respectively.
The following discussion and analysis for the three and nine months ended September 30, 2019 and 2018 provides information on AWR’s consolidated operations and assets and, where necessary, includes specific references to AWR’s individual segments and subsidiaries: GSWC and ASUS and its subsidiaries.
GSWC relies upon approvals by the CPUC of rate increases to recover operating expenses and to provide for a return on invested and borrowed capital used to fund utility plant for GSWC. Registrant relies on economic price and equitable adjustments by the U.S. government in order to recover operating expenses and provide a profit margin for ASUS. Current operating revenues and earnings can be negatively impacted if the Military Privatization Subsidiaries do not receive
adequate rate relief or adjustments in a timely manner. ASUS’s earnings are also impacted by the level of additional construction projects at the Military Utility Privatization Subsidiaries, which may or may not continue at current levels in future periods.
Water
For the three months ended September 30, 2019, revenues from water operations increased $7.6 million to $95.2 million as compared to the same period in 2018 due primarily to new water rates approved in the May 2019 CPUC decision, which were retroactive to January 1, 2019. There were also revenue increases related to CPUC-approved surcharges
to recover previously incurred costs as well as to cover increases in supply costs experienced in most ratemaking areas. These surcharges are largely offset by corresponding increases in operating expenses, resulting in an immaterial impact to earnings.
Billed water consumption for the third quarter of 2019 decreased by approximately 5% as compared to the same period in 2018. In general, changes in consumption do not have a significant impact on recorded revenues due to the CPUC-approved Water Revenue Adjustment Mechanism ("WRAM") in place in all but one small rate-making area. GSWC records the difference between what it bills its water customers and that which is authorized by the CPUC in the WRAM accounts as regulatory assets or liabilities.
Electric
Electric
revenues for the three months ended September 30, 2019 increased $4.1 million to $12.0 million, due to new rates approved in the August 2019 CPUC final decision on the electric general rate case, which was retroactive to January 1, 2018. Included in the $12.0 million of electric revenues was approximately $3.7 million relating to periods prior to the third quarter of 2019.
Billed electric usage during the three months ended September 30, 2019 decreased by approximately 3% as compared to the three months ended September 30,
2018. Due to the CPUC-approved Base Revenue Requirement Adjustment Mechanism ("BRRAM"), which adjusts certain revenues to adopted levels authorized by the CPUC, changes in usage do not have a significant impact on earnings.
Contracted Services
Revenues from contracted services are composed of construction revenues (including renewal and replacements) and management fees for operating and maintaining the water and/or wastewater systems at various military bases. For the three months ended September 30, 2019, revenues from contracted services decreased $1.4 million to $27.3 million as compared to $28.6 million for the
same period in 2018 largely due to differences in timing of construction work performed in 2019 as compared to 2018.
ASUS subsidiaries continue to enter into U.S. government-awarded contract modifications and agreements with third-party prime contractors for new construction projects at the Military Utility Privatization Subsidiaries. During 2019, ASUS has been awarded approximately $20.5 million in new construction projects, which have been or are expected to be completed during 2019 and 2020. Earnings and cash flows from modifications to the original 50-year contracts with the U.S. government and agreements with third-party prime contractors for additional construction projects may or may not continue in future periods.
Operating Expenses:
Supply Costs
Supply
costs for the water segment consist of purchased water, purchased power for pumping, groundwater production assessments and changes in the water supply cost balancing accounts. Supply costs for the electric segment consist of purchased power for resale, the cost of natural gas used by BVES’s generating unit, the cost of renewable energy credits and changes in the electric supply cost balancing account. Water and electric gross margins are computed by subtracting total supply costs from total revenues. Registrant uses these gross margins and related percentages as an important measure in evaluating its operating results. Registrant believes these measures are useful internal benchmarks in evaluating the utility business performance within its water and electric 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, which is determined in accordance with GAAP.
Total supply costs comprise the largest segment of total operating expenses. Supply costs accounted for approximately 34.6% and 31.5% of total operating expenses for the three months ended September 30,2019
and 2018, respectively.
The table below provides the amounts (in thousands) of increases (decreases) and percent changes in water and electric revenues, supply costs and gross margin during the three months ended September 30,2019 and 2018. There was a $963,000 increase in surcharges recorded in water revenues to recover previously incurred costs, which did not impact water earnings. Surcharges to recover previously incurred costs are recorded to revenues when billed to customers and are offset by a corresponding amount in operating expenses, resulting in no impact to earnings.
(1) As
reported on AWR’s Consolidated Statements of Income, except for supply cost balancing accounts. The sum of water and electric supply cost balancing accounts in the table above are shown in AWR’s Consolidated Statements of Income and totaled $(2,680,000) and $(5,212,000) for the three months ended September 30,2019 and 2018, respectively. Revenues include surcharges, which increase both revenues and operating expenses by corresponding amounts, thus having no net earnings impact.
(2) Water and electric gross margins do not include any depreciation and amortization, maintenance, administrative
and general, property or other taxes or other operation expenses.
Two of the principal factors affecting water supply costs are the amount of water produced and the source of the water. Generally, the variable cost of producing water from wells is less than the cost of water purchased from wholesale suppliers. Under the CPUC-approved Modified Cost Balancing Account ("MCBA"), GSWC tracks adopted and actual expense levels for purchased water, power purchased for pumping and pump taxes. GSWC records the variances (which include the effects of changes in both rate and volume) between adopted and actual purchased water, purchased power, and pump tax expenses. GSWC recovers from, or refunds to, customers the amount of such variances. GSWC tracks these variances individually for each water ratemaking area.
The overall actual percentages of purchased water for the three months ended
September 30,2019 and 2018 were approximately 47% and 43%, respectively, as compared to the authorized adopted percentages of 39% and 30% for the three months ended September 30,2019 and 2018, respectively. The higher actual percentage of purchased water as compared to the adopted percentage resulted from a higher volume of purchased water costs due to several wells being out of service. Purchased water costs for the three months ended September
30,2019 increased to $23.4 million as compared to $21.8 million for the same period in 2018. The decrease in power purchased for pumping as well as groundwater production assessments were due to a higher mix of purchased water as compared to pumped water.
The under-collection balance in the water supply cost balancing account decreased by $2.3 million during the three months ended September 30,2019 as compared to the same period in 2018 mainly due to updated adopted supply cost expenses
from the approved water general rate case, resulting in a lower under-collection in the water supply cost balancing account.
For the three months ended September 30,2019, the cost of power purchased for resale to BVES's customers decreased to $2.4 million as compared to $2.6 million during the same period in 2018. The over-collection in the electric supply cost balancing
account increased as compared to the three months ended September 30,2018 due to a decrease in the average price per megawatt-hour ("MWh"). The average price per MWh, including fixed costs, decreased from $81.95 for the three months ended September 30,2018 to $77.48 for the same period in 2019.
Other Operation
The primary components of other operation expenses for GSWC include payroll, materials and supplies, chemicals and water treatment costs and outside service costs of operating the regulated water systems, including the costs associated with
water transmission and distribution, pumping, water quality, meter reading, billing, and operations of district offices as well as the electric system. Registrant’s contracted services operations incur many of the same types of expenses as well. For the three months ended September 30,2019 and 2018, other operation expenses by business segment consisted of the following (dollar amounts in thousands):
For
the three months ended September 30,2019, other operation expense at the water segment increased due to higher surcharges billed for recovery of costs as compared to the same period in 2018. Excluding the increase in surcharges, which have no impact to earnings, other operation expenses at the water segment decreased by $50,000.
For the three months ended September 30,2019, total other operation expenses for the electric segment decreased due to lower outside service costs and bad debt expense, while the $247,000 decrease at the contracted services segment
was due to lower operation-related labor costs.
Administrative and General
Administrative and general expenses include payroll related to administrative and general functions, all employee-related benefits, insurance expenses, outside legal and consulting fees, regulatory-utility-commission expenses, expenses associated with being a public company and general corporate expenses charged to expense accounts. For the three months ended September 30,2019 and 2018, administrative and general expenses by business segment, including AWR (parent), consisted of the following (dollar amounts in thousands):
For
the three months ended September 30, 2019, administrative and general expenses at the water segment decreased by $795,000 due primarily to timing differences related to the recognition of stock-based compensation expense recorded in accordance with the respective accounting guidance. This decrease was partially offset by higher labor, other employee-related benefits and outside services costs, as well as an increase in surcharges billed for the recovery of administrative and general expenses as compared to the same period in 2018, which have no impact to earnings,
The decrease in administrative and general expenses at the electric segment was due to lower outside service and regulatory expenses.
For
the three months ended September 30, 2019, the increase in administrative and general expenses for the contracted services segment was due to higher labor and labor-related costs, an increase in legal and outside service costs, and a greater proportion of shared services cost allocated to ASUS pursuant to the water general rate case decision.
For the three months ended September 30,2019 and 2018, depreciation and amortization by business segment consisted of the following (dollar amounts in thousands):
The
May 2019 CPUC final decision in the water general rate case approved lower overall composite depreciation rates based on a revised depreciation study. The decrease in composite depreciation rates lowers the water gross margin, with a corresponding decrease in depreciation expense, resulting in no impact to net earnings. The decrease in depreciation expense resulting from the new composite rates was partially offset by increased depreciation from additions to utility plant.
The increases in depreciation expense at the electric and contracted services segments were due to plant additions in 2018 and 2019.
Maintenance
For the three months ended September 30,2019 and 2018,
maintenance expense by business segment consisted of the following (dollar amounts in thousands):
Maintenance
expense at the water segment increased due to higher planned and unplanned maintenance as compared to the same period in 2018. Maintenance expense at the water segment is expected to continue increasing during the remainder of 2019.
For the three months ended September 30,2019, the decrease in maintenance expense for the electric segment includes a $302,000 reduction to reflect the recovery of previously incurred costs approved by the CPUC in August 2019.
Property and Other Taxes
For the three months ended September 30,2019
and 2018, property and other taxes by business segment consisted of the following (dollar amounts in thousands):
Property
and other taxes increased overall due, in part, to capital additions at the water segment. There was also an increase in local franchise fees paid to various municipalities and counties, which are derived based on revenues and utility plant. With the approval of the new water rate case, the increase in franchise fees is reflected in the newly adopted revenue requirement.
For the three months ended September 30,2019, construction expenses for
contracted services were $12.9 million, decreasing $726,000 compared to the same period in 2018 due primarily to differences in the timing of construction work performed during 2019 as compared to 2018.
Interest Expense
For the three months ended September 30,2019 and 2018, interest expense by business segment, including AWR (parent), consisted of the following (dollar amounts in thousands):
The
overall increase in interest expense is due to higher average borrowings as well as higher interest rates on the revolving credit facility as compared to 2018. In March 2019, AWR exercised an option in the credit facility to increase its borrowing capacity from $150.0 million to $200.0 million. Borrowings made during 2019 were used to repay $40.0 million of GSWC's 6.70% senior note, which matured in March 2019, as well as to fund a portion of GSWC's capital expenditures.
Interest Income
For the three months ended September 30,2019 and 2018,
interest income by business segment, including AWR (parent), consisted of the following (dollar amounts in thousands):
The
increase in interest income during the three months ended September 30,2019 was largely due to interest income recognized on certain initial construction projects performed by the contracted services segment at Fort Riley during the three months ended September 30,2019, as well as interest related to regulatory assets for the electric segment as a result of the August 2019 CPUC final decision.
Other, net
For the three months ended September 30, 2019, other income decreased due to lower gains recorded on Registrant's
investments held for a retirement benefit plan because of recent market conditions as compared to the same period in 2018. There was also an increase in the non-service cost components of net periodic benefit costs related to Registrant's defined benefit pension plan and other retirement benefits. However, as a result of GSWC's pension balancing account authorized by the CPUC, changes in net periodic benefit costs are mostly offset by corresponding changes in revenues, having no material impact to earnings.
For the three months ended September
30,2019 and 2018, income tax expense by business segment, including AWR (parent), consisted of the following (dollar amounts in thousands):
Consolidated
income tax expense for the three months ended September 30,2019 increased by $2.5 million due primarily to an increase in pretax income, largely due to new water rates as well as the retroactive impact of the electric general rate case. AWR's effective income tax rate ("ETR") was 25.1% and 23.2% for the three months ended September 30, 2019 and 2018, respectively. The increase was due primarily to the increase in GSWC's ETR, which was 26.4% and 23.2%
for the three months ended September 30, 2019 and 2018, respectively, resulting primarily from changes in certain flow-through items. Partially offsetting the increase in GSWC's ETR were lower state taxes at AWR (parent).
For the nine months ended September 30, 2019, revenues from water operations increased $19.3 million to $248.1 million
as compared to the same period in 2018 as a result of new CPUC-approved water rates effective January 1, 2019 as part of the May 2019 general rate case final decision. There were also revenue increases related to CPUC-approved surcharges to recover previously incurred costs as well as to cover increases in supply costs experienced in most ratemaking areas. These surcharges are largely offset by corresponding increases in operating expenses, resulting in an immaterial impact to earnings. The increase in surcharge revenues was offset by a corresponding increase in operating expenses (primarily administrative and general), also resulting in no impact to earnings.
Billed water consumption for the first nine months of 2019 decreased approximately
8% as compared to the same period in 2018. Changes in consumption generally do not have a significant impact on revenues due to the WRAM.
Electric
For the nine months ended September 30, 2019, revenues from electric operations were $30.0 million as compared to $25.5 million for the same period in 2018 due to new rates approved in the August 2019 CPUC final decision on the electric general rate case, which were retroactive to January 1, 2018. Included in revenues for the nine
months ended September 30, 2019 was approximately $2.3 million which related to the full year of 2018.
Billed electric usage increased by approximately 4% during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018. Due to the CPUC-approved BRRAM, which adjusts certain revenues to adopted levels authorized by the CPUC, changes in usage do not have a significant impact on earnings.
Contracted Services
For
the nine months ended September 30, 2019, revenues from contracted services increased $11.3 million to $82.7 million as compared to $71.4 million for the same period in 2018, primarily due to the commencement of operations at Fort Riley in July 2018. There was also an increase in management fees and construction revenues at various other military bases served.
Total supply costs comprise the largest segment of total operating expenses. Supply costs accounted for approximately 31.5% and 28.9% of total operating expenses for the nine months ended September 30, 2019 and 2018, respectively. The following table provides the amount of increases (decreases) and percent changes in water and electric revenues, supply costs and gross margin during the nine months ended September 30, 2019
and 2018 (dollar amounts in thousands). There was an increase in surcharges of $497,000 recorded in water revenues, which did not impact water earnings. Surcharges are recorded to revenues when billed to customers and are offset by a corresponding increase in operating expenses, resulting in no impact to earnings.
(1)As
reported on AWR’s Consolidated Statements of Income, except for supply cost balancing accounts. The sum of water and electric supply cost balancing accounts in the table above are shown on AWR’s Consolidated Statements of Income and totaled $(2,845,000) and $(11,110,000) for the nine months ended September 30, 2019 and 2018, respectively. Revenues include surcharges, which increase both revenues and operating expenses by corresponding amounts, thus having no net earnings impact.
(2)Water and electric gross margins do not include any depreciation and
amortization, maintenance, administrative and general, property or other taxes or other operation expenses.
The overall actual percentages of purchased water for the nine months ended September 30, 2019 and 2018 were 45% and 41%, respectively, as compared to the adopted percentage of approximately 36% and 29% for the nine months ended September 30, 2019 and 2018, respectively. The higher actual percentages of purchased water as compared to adopted percentages
resulted primarily from several wells being out of service. Purchased water costs for the nine months ended September 30, 2019 increased to $55.3 million as compared to $52.1 million for the same period in 2018 primarily due to an increase in wholesale water costs, partially offset by a decrease in customer usage.
For the nine months ended September 30, 2019 and 2018, power purchased for pumping decreased by $579,000
due to a higher mix of purchased water as compared to pumped water. Groundwater production assessments decreased $1.1 million due to a decrease in the amount of water pumped, partially offset by higher pump tax rates for the nine months ended September 30, 2019 as compared to the same period in 2018.
The under-collection in the water supply cost balancing account decreased $7.7 million during the nine months ended September 30, 2019 as compared to the same period in 2018
mainly due to updated adopted supply cost amounts from the general rate case, resulting in a lower under-collection in the water supply cost balancing account as compared to the same period in 2018.
For the nine months ended September 30,2019 and 2018,
other operation expenses by business segment consisted of the following (dollar amounts in thousands):
For
the nine months ended September 30,2019, other operation expenses at the water segment increased due primarily to an increase in surcharges, with a corresponding increase in water revenues, resulting in no impact to earnings.
Administrative and General
For the nine months ended September 30,2019 and 2018, administrative and general expenses by business segment, including AWR (parent), consisted
of the following (dollar amounts in thousands):
For
the nine months ended September 30,2019, administrative and general expenses at the water segment decreased due, in part, to a $1.1 million reduction to reflect the CPUC's approval in the May 2019 final decision on the water general rate case for recovery of previously incurred costs that were being tracked in CPUC-authorized memorandum accounts. Excluding this reduction as well as a decrease in surcharges billed during the nine months ended September 30,2019 as compared to the same period of 2018, administrative and general costs at the water segment
increased by $548,000 due primarily to higher employee-related compensation and other benefits. As previously discussed, surcharges are recorded in revenue with a corresponding and offsetting amount recorded to administrative and general expenses, having no impact on earnings.
For the nine months ended September 30,2019, administrative and general expenses for contracted services increased by $1.5 million as compared to the nine months ended September 30,2018 due to labor and labor-related costs from the commencement
of operations at Fort Riley as of July 1, 2018, and a greater allocation of shared services costs to ASUS pursuant to the final decision on the water general rate case.
Depreciation and Amortization
For the nine months ended September 30,2019 and 2018, depreciation and amortization by business segment consisted of the following (dollar amounts in thousands):
For
the nine months ended September 30, 2019, depreciation and amortization expense for water services decreased due to lower overall composite depreciation rates approved in the water general rate case. The decrease in depreciation expense was partially offset by increased depreciation from additions to utility plant at both the water and electric segments. The decrease in composite depreciation rates lowers the water gross margin, with a corresponding decrease in depreciation expense, resulting in
no impact
to net earnings. The increase in depreciation for the contracted services segment was due primarily to construction vehicles and other heavy equipment additions to fixed assets, as well as the commencement of operations at Fort Riley.
Maintenance
For the nine months ended September 30,2019 and 2018, maintenance expense by business segment consisted of the following (dollar amounts in thousands):
Maintenance
expense for water services decreased due to a lower level of unplanned maintenance as compared to the same period in 2018. Maintenance expense at the water segment is expected to increase during the remainder of 2019. The decrease in maintenance expense for the electric segment reflects a $302,000 reduction recorded in connection with the CPUC's approval in the electric general rate case for recovery of previously incurred maintenance costs.
Property and Other Taxes
For the nine months ended September 30,2019 and 2018, property and other taxes by business
segment consisted of the following (dollar amounts in thousands):
Property
and other taxes increased overall during the nine months ended September 30,2019 due primarily to capital additions and associated higher assessed property values.
ASUS Construction
For the nine months ended September 30,2019, construction expenses for contracted services were $39.7 million, increasing $4.5 million compared to the same period in 2018 due to an increase in
overall construction activity as compared to the same period in 2018.
Interest Expense
For the nine months ended September 30,2019 and 2018, interest expense by business segment, including AWR (parent) consisted of the following (dollar amounts in thousands):
The
overall increase in interest expense is due to higher average borrowings as well as higher interest rates on the revolving credit facility as compared to 2018. In March 2019, AWR exercised an option in the credit facility to increase its borrowing capacity from $150.0 million to $200.0 million. Borrowings made during 2019 were used to repay $40.0 million of GSWC's 6.70% senior note, which matured in March 2019, as well as to fund a portion of GSWC's capital expenditures.
For the nine months ended September 30,2019 and 2018, interest income by business segment, including AWR (parent), consisted of the following (dollar amounts in thousands):
The
increase in interest income during the nine months ended September 30,2019, was largely due to interest income recognized on certain initial construction projects performed at Fort Riley as well as interest related to regulatory assets for the electric segment as a result of the August 2019 CPUC final decision.
Other, net
For the nine months ended September 30,2019, other income increased by $229,000 due primarily to higher gains on investments
due to recent market conditions, as compared to the same period in 2018, partially offset by an increase in the non-service cost components of net periodic benefit costs related to Registrant's defined benefit pension plans and other retirement benefits as compared to the same period in 2018. However, as a result of GSWC's pension balancing account authorized by the CPUC, changes in net periodic benefit costs are mostly offset by corresponding changes in revenues, having no material impact to earnings.
Income Tax Expense
For the nine months ended September 30,2019 and 2018,
income tax expense by business segment, including AWR (parent), consisted of the following (dollar amounts in thousands):
Consolidated
income tax expense for the nine months ended September 30,2019 increased due to an increase in pretax income. AWR's consolidated ETR increased to 23.3% for the nine months ended September 30,2019 as compared to 21.7% for the nine months ended September 30,2018. GSWC's ETR during the nine
months ended September 30,2019 was 24.1% as compared to 22.5% for the nine months ended September 30,2018 due, in part, to changes in certain flow taxes.
Critical accounting policies and estimates are those that are important to the portrayal of AWR’s financial condition, results of operations and cash flows, and require the most difficult, subjective or complex judgments of AWR’s management. The need to make estimates about the effect of items that are uncertain is what makes these judgments difficult, subjective and/or complex. Management makes subjective judgments about the accounting and regulatory treatment of many items. These judgments are based on AWR’s historical experience, terms of existing contracts, AWR’s observance of trends in the industry, and information available from other outside sources, as appropriate. Actual results may differ from these estimates under different assumptions or conditions.
The
critical accounting policies used in the preparation of the Registrant’s financial statements that it believes affect the more significant judgments and estimates used in the preparation of its consolidated financial statements presented in this report are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Registrant’s Annual Report on Form 10-K for the year ended December 31, 2018. There have been no material changes to Registrant’s critical accounting policies. Registrant adopted the new lease guidance beginning January 1, 2019 as further described in Note 10 of the Notes to Consolidated Financial Statements.
Registrant’s regulated business is capital intensive and requires considerable capital resources. A portion of these capital resources is provided by internally generated cash flows from operations. AWR anticipates that interest expense will increase due to the need for additional external capital to fund its construction program and increases in market interest rates. AWR believes that costs associated with capital used to fund construction at GSWC will continue to be recovered through water and electric rates charged to customers. AWR funds its operating expenses and pays dividends on its outstanding Common Shares primarily through dividends from its wholly owned subsidiaries. The ability of GSWC to pay dividends to AWR is restricted
by California law. Under these restrictions, approximately $245.5 million was available on September 30, 2019 to pay dividends to AWR. The ability of ASUS to pay dividends to AWR is also restricted by California law and by the ability of its subsidiaries to pay dividends to it.
When necessary, Registrant obtains funds from external sources in the capital markets and through bank borrowings. Access to external financing on reasonable terms depends on the credit ratings of AWR and GSWC and current business conditions, including that of the water utility industry in general as well as conditions in the debt or equity capital markets.
AWR borrows under a credit facility, which expires in May 2023, and provides funds to its subsidiaries, GSWC
and ASUS, in support of their operations. In March 2019, AWR amended this credit facility to increase its borrowing capacity from $150.0 million to $200.0 million. As of September 30, 2019, there was $194.5 millionoutstanding under this facility. On October 31, 2019, AWR further amended its credit facility to temporarily increase its borrowing capacity by $25 million, from $200.0 million to $225.0 million, effective through June 30, 2020. Management intends to obtain additional financing during 2020 by issuing long-term debt at GSWC. GSWC intends to use the proceeds
from any additional long-term debt to reduce its intercompany borrowings and to partially fund capital expenditures. AWR parent intends to use any financing proceeds from GSWC to pay down the amounts outstanding under its credit facility.
During the nine months ended September 30, 2019, GSWC incurred $100.3 million in company-funded capital expenditures. During 2019, Registrant's company-funded capital expenditures are estimated to be approximately $115 - $125 million.
In April 2019, Standard and Poor’s Global Ratings (“S&P”) affirmed an A+ credit rating with a stable outlook on both AWR and GSWC. S&P’s debt ratings range from AAA (highest possible) to D (obligation is in default). In
May 2019, Moody's Investors Service ("Moody's") affirmed its A2 rating with a revised outlook from positive to stable for GSWC. Securities ratings are not recommendations to buy, sell or hold a security, and are subject to change or withdrawal at any time by the rating agencies. Registrant believes that AWR’s sound capital structure and A+ credit rating, combined with its financial discipline, will enable AWR to access the debt and equity markets. However, unpredictable financial market conditions in the future may limit its access or impact the timing of when to access the market, in which case Registrant may choose to temporarily reduce its capital spending.
AWR’s ability to pay cash dividends on its Common Shares outstanding depends primarily upon cash flows from its subsidiaries. AWR intends to continue paying quarterly cash dividends on or about March 1, June 1, September 1 and December 1, subject to earnings
and financial conditions, regulatory requirements and such other factors as the Board of Directors may deem relevant. Registrant has paid common dividends for over 80 consecutive years. On October 29, 2019, AWR's Board of Directors approved a fourth quarter dividend of $0.305 per share on AWR's Common Shares. Dividends on the Common Shares will be paid on December 2, 2019 to shareholders of record at the close of business on November 15, 2019.
Registrant's current liabilities may at times exceed its current assets. Management believes that internally generated funds along with borrowings from AWR's credit facility are adequate to provide sufficient capital to maintain normal operations and to meet its capital and financing requirements.
Cash
Flows from Operating Activities:
Cash flows from operating activities have generally provided sufficient cash to fund operating requirements, including a portion of construction expenditures at GSWC and construction expenses at ASUS, and to pay dividends. Registrant’s future cash flows from operating activities are expected to be affected by a number of factors, including utility regulation; changes in tax law; maintenance expenses; inflation; compliance with environmental, health and safety standards; production costs; customer growth; per-customer usage of water and electricity; weather and seasonality; conservation efforts; compliance with local governmental requirements, including mandatory restrictions on water use; and required cash contributions to pension and post-retirement plans. Future cash flows from contracted services subsidiaries will depend on new business activities, existing operations,
the construction of new and/or replacement infrastructure at military bases, timely economic price and equitable adjustment of prices, and timely collection of payments from the U.S. government and other prime contractors operating at the military bases and any adjustments arising out of an audit or investigation by federal governmental agencies.
The lower federal tax rate and the elimination of bonus depreciation brought about by the Tax Act are expected to reduce Registrant's cash flows from operating activities, and result in higher financing costs arising from an increased need to borrow and/or issue equity securities. The most significant
provisions of the Tax Act impacting GSWC was the reduction of the federal corporate income tax rate from 35% to 21% and the elimination of bonus depreciation for regulated utilities. Pursuant to a CPUC directive, the 2018 impact of the Tax Act on the water adopted revenue requirement was tracked in a memorandum account effective January 1, 2018. On July 1, 2018, new lower water rates, which incorporate the new federal income tax rate, were implemented for all water ratemaking areas. As a result of receiving the May 2019 CPUC final decision on the water general rate case, in the third quarter of 2019 GSWC refunded to water customers approximately $7.2 million of over-collections recorded in this memorandum account as a one-time surcredit.
ASUS funds its operating expenses primarily through internal operating sources, which
include U.S. government funding under 50-year contracts for operations and maintenance costs and construction activities, as well as investments by, or loans from, AWR. ASUS, in turn, provides funding to its subsidiaries. ASUS's subsidiaries may also from time to time provide funding to ASUS or its subsidiaries.
Cash flows from operating activities are primarily generated by net income, adjusted for non-cash expenses such as depreciation and amortization, and deferred income taxes. Cash generated by operations varies during the year. Net cash provided by operating activities of Registrant was $84.3 million for the nine months ended September 30, 2019 as compared to $108.4 million for the same
period in 2018. There was a decrease in cash receipts due to lower water customer usage, delays in receiving decisions on the water and electric general rate cases and also the refunding of $7.2 million to water customers during the third quarter of 2019 related to the Tax Act. The decrease in water customer usage increases the under-collection balance in the WRAM regulatory asset, which is filed annually for recovery. The timing of cash receipts and disbursements related to other working capital items also affected the change in net cash provided by operating activities.
Cash Flows from Investing Activities:
Net cash used in investing activities was $110.7 million for the nine months ended September 30,
2019 as compared to $88.8 million for the same period in 2018, due to an increase in capital expenditures during the first nine months of 2019. Registrant invests capital to provide essential services to its regulated customer base, while working with its regulators to have the opportunity to earn a fair rate of return on investment. Registrant’s infrastructure investment plan consists of both infrastructure renewal programs (where infrastructure is replaced, as needed) and major capital investment projects (where new water treatment, supply and delivery facilities are constructed). GSWC may also be required from time to time to relocate existing infrastructure in order to accommodate local infrastructure improvement projects. Projected capital expenditures and other investments are subject to periodic
review and revision.
Cash Flows from Financing Activities:
Registrant’s financing activities include primarily: (i) the sale proceeds from the issuance of Common Shares and stock option exercises and the repurchase of Common Shares, (ii) the issuance and repayment of long-term debt and notes payable to banks, and (iii) the payment of dividends on Common Shares. In order to finance new infrastructure, GSWC also receives customer advances (net of refunds) for, and contributions in aid of, construction. Borrowings on Registrant's credit facility are used to fund capital expenditures until long-term financing is arranged.
Net cash provided by financing activities was $29.6 million for the nine months ended September 30,
2019 as compared to cash used in financing activities of $17.9 million during the same period in 2018. This increase in cash was due to an increase in borrowings under Registrant's revolving credit facility during the nine months ended September 30, 2019. The increased borrowings were used to repay $40.0 million of GSWC's 6.70% senior note, which matured in March 2019, and to fund a portion of capital expenditures.
GSWC
GSWC funds its operating expenses, payments on its debt, dividends on its outstanding common shares, and a portion of its construction expenditures through internal
sources. Internal sources of cash flow are provided primarily by retention of a portion of earnings from operating activities. Internal cash generation is influenced by factors such as weather patterns, conservation efforts, environmental regulation, litigation, changes in tax law and deferred taxes, changes in supply costs and regulatory decisions affecting GSWC’s ability to recover these supply costs, timing of rate relief, increases in maintenance expenses and capital expenditures, surcharges authorized by the CPUC to enable GSWC to recover expenses previously incurred from customers, and CPUC requirements to refund amounts previously charged to customers.
GSWC may, at times, utilize external sources, including equity investments and borrowings from AWR, and long-term debt to help fund a portion of its construction expenditures. On October 31, 2019, AWR amended its credit
facility to temporarily increase its borrowing capacity by $25 million, from $200.0 million to $225.0 million, effective through June 30, 2020. Management intends to obtain additional financing during 2020 by issuing long-term debt at GSWC. GSWC intends to use the proceeds from any additional long-term debt to reduce its intercompany borrowings and to partially fund capital expenditures.
In addition, GSWC receives advances and contributions from customers, homebuilders and real estate developers to fund
construction necessary to extend service to new areas. Advances for construction are generally refundable at a rate of 2.5% in equal annual installments over 40 years. Amounts that are no longer subject to refund are reclassified to contributions in aid of construction. Utility plant funded by advances and contributions is excluded from rate base. Generally, GSWC amortizes contributions in aid of construction at the same composite rate of depreciation for the related property.
Cash generated from operating activities is expected to increase due to new water and electric rates and surcharges implemented as a result of the CPUC final decisions on the water and electric general rate cases issued in May and August of 2019, respectively.
As is often the case with public utilities, GSWC’s current liabilities may at times exceed its current assets. Management
believes that internally generated funds along with the proceeds from the issuance of long-term debt, borrowings from AWR and Common Share issuances to AWR will be adequate to provide sufficient capital to enable GSWC to maintain normal operations and to meet its capital and financing requirements pending recovery of costs in rates.
Cash Flows from Operating Activities:
Net cash provided by operating activities was $69.0 million for the nine months ended September 30, 2019 as compared to $93.8 million for the same period in 2018. There was a decrease in cash receipts due to lower water
customer usage, delays in receiving decisions on the water and electric general rate cases and also the refunding of $7.2 million to water customers during the third quarter of 2019 related to the Tax Act. The decrease in water customer usage increases the under-collection balance in the WRAM regulatory asset, which is filed annually for recovery. The timing of cash receipts and disbursements related to other working capital items also affected the change in net cash provided by operating activities.
Cash Flows from Investing Activities:
Net cash used in investing activities was $104.4 million for the nine months ended September 30, 2019 as compared to $80.7
million for the same period in 2018. Cash used for capital expenditures was $104.8 million for the nine months ended September 30, 2019 as compared to $79.2 million during the same period in 2018. During 2019, GSWC's company-funded capital expenditures are estimated to be approximately $115 - $125 million.
Cash Flows from Financing Activities:
Net cash provided by financing activities was $35.7 million for the nine months
ended September 30, 2019 as compared to cash used of $13.1 million for the same period in 2018. The increase in cash from financing activities was due to an increase in intercompany borrowings during the nine months ended September 30, 2019, which were used to repay $40.0 million of GSWC's 6.70% senior note, which matured in March 2019, and to fund a portion of GSWC's capital expenditures.
Contractual Obligations and Other Commitments
Registrant
has various contractual obligations, which are recorded as liabilities in the consolidated financial statements. Other items, such as certain purchase commitments, are not recognized as liabilities in the consolidated financial statements but are required to be disclosed. In addition to contractual maturities, Registrant has certain debt instruments that contain an annual sinking fund or other principal payments. Registrant believes that it will be able to refinance debt instruments at their maturity through public issuance, or private placement, of debt or equity. Annual payments to service debt are generally made from cash flows from operations.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations, Commitments and Off-Balance Sheet Arrangements” section of the Registrant’s Form 10-K for the year ended December 31,
2018 for a detailed discussion of contractual obligations and other commitments. In September 2019, GSWC entered into new purchase power agreements as further described in Note 5 of the Notes to Consolidated Financial Statements, increasing GSWC's total purchase power commitments to $28.0 million. In March 2019, GSWC repaid $40 million of its 6.70% senior note. Effective January 1, 2019, Registrant adopted the new lease standard as further described in Note 10 of the Notes to Consolidated Financial Statements.
Under the terms of its utility privatization contracts with the U.S. government, each contract's price is subject to an economic price adjustment (“EPA”) on an annual basis. In the event that ASUS (i) is managing more assets at specific military bases than were included in the U.S. government’s request for proposal, (ii) is managing assets that are in substandard condition as compared to what was disclosed in the request for proposal, (iii) prudently incurs costs not contemplated under the terms of the utility privatization contract, and/or (iv) becomes subject to new regulatory requirements, such as more stringent water-quality standards, ASUS is permitted to file, and has filed, requests for equitable adjustment (“REA”). The timely filing for and receipt of EPAs and/or REAs continues to be critical in order
for the Military Utility Privatization Subsidiaries to recover increasing costs of operating, maintaining, renewing and replacing the water and/or wastewater systems at the military bases it serves.
Under the Budget Control Act of 2011 (the “2011 Act”), substantial automatic spending cuts, known as "sequestration," have impacted the expected levels of Department of Defense budgeting. The Military Utility Privatization Subsidiaries have not experienced any earnings impact to their existing operations and maintenance and renewal and replacement services, as utility privatization contracts are an "excepted service" within the 2011 Act. While the ongoing effects of sequestration have been mitigated through the passage of a continuing resolution for the fiscal year 2019/2020 Department of Defense budget, similar issues may arise as part of fiscal uncertainty and/or future debt-ceiling limits imposed by Congress. However,
any future impact on ASUS and its operations through the Military Utility Privatization Subsidiaries will likely be limited to (a) the timing of funding to pay for services rendered, (b) delays in the processing of EPAs and/or REAs, (c) the timing of the issuance of contract modifications for new construction work not already funded by the U.S. government, and/or (d) delays in the solicitation for and/or awarding of new contracts under the Department of Defense utility privatization program.
At times, the Defense Contract Audit Agency and/or the Defense Contract Management Agency may, at the request of a contracting officer, perform audits/reviews of contractors for compliance with certain government guidance and regulations, such as the Federal Acquisition Regulations and Defense Federal Acquisition Regulation Supplements. Certain audit/review findings, such as system deficiencies for government-contract-business-system requirements,
may result in delays in the timing of resolution of filings submitted to and/or the ability to file new proposals with the U.S. government.
Regulatory Matters
General Rate Cases and Other Filings:
Water Segment:
In July 2017, GSWC filed a general rate case application for all of its water regions and the general office to determine new rates for the years 2019 - 2021. On May 30, 2019, the CPUC issued a final decision which authorizes 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.
Excluding the advice letter project revenues, the new rates approved are expected to increase the water gross margin for 2019 by approximately $7.1 million, adjusted for updated inflation index values since the August 2018 settlement, as compared to the 2018 adopted water gross margin. The 2019 water revenue requirement has been reduced to reflect a decrease of approximately $7.0 million in depreciation expense, compared to the adopted 2018 depreciation expense, due to a reduction in the overall composite depreciation rates based on a revised study filed in the general rate case. The decrease in depreciation expense lowers the water gross margin, with a corresponding decrease in depreciation expense, resulting in no impact to net earnings. In addition, the 2019 water revenue requirement includes a decrease of approximately $2.2 million for excess
deferred tax refunds as a result of the Tax Act, with a corresponding decrease in income tax expense resulting in no impact to net earnings. Had depreciation expense remained the same as the 2018 adopted amount and there were no excess deferred tax refunds that lowered the 2019 revenue requirement, the water gross margin for 2019 would have increased by approximately $16.3 million.
As result of the May 2019 CPUC final decision, GSWC implemented new water rates on June 8, 2019. The new rates are retroactive to January 1, 2019. Due to the delay in receiving a final decision by the CPUC, billed water revenues up to June 8, 2019 were based on 2018 adopted rates. Because the new rates are retroactive to January 1, 2019, the cumulative
retroactive impact of the CPUC decision was recorded during the second quarter of 2019. The final decision also approved the recovery of previously incurred costs that were being tracked in CPUC-authorized memorandum accounts. Surcharges have been implemented to recover the rate difference between billed water revenues through June 8, 2019, and final rates authorized by the CPUC, retroactive to January 1, 2019, over 12 to 24 months.
In December 2017, the Tax Act was signed into federal law and was generally effective January 1, 2018. The most significant provisions of the Tax Act impacting GSWC was the reduction of the federal corporate income tax rate from 35% to 21% and the elimination of bonus depreciation for regulated utilities. Pursuant to a CPUC
directive, the 2018 impact of the Tax Act on the water adopted revenue requirement was tracked in a memorandum account effective January 1, 2018. On July 1, 2018, new lower water rates, which incorporate the new federal income tax rate, were implemented for all water ratemaking areas. As a
result of receiving the May 2019 CPUC final decision on the water general rate case, during the third quarter of 2019 GSWC refunded to water customers approximately $7.2 million of over-collections recorded in this memorandum account.
The
final decision also allows for potential additional water revenue increases in 2020 and 2021 of approximately $9.1 million (based on current inflationary index values) and $12.0 million, respectively, subject to the results of an earnings test and changes to the forecasted inflationary index values.
Electric Segment:
In May 2017, GSWC filed its electric general rate case application with the CPUC to determine new electric rates for the years 2018 through 2021.
On August 15, 2019, the CPUC issued a final decision on this general rate case which, among other things, authorizes a new return on equity for GSWC's electric segment of 9.60%, as compared to its previously authorized return of 9.95%. The decision also includes 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. Furthermore, the decision (i) extends the rate cycle by one year (new rates will be effective for 2018 - 2022); (ii) increases the electric gross margin for 2018 by approximately $2.0 million compared to the 2017 adopted electric gross margin, adjusted for the Tax Act changes; (iii) authorizes BVES to construct all the capital projects requested in its application and provides additional funding for the fifth year added to the rate cycle, which total approximately $44 million of capital projects 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).
Due to the delay in finalizing
the electric general rate case, billed electric revenues during 2018 and the first nine months of 2019 were based on 2017 adopted rates. Because the CPUC final decision is retroactive to January 1, 2018, the cumulative retroactive earnings impact of the decision is included in the third quarter results of 2019, including approximately $0.03 per share related to the first six months of 2019, and $0.04 per share relating to the full year ended December 31, 2018.
Application to Transfer Electric Utility Operations to New Subsidiary:
GSWC filed applications with the CPUC and the Federal Energy Regulatory Commission in December 2018 and July 2019, respectively, to transfer the assets and liabilities
of the BVES division of GSWC to Bear Valley Electric Service, Inc., a newly created separate legal entity and stand-alone subsidiary of AWR. Due to the differences in operations, regulations, and risks, management believes a separate electric legal entity and stand-alone subsidiary of AWR is in the best interests of customers, employees, and the communities served. This reorganization plan is subject to regulatory approvals and, if approved, is not expected to result in a substantive change to AWR's operations and business segments. On October 11, 2019, the Federal Energy Regulatory Commission approved GSWC's application for reorganization. The CPUC is scheduled to issue a final decision on this matter by the end of 2019.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Regulatory Matters”
section of the Registrant’s Form 10-K for the year-ended December 31, 2018 for a discussion of other regulatory matters.
GSWC is required to comply with the safe drinking water standards established by the U.S. Environmental Protection Agency (“US EPA”) and the Division of Drinking Water ("DDW"), under the State Water Resources Control Board (“SWRCB”).
The US EPA regulates contaminants that may have adverse health effects that are known or likely to occur at levels of public health concern, and the regulation of which will provide a meaningful opportunity for health risk reduction. The DDW, acting on behalf of the US EPA, administers the US EPA’s program in California. Similar state agencies administer these rules in the other states in which Registrant operates.
GSWC currently tests its water supplies and water systems according to, among other things, pursuant to requirements listed in the Federal Safe Drinking Water Act (“SDWA”). In compliance with the SDWA and to assure a safe drinking water supply to its customers, GSWC has incurred operating costs for testing to determine the levels, if any, of the constituents in its sources of supply and additional expense to treat contaminants in order to meet federal and state maximum contaminant level standards and consumer
demands. GSWC expects to incur additional capital costs as well as increased operating costs to maintain or improve the quality of water delivered to its customers in light of anticipated stress on water resources associated with watershed and aquifer pollution, as well as to meet future water quality standards. The CPUC ratemaking process provides GSWC with the opportunity to recover prudently incurred capital and operating costs in future filings associated with achieving water quality standards. Management believes that such incurred and expected future costs will be authorized for recovery by the CPUC.
Drinking Water Notifications Levels:
In July 2018, DDW issued drinking water notification levels for certain fluorinated organic chemicals used to make certain fabrics and other materials, and used in various industrial processes. These chemicals were
also present in certain fire suppression agents. These chemicals are referred to as perfluoroalkyl substances (e.g., PFOA and PFAS). Notification levels are health-based advisory levels established for contaminants in drinking water for which maximum contaminant levels have not been established. The US EPA has also established health advisory levels for these compounds. Notification to consumers is required when the advisory levels or notification levels are exceeded. Assembly Bill 756, signed into law in July 2019 and effective in January 2020, requires, among other things, additional notification requirements for water systems detecting levels of PFAS above certain levels. GSWC is in the process of collecting and analyzing samples for PFAS under the direction of DDW. GSWC has removed some wells from service, and expects to incur additional treatment costs to treat impacted wells. GSWC has provided customers with information regarding PFAS detections, and provided
updated information via its website.
Lead Testing in Schools:
In January 2017, the California State Water Resources Control Board - Division of Drinking Water (DDW) issued a permit amendment that required all community water systems to test the schools in their service area for lead, if sampling is requested in writing by the institution’s officials. In addition, the California Assembly passed Assembly Bill 746 in October 2017, which required all community water systems that serve a school site of a local educational agency with a building constructed before January 1, 2010, to test for lead in the potable water system of the school site on or before July 1, 2019. GSWC worked extensively with the schools in its service areas. As a
result of concerted outreach to the schools, GSWC completed lead sampling at all schools in its service area as of June 30, 2019, with the exception of one school district in the Bell-Bell Gardens system. DDW has been notified regarding the lack of response from this school district.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Environmental Matters” section of the Registrant’s Form 10-K for the year-ended December 31, 2018 for a discussion of environmental matters applicable to GSWC and ASUS and its subsidiaries.
Water
Supply
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—California Drought” section of the Registrant’s Form 10-K for the year-ended December 31, 2018 for a discussion of water supply issues. The discussion below focuses on significant matters and changes since December 31, 2018.
Drought Impact:
In May 2018, the California Legislature passed two bills that provide a framework for long-term water-use efficiency standards and drought planning and resiliency. The initial steps for implementing this legislation have been laid out in
a summary document by the California Department of Water Resources ("DWR") and the State Water Resources Control Board ("SWRCB"). Over the next several years, State agencies, water suppliers and other entities will be working to meet the requirements and implement plans. A notable milestone is the establishment of an indoor water use standard of 55 gallons per capita per day (gpcd) until 2025, at which time the standard may be reduced to 52.5 gpcd or a new standard as recommended by DWR.
California's recent period of multi-year drought resulted in reduced recharge to the state's groundwater basins. GSWC utilizes groundwater from
numerous groundwater basins throughout the state. Several of these basins, especially smaller basins, experienced lower groundwater levels because of the drought. Several of GSWC's service areas rely on groundwater as their only source of supply. Given the critical nature of the groundwater levels in California’s Central Coast area, GSWC implemented mandatory water restrictions in certain service areas, in accordance with CPUC procedures. In the event of water supply shortages beyond the locally available supply, GSWC would need to transport additional water from other areas, increasing the cost of water supply.
As of October 29, 2019, the U.S. Drought Monitor estimated that approximately 18% of California ranks as “Abnormally Dry” with 2% of the State in the rank of “Moderate Drought.” This is in comparison to October of 2018 when approximately 19% of the
State was considered in “Severe Drought” and 3% was in the rank of "Extreme Drought.” Due to local conditions, water-use restrictions and allocations remain in place for customers in some of GSWC’s service areas. GSWC continues assessing water supply conditions and water-use restrictions in these service areas and will make appropriate adjustments as needed.
Metropolitan Water District/ State Water Project:
GSWC supplements groundwater production with wholesale purchases from the Metropolitan Water District of Southern California ("MWD") member agencies. Water supplies available to the MWD through the State Water Project ("SWP") vary from year to year based on several factors. Every year, the California Department of Water Resources ("DWR") establishes the SWP allocation for water deliveries to
state water contractors. DWR generally establishes a percentage allocation of delivery requests based on several factors, including weather patterns, snow-pack levels, reservoir levels and biological diversion restrictions. The SWP is a major source of water for the MWD. In June 2019, DWR set SWP delivery allocation at 75 percent of requests for the 2019 calendar year.
New Accounting Pronouncements
Registrant is subject to newly issued requirements as well as changes in existing requirements issued by the Financial Accounting Standards Board. Differences in financial reporting between periods for GSWC could occur unless and until the CPUC approves such changes for conformity through regulatory proceedings. See Note 1 of the Unaudited Notes to Consolidated
Financial Statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Registrant is exposed to certain market risks, including fluctuations in interest rates, commodity price risk, primarily relating to changes in the market price of electricity at GSWC's electric division, and other economic conditions. Market risk is the potential loss arising from adverse changes in prevailing market rates and prices.
The
quantitative and qualitative disclosures about market risk are discussed in Item 7A-Quantitative and Qualitative Disclosures About Market Risk, contained in Registrant’s Annual Report on Form 10-K for the year ended December 31, 2018.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Securities and Exchange Act of 1934 (the “Exchange Act”), we have carried out an evaluation, under the supervision and with the participation of our management, including
our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), of the effectiveness, as of the end of the fiscal quarter covered by this report, of the design and operation of our “disclosure controls and procedures” as defined in Rule 13a-15(e) and 15d-15(e) promulgated by the SEC under the Exchange Act. Based upon that evaluation, the CEO and the CFO concluded that disclosure controls and procedures, as of the end of such fiscal quarter, were adequate and effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
(b) Changes in Internal
Controls over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended September 30, 2019, that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Registrant is subject to ordinary routine litigation incidental to its business, some of which may include claims for compensatory and punitive damages. No legal proceedings are pending, which are believed to be material. Management believes that rate recovery, proper insurance coverage and reserves are in place to insure against, among other things, property, general liability, employment, and workers’ compensation claims incurred in the ordinary course of business. Insurance coverage may not cover certain claims involving punitive damages.
Item 1A. Risk Factors
There have been no significant changes in the risk factors disclosed in our 2018 Annual
Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The shareholders of AWR have approved the material features of all equity compensation plans under which AWR directly issues equity securities. The following table provides information about repurchases of Common Shares by AWR during the third quarter of 2019:
Period
Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)
Maximum Number of Shares That May Yet Be Purchased under the Plans or Programs
(1)(3)
July 1 – 31, 2019
11,795
$
76.66
—
—
August
1 – 31, 2019
282
$
87.07
—
—
September 1 –
30, 2019
2,603
$
92.91
—
—
Total
14,680
(2)
$
79.74
—
(1)
None of the common shares were purchased pursuant to any publicly announced stock repurchase program.
(2)Of this amount, 11,124 Common Shares were acquired on the open market for employees pursuant to the Company's 401(k) plan and the remainder was acquired on the open market for participants in the Common Share Purchase and Dividend Reinvestment Plan.
(3) Neither the 401(k) plan nor the Common Share Purchase and Dividend Reinvestment Plan contain a maximum number of common shares that may be purchased in the open market.
Item 3. Defaults Upon Senior Securities
None
Item
4. Mine Safety Disclosure
Not applicable
Item 5. Other Information
(a)
On October 29, 2019, AWR's Board of Directors approved a fourth quarter dividend of $0.305 per share on AWR's Common Shares. Dividends on the Common Shares will be paid on December 2, 2019 to shareholders of record at the close of business on November 15, 2019.
(b)
On
October 31, 2019, the Company entered into an eighth amendment to its Credit Agreement in order to temporarily increase the aggregate commitment of the Lender by an additional $25,000,000 to $225,000,000 through June 30, 2020.
(c)
There have been no material changes during the third quarter of 2019 to the procedures by which shareholders may nominate persons to the Board of Directors of AWR.
Second
Sublease dated October 5, 1984 between Golden State Water Company and Three Valleys Municipal Water District incorporated herein by reference to Registrant's Registration Statement on Form S-2, Registration No. 33-5151
10.2
Note Agreement dated as of May 15, 1991 between Golden State Water Company and Transamerica Occidental Life Insurance Company incorporated herein by reference to Registrant's Form 10-Q with respect to the quarter ended June 30, 1991 (File No. 1-14431)
10.3
Schedule
of omitted Note Agreements, dated May 15, 1991, between Golden State Water Company and Transamerica Annuity Life Insurance Company, and Golden State Water Company and First Colony Life Insurance Company incorporated herein by reference to Registrant's Form 10-Q with respect to the quarter ended June 30, 1991 (File No. 1-14431)
Agreement for Financing Capital Improvement dated as of June 2, 1992 between Golden State Water Company and Three Valleys Municipal Water District incorporated herein by reference to Registrant's Form 10-K with respect
to the year ended December 31, 1992 (File No. 1-14431)
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(1) Filed concurrently herewith
(2)
Management contract or compensatory arrangement
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized and as its principal financial officer.
