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AWR > SEC Filings for AWR > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for AMERICAN STATES WATER CO

Form 10-K for AMERICAN STATES WATER CO


26-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation

The following discussion and analysis provides information on AWR's consolidated operations and assets and where necessary, includes specific references to AWR's individual segments and/or other subsidiaries: GSWC and ASUS and its subsidiaries. Included in the following analysis is a discussion of water and electric gross margins. Water and electric gross margins are computed by taking total revenues, less total supply costs. Registrant uses these gross margins and related percentages as an important measure in evaluating its operating results. Registrant believes this measure is a useful internal benchmark 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. Registrant believes that the disclosure of earnings per share by business segment provides investors with clarity surrounding the performance of our differing services. Registrant reviews these measurements regularly and compares them to historical periods and to our operating budget. However, these measures, which are not presented in accordance with Generally Accepted Accounting Principles ("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 are included in the table under the section titled "Operating Expenses: Supply Costs". Reconciliations to AWR's diluted earnings per share are included in the discussions under the sections titled "Summary Results by Segment."

Overview

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. Factors affecting the financial performance of GSWC are described under Forward-Looking Information and include: the process and timing of setting rates charged to customers; the ability to recover, and the process for recovering in rates, the costs of distributing water and electricity and overhead costs; pressures on water supply caused by the drought in California, changing weather patterns in the West, population growth, more stringent water quality standards and deterioration in water quality and water supply from a variety of causes; fines, penalties and disallowances by the CPUC arising from failures to comply with regulatory requirements; the impact of increased water quality standards and environmental regulations on the cost of operations and capital expenditures; changes in long-term customer demand due to changes in usage patterns as a result of conservation efforts, mandatory regulatory changes impacting the use of water, such as new landscaping or irrigation requirements, recycling of water by the customer and purchases of recycled water by customers from other third parties; capital expenditures needed to upgrade water systems and increased costs and risks associated with litigation relating to water quality and water supply, including suits initiated by GSWC to protect its water supply. 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 much higher levels than depreciation expense. When necessary, GSWC obtains funds from external sources in the capital markets and through bank borrowings.

ASUS's revenues, operating income and cash flows are earned by providing water and/or wastewater services, including the operation, maintenance, renewal and replacement of 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 contracts is subject to prospective price redeterminations. 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. As a result, ASUS is subject to risks that are different than those of GSWC. Factors affecting the financial performance of our Military Utility Privatization Subsidiaries are described under Forward-Looking Information and under Risk Factors and include delays in receiving payments from and the redetermination and equitable adjustment of prices under the contracts with the U.S. government; fines, penalties or disallowance of costs by the U.S. government; and termination of contracts and suspension or debarment for a period of time from contracting with the government due to violations of federal law and regulations in connection with military utility privatization activities. Our financial performance is also dependent upon our ability to accurately estimate our costs in bidding on firm fixed-price construction contracts and the costs of seeking new contracts for the operation and maintenance and renewal and replacement of water and/or wastewater services at military bases and for additional construction work at existing bases. ASUS is actively pursuing utility privatization contracts of other military bases to expand the contracted services segment.


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On November 19, 2013, the CPUC issued a Proposed Decision ("PD") on GSWC's Certificate of Public Convenience and Necessity application to provide retail water service in a portion of Sutter County, California within the Natomas Central Mutual Water Company service area. A final decision on the PD is expected later in 2014.

In June 2013, GSWC entered into an agreement to purchase all of the operating assets of Rural Water Company ("Rural"). The transaction is subject to CPUC approval. Rural serves approximately 900 customers in the county of San Luis Obispo, California, which is near GSWC's Santa Maria customer service area.

On May 9, 2013, the CPUC issued a final decision on GSWC's water general rate case approving new rates for 2013 through 2015 at GSWC's three water regions which include recovery of costs incurred at the general office. The new rates were retroactive to January 1, 2013 and generated approximately $10 million in additional annual revenues in 2013 as compared to 2012 adopted revenues. The 2013 adopted water gross margin increased by approximately $14 million as compared to the 2012 adopted water gross margin. Among other things, the final decision in the water general rate case also reduced the overall composite depreciation rates and approved the recovery of various memorandum accounts which tracked certain costs that were previously expensed as incurred. As a result, during the first quarter of 2013, GSWC recorded a decrease of approximately $3.0 million in certain operating expenses related to the approval of these memorandum accounts in the final decision. During the second quarter of 2013, surcharges were implemented to recover the costs in these memorandum accounts. These surcharges increased water revenues and increased operating expenses by corresponding amounts, resulting in no impact to pretax operating income.

Summary Results by Segment

The table below sets forth diluted earnings per share by business segment for
AWR's operations:
                                             Diluted Earnings per Share
                                               Year Ended
                                        12/31/2013        12/31/2012     CHANGE
Water                               $    1.19            $      0.90    $ 0.29
Electric                                 0.06                   0.12     (0.06 )
Contracted services                      0.30                   0.39     (0.09 )
AWR (parent)                             0.06                      -      0.06
Totals from operations, as reported $    1.61            $      1.41    $ 0.20

For the year ended December 31, 2013, fully diluted earnings per share contributed by the water segment increased by $0.29 per share to $1.19 per share, as compared to $0.90 per share for 2012. Items impacting the comparability of the two periods were:

            An increase in the water gross margin of approximately $13.4
             million, or $0.20 per share, due primarily to rate increases and a
             higher adopted water gross margin effective January 1, 2013 approved
             by the CPUC on May 9, 2013 in connection with the water general rate
             case. In addition, there was an increase of $4.6 million in revenues
             with a corresponding increase in operating expenses, representing
             new surcharges billed to customers during 2013 to recover previously
             incurred costs. These surcharges had no impact to net earnings.



            The CPUC's approval for recovery of previously incurred operating
             expenses in connection with the water general rate case final
             decision issued in May 2013. As a result of the approval, GSWC
             recorded a $2.7 million, or $0.04 per share, decrease in operating
             expenses. Among other things, the final decision approved the
             one-time recovery of various memorandum accounts, which tracked
             certain costs that were previously expensed as incurred. As a
             result, GSWC recorded regulatory assets for these memorandum
             accounts with a corresponding reduction in operating expenses during
             the first quarter of 2013.



            Excluding supply costs, the $4.6 million of surcharges and the
             impact of the memorandum accounts discussed above, operating
             expenses decreased by approximately $1.7 million, or $0.03 per
             share, due primarily to decreases in: (i) depreciation expense as a
             result of lower composite depreciation rates approved in the water
             rate case, and (ii) operation-related expenses resulting from lower
             bad debt expense, labor and other employee-related expenses. These
             decreases were partially offset by increases in: (i) administrative
             and general expenses resulting from higher legal and other outside
             services cost and workers compensation costs, and (ii) maintenance
             expense for planned maintenance work.


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            A decrease in the water effective income tax rate for the water
             segment during the year ended December 31, 2013 as compared to 2012,
             which increased earnings by approximately $0.02 per share primarily
             resulting from changes between book and taxable income that are
             treated as flow-through adjustments in accordance with regulatory
             requirements. Flow-through tax adjustments increase or decrease tax
             expense in one period, with an offsetting decrease or increase
             occurring in another period.

Diluted earnings from the electric segment decreased by $0.06 per share as compared to 2012. In May 2013, the CPUC approved recovery of legal and outside services costs previously expensed in connection with GSWC's effort to procure renewable resources under the CPUC's renewables portfolio standard ("RPS"). As a result, GSWC recorded an $834,000 reduction in other operating expenses during 2013 as compared to the RPS recovery approved during 2012 of $1.2 million. The difference resulted in a decrease of $416,000 in pretax income, or $0.01 per share for 2013. In addition to the impact of this RPS recovery, there was an increase of $1.2 million, or $0.03 per share, in other operating expenses, excluding supply costs and surcharges billed to customers during 2013 to recover previously incurred costs. These surcharges had no impact to net earnings. Finally, there was a higher electric effective income tax rate during 2013, negatively impacting earnings by $0.02 per share.

Diluted earnings from contracted services decreased by $0.09 per share during the year ended December 31, 2013 due primarily to: (i) an overall decrease in construction activities on major construction projects as compared to 2012; (ii) an increase in administrative expenses related to employee related costs and consulting and other outside services costs, in part, to pursue new military base utility privatization opportunities, and (iii) a contract modification received in April 2012 for a major water and wastewater pipeline replacement project at Fort Bragg resulting in additional pretax operating income of $820,000, or approximately $0.01 per share with no similar contract modification received during 2013. The decrease in construction activities was due, in part, to delays in construction caused by unfavorable weather conditions and permitting delays outside the Company's control, which have now been resolved. As a result, these delayed projects are now expected to progress and be completed in 2014, rather than 2013. These decreases were partially offset by a lower effective tax rate as the result of a cumulative tax deduction for certain construction activities taken on a recently filed tax return and expected to be taken on amended tax returns. As a result, the lower effective income tax rate for contracted services increased earnings by $0.04 per share as compared to 2012.

Diluted earnings from AWR (parent) increased by $0.06 per share as compared to 2012 resulting primarily from a cumulative tax benefit related to an employee benefit program of approximately $1.5 million recorded during the third quarter of 2013 for deductions taken on recently filed tax returns and amounts expected to be taken on amended income tax returns. Approximately $1.3 million of this tax benefit related to periods prior to 2013. It is management's intention to amend tax returns for open years to reflect these deductions which cover a period of 5 years.

The following discussion and analysis for the years ended December 31, 2013, 2012 and 2011 provides information on AWR's consolidated operations and assets and, where necessary, includes specific references to AWR's individual segments and/or other subsidiaries: GSWC and ASUS and its subsidiaries.


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Consolidated Results of Operations - Years Ended December 31, 2013 and 2012 (amounts in thousands, except per share amounts):

                                           Year Ended     Year Ended         $             %
                                           12/31/2013     12/31/2012      CHANGE        CHANGE
OPERATING REVENUES
Water                                     $  320,131     $  305,898     $  14,233          4.7  %
Electric                                      38,409         37,033         1,376          3.7  %
Contracted services                          113,537        123,977       (10,440 )       -8.4  %
Total operating revenues                     472,077        466,908         5,169          1.1  %

OPERATING EXPENSES
Water purchased                               58,930         54,010         4,920          9.1  %
Power purchased for pumping                    9,518          8,355         1,163         13.9  %
Groundwater production assessment             15,541         14,732           809          5.5  %
Power purchased for resale                    13,392         12,120         1,272         10.5  %
Supply cost balancing accounts                   214         11,709       (11,495 )      -98.2  %
Other operation                               27,767         29,790        (2,023 )       -6.8  %
Administrative and general                    77,291         70,556         6,735          9.5  %
Depreciation and amortization                 40,090         41,385        (1,295 )       -3.1  %
Maintenance                                   17,772         15,887         1,885         11.9  %
Property and other taxes                      15,865         15,381           484          3.1  %
ASUS construction                             76,627         81,957        (5,330 )       -6.5  %
Net gain on sale of property                      (2 )          (68 )          66        -97.1  %
Total operating expenses                     353,005        355,814        (2,809 )       -0.8  %

OPERATING INCOME                             119,072        111,094         7,978          7.2  %

OTHER INCOME AND EXPENSES
Interest expense                             (22,415 )      (22,765 )         350         -1.5  %
Interest income                                  707          1,333          (626 )      -47.0  %
Other, net                                     1,105            431           674        156.4  %
                                             (20,603 )      (21,001 )         398         -1.9  %

INCOME FROM OPERATIONS BEFORE INCOME TAX
EXPENSE                                       98,469         90,093         8,376          9.3  %

Income tax expense                            35,783         35,945          (162 )       -0.5  %

NET INCOME                                $   62,686     $   54,148     $   8,538         15.8  %

Basic earnings per common share           $     1.61     $     1.42     $    0.19         13.4  %

Fully diluted earnings per common share   $     1.61     $     1.41     $    0.20         14.2  %


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Operating Revenues
General
Registrant relies upon rate approvals by the CPUC to recover operating expenses and to provide for a return on invested and borrowed capital used to fund utility plant for GSWC. ASUS files price redeterminations and requests for equitable adjustments with the U.S. government in order to recover operating expenses and provide profit margin for contracted services. If adequate rate relief and price redeterminations and adjustments are not granted in a timely manner, operating revenues and earnings can be negatively impacted. ASUS' earnings have also been positively impacted by additional construction projects at each of the Military Utility Privatization Subsidiaries.

Water
For the year ended December 31, 2013, revenues from water operations increased by $14.2 million to $320.1 million, compared to $305.9 million for the year ended December 31, 2012. The increase in water revenues is primarily due to higher water rates approved by the CPUC effective January 1, 2013 in connection with the general rate case for all three water regions and the general office, as previously discussed. The revenue increase adopted by the CPUC for 2013 was approximately $10 million over 2012 adopted levels. In addition, there was also a $4.6 million increase in surcharges during the year ended December 31, 2013 to recover previously incurred costs approved by the CPUC. The increase in revenues from these surcharges is offset by a corresponding increase in operating expenses (primarily administrative and general) resulting in no impact to pretax operating income.
GSWC's revenue requirement and volumetric revenues are adopted as part of a general rate case ("GRC") every three years. GSWC intends to file a GRC for all three water regions in July of 2014 with rates expected to be effective January 1, 2016. For the year ended December 31, 2013, GSWC's billed customer water usage increased by approximately 3.0% as compared to 2012, but was lower than adopted consumption. Changes in consumption do not have a significant impact on revenues due to the CPUC-approved Water Revenue Adjustment Mechanism ("WRAM") account in place in all three water regions. 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
For the year ended December 31, 2013, revenues from electric operations were $38.4 million compared to $37.0 million for 2012. There was a $1.4 million increase in surcharges during 2013 to recover previously incurred costs approved by the CPUC. As previously discussed, increases in revenues from these surcharges is offset by a corresponding increase in operating expenses (primarily administrative and general) resulting in no impact to pretax operating income. Excluding the impact of these surcharges, electric revenues remained unchanged compared to 2013 as a result of the pending rate case. In February 2012, GSWC filed its BVES rate case for rates in years 2013 through 2016. GSWC and the Office of Ratepayer Advocates ("ORA") have engaged in settlement discussions regarding this general rate case. A final decision from the CPUC is expected in the third quarter of 2014. Pending a final decision on the BVES rate case, electric revenues have been recorded using 2012 adopted levels authorized by the CPUC.
Billed electric usage for the year ended December 31, 2013 increased 2.6% as compared to 2012. Due to the CPUC approved Base Revenue Requirement Adjustment Mechanism, which adjusts certain revenues to adopted levels authorized by the CPUC, this change in usage did not have a significant impact on revenues.
Contracted Services
Revenues from contracted services consist primarily of construction revenues (including renewals and replacements) and management fees for operating and maintaining the water and/or wastewater systems at military bases. For the year ended December 31, 2013, revenues from contracted services decreased to $113.5 million as compared to $124.0 million for 2012. The decrease was mainly due to lower construction activity at various military bases, particularly at Fort Bliss in Texas and Fort Bragg in North Carolina. This decrease in construction activities was due, in part, to construction delays caused by unfavorable weather conditions and permitting delays outside the Company's control, which have now been resolved. As a result, these delayed construction projects expected to be completed in 2013 are now expected to progress and be completed in 2014. This was partially offset by an increase in construction revenues at the military bases in Virginia as compared to 2012.
The contracted services business continues to receive contract modifications from the U.S. government and agreements with third-party prime contractors for new construction projects related to the water and wastewater systems operated by at the Military Utility Privatization Subsidiaries. Earnings and cash flows from modifications to the original 50-year contracts with the U.S. government and/or agreements with third-party prime contractors may or may not continue in future periods.


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Operating Expenses:

Supply Costs

Supply costs for the water segment consist of purchased water, power purchased for pumping, groundwater production assessments and water supply cost balancing accounts. Supply costs for the electric segment consist of power purchased for resale, the cost of natural gas used by BVES' generating unit, renewable energy credits and the electric supply cost balancing account. Water and electric gross margins are computed by taking total revenues, less total supply costs. Registrant uses these gross margins and related percentages as important measures 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 Generally Accepted Accounting Principles ("GAAP"), may not be comparable to similarly titled measures used by other entities and should not be considered as alternatives 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 27.6% and 28.4% of total operating expenses for the years ended December 31, 2013 and 2012, respectively.

The table below provides the amount of increases (decreases), percent changes in supply costs, and gross margins during the years ended December 31, 2013 and 2012 (dollar amounts in thousands):

                                             Year Ended     Year Ended         $             %
                                             12/31/2013     12/31/2012      CHANGE        CHANGE
WATER OPERATING REVENUES (1)                $  320,131     $  305,898     $  14,233          4.7  %
WATER SUPPLY COSTS:
Water purchased (1)                             58,930         54,010         4,920          9.1  %
Power purchased for pumping (1)                  9,518          8,355         1,163         13.9  %
Groundwater production assessment (1)           15,541         14,732           809          5.5  %
Water supply cost balancing accounts (1)        (1,958 )        8,676       (10,634 )     -122.6  %
TOTAL WATER SUPPLY COSTS                    $   82,031     $   85,773     $  (3,742 )       -4.4  %
WATER GROSS MARGIN (2)                      $  238,100     $  220,125     $  17,975          8.2  %
PERCENT MARGIN - WATER                            74.4 %         72.0 %         0.7

ELECTRIC OPERATING REVENUES (1)             $   38,409     $   37,033     $   1,376          3.7  %
ELECTRIC SUPPLY COSTS:
Power purchased for resale (1)                  13,392         12,120         1,272         10.5  %
Electric supply cost balancing accounts (1)      2,172          3,033          (861 )      -28.4  %
TOTAL ELECTRIC SUPPLY COSTS                 $   15,564     $   15,153     $     411          2.7  %
ELECTRIC GROSS MARGIN (2)                   $   22,845     $   21,880     $     965          4.4  %
PERCENT MARGIN - ELECTRIC                         59.5 %         59.1 %         0.6

(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 is shown on AWR's Consolidated Statements of Income and totaled $214,000 and $11,709,000 for the years ended December 31, 2013 and 2012, 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 tax, 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 modified cost balancing account ("MCBA"), GSWC tracks adopted and actual expense levels for purchased water,


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purchased power and pump taxes, as established by the CPUC. GSWC records the variances (which include the effects of changes in both rate and volume) between adopted and actual water purchased, power purchased, and pump tax expenses as regulatory assets or liabilities. GSWC recovers from or refunds to customers the . . .

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