SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

(Mark One)

 

x

Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2007 or

o

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from          to

 

Commission
File Number

 

Registrant, State of Incorporation
Address and Telephone Number

 

IRS Employer
Identification No.

001-14431

 

American States Water Company
(Incorporated in California)
630 E. Foothill Boulevard, San Dimas, CA 91773-1212
(909) 394-3600

 

95-4676679

 

 

 

 

 

001-12008

 

Golden State Water Company
(Incorporated in California)
630 E. Foothill Boulevard, San Dimas, CA 91773-1212
(909) 394-3600

 

95-1243678

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

American States Water Company Common Shares

 

New York Stock Exchange

 

 

 

Rights to Purchase Junior Participating Preferred Stock

 

 

Securities registered pursuant to Section 12(g) of the Act:   None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

American States Water Company

 

Yes o No x

Golden State Water Company

 

Yes o No x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

American States Water Company

 

Yes o No x

Golden State Water Company

 

Yes o No x

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.

American States Water Company

 

Yes x No o

Golden State Water Company

 

Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.    
x

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

Large accelerated filer o

 

Accelerated filer x

 

Non-accelerated filer o

Smaller reporting company o

 

 

 

 

(Do not check if a smaller reporting company)

 

Golden State Water Company

Large accelerated filer o

 

Accelerated filer o

 

Non-accelerated filer x

Smaller reporting company o

 

 

 

 

(Do not check if a smaller reporting company)

 

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 o No x

Golden State Water Company

 

Yes o No x

The aggregate market value of the total voting common stock held by non-affiliates of American States Water Company was approximately $608,601,000 and $588,156,000 on June 29, 2007 and March 12, 2008, respectively. The closing price per Common Share on March 12, 2008, as quoted in the The Wall Street Journal website, was $34.11.  As of March 12, 2008, the number of Common Shares of American States Water Company, outstanding was 17,242,917. As of that same date, American States Water Company owned all 122 outstanding Common Shares of Golden State Water Company. The aggregate market value of the total voting stock held by non-affiliates of Golden State Water Company was zero on June 29, 2007 and March 12, 2008.

Documents Incorporated by Reference:

Portions of the Proxy Statement of American States Water Company will be subsequently filed with the Securities and Exchange Commission as to Part III, Item Nos. 10, 11,  13 and 14 and portions of Item 12, in each case as specifically referenced herein.

 



 

AMERICAN STATES WATER COMPANY
and

GOLDEN STATE WATER COMPANY

 

FORM 10-K

 

INDEX

 

Part I

 

 

 

 

 

 

 

Item 1:

 

Business

3

Item 1A:

 

Risk Factors

6

Item 1B:

 

Unresolved Staff Comments

12

Item 2:

 

Properties

13

Item 3:

 

Legal Proceedings

15

Item 4:

 

Submission of Matters to a Vote of Security Holders

16

 

 

 

 

Part II

 

 

 

 

 

 

 

Item 5:

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

17

Item 6:

 

Selected Financial Data

20

Item 7:

 

Management’s Discussion and Analysis of Financial Condition and Results of Operation

21

Item 7A:

 

Quantitative and Qualitative Disclosures about Market Risk

67

Item 8:

 

Financial Statements and Supplementary Data

68

Item 9:

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

128

Item 9A:

 

Controls and Procedures

128

Item 9A(T)

 

Controls and Procedures

128

Item 9B:

 

Other Information

128

 

 

 

 

Part III

 

 

 

 

 

 

 

Item 10:

 

Directors, Executive Officers and Corporate Governance

129

Item 11:

 

Executive Compensation

129

Item 12:

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

129

Item 13:

 

Certain Relationships and Related Transactions, and Director Independence

129

Item 14:

 

Principal Accounting Fees and Services

129

 

 

 

 

Part IV

 

 

 

 

 

 

 

Item 15:

 

Exhibits, Financial Statement Schedules

130

 

 

 

 

 

 

Reports of Independent Registered Public Accounting Firm

125

 

 

Report from Management on the Responsibility for Financial Statements

127

 

 

Schedule I — Condensed Financial Information of Parent and Notes

134

 

 

2



 

PART I

 

Item 1. Business

 

This annual report on Form 10-K is a combined report being filed by two separate Registrants: American States Water Company (hereinafter “AWR”), and Golden State Water Company (hereinafter “GSWC”). 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 relating to AWR and its subsidiaries, other than GSWC.

 

AWR makes its periodic reports, Form 10-Q and Form 10-K, and current reports, Form 8-K, available free of charge through its website, www.aswater.com, as soon as material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). Such reports are also available on the SEC’s internet website at http://www.sec.gov. AWR also makes available free of charge its code of business conduct and ethics, its corporate governance guidelines and the charters of its Nominating and Governance Committee, its Compensation Committee, and its Audit and Finance Committee through its website or by calling (800) 999-4033. AWR and GSWC have filed the certification of officers required by Section 302 of the Sarbanes-Oxley Act as Exhibits 31.1 and 31.2 to its Form 10-K for the year ended December 31, 2007.

 

AWR submitted a CEO Certification to the New York Stock Exchange in June 2007 certifying that the Registrant was in compliance with the corporate governance rules of the New York Stock Exchange.

 

General

 

AWR is the parent company of GSWC, Chaparral City Water Company (“CCWC”) 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”) and Old North Utility Services, Inc. (“ONUS”)). AWR was incorporated as a California corporation in 1998 as a holding company.  AWR has three reportable segments: water, electric and contracted services. Within the segments, AWR has three principal business units: water and electric service utility operations conducted through GSWC, a water-service utility operation conducted through CCWC, and a contracted services unit conducted through ASUS and its subsidiaries.

 

GSWC is a California public utility company engaged principally in the purchase, production and distribution of water. GSWC also distributes electricity in one customer service area. GSWC is regulated by the California Public Utilities Commission (“CPUC”) and was incorporated as a California corporation on December 31, 1929. GSWC is organized into one electric customer service area and three water service regions operating within 75 communities in 10 counties in the State of California and provides water service in 21 customer service areas. Region I consists of 7 customer service areas in northern and central California; Region II consists of 4 customer service areas located in Los Angeles County; and Region III consists of 10 customer service areas in eastern Los Angeles County, and in Orange, San Bernardino and Imperial counties. GSWC also provides electric service to the City of Big Bear Lake and surrounding areas in San Bernardino County through its Bear Valley Electric Service (“BVES”) division.

 

GSWC served 254,546 water customers and 23,273 electric customers at December 31, 2007, or a total of 277,819 customers, compared with 277,218 total customers at December 31, 2006. GSWC’s utility operations exhibit seasonal trends. Although GSWC’s water utility operations have a diversified customer base, residential and commercial customers account for the majority of GSWC’s water sales and revenues. Revenues derived from commercial and residential water customers accounted for approximately 91% of total water revenues for the years ended December 31, 2007 and 2006.

 

CCWC is an Arizona public utility company serving 13,488 customers as of December 31, 2007, compared with 13,343 customers at December 31, 2006. Located in the town of Fountain Hills, Arizona and a portion of the City of Scottsdale, Arizona, the majority of CCWC’s customers are residential. The Arizona Corporation Commission (“ACC”) regulates CCWC.

 

ASUS contracts, either directly or through wholly-owned subsidiaries, with the U.S. government and others to provide water and wastewater services, including the operation and maintenance of water and wastewater systems and water marketing. ASUS commenced operation and maintenance of water and wastewater systems through a wholly-owned subsidiary at its first military base in Texas in October 2004. Since that date, ASUS commenced operation and maintenance of water and wastewater systems at military bases through wholly-owned subsidiaries in Maryland and Virginia in the first and second quarters of 2006 and in South Carolina in the first quarter of 2008.  ASUS is expected to commence operations at another base located in North Carolina during the first quarter of 2008. All of these contracts may be terminated, in whole or in part, prior to the end of the 50-year term for convenience of the U.S. government or as a result of default or nonperformance by the subsidiary performing the contract. In either event, the ASUS subsidiary is entitled to recover the remaining amount of its capital investment pursuant to the terms of a termination settlement with the U.S. government at the time of termination as provided in each of the contracts. The contract price for each of these contracts is subject to

 

 

3



 

redetermination two years after commencement of operations and every three years thereafter to the extent provided in each of the contracts. Prices are also subject to equitable adjustment based upon changes in circumstances and changes in wages and fringe benefits to the extent provided in each of the contracts. Registrant may refer to FBWS, ODUS, TUS, PSUS and ONUS collectively as the “Military Utility Privatization Subsidiaries” herein.

 

In September and early October of 2007, ASUS was awarded contracts to operate and maintain the water and wastewater systems at Fort Jackson, South Carolina and at Fort Bragg, North Carolina pursuant to 50-year contracts. These agreements are also subject to periodic price redetermination adjustments and modifications for changes in circumstances. ASUS through PSUS commenced operations at Fort Jackson on January 2, 2008 under a 50-year agreement.  ASUS through ONUS commenced operations at Fort Bragg under a 50-year agreement on March 1, 2008 following the expiration of its transition period.

 

ASUS and GSWC have been pursuing an opportunity to provide retail water services within the service area of the Natomas Central Mutual Water Company (“Natomas”). Natomas is a California mutual water company which currently provides water service to its shareholders, primarily for agricultural irrigation in portions of Sacramento and Sutter counties in northern California. In August 2004, Natomas and ASUS entered into a contract under which ASUS acts as the exclusive agent for marketing water that has become temporarily surplus to the internal needs of Natomas, and that arises under water rights permits and contracts owned or controlled by Natomas, to third parties outside the Natomas service area. On January 31, 2006, ASUS and Natomas entered into a water purchase and sale agreement under which ASUS will acquire 5,000 acre-feet of permanent Sacramento River water diversion rights from Natomas. Pursuant to the terms of this agreement, Natomas will sell, transfer and convey to ASUS, in perpetuity, water rights and entitlements to divert from the Sacramento River up to 5,000 acre-feet of water per year for consumptive use, subject to certain regulatory approvals. Terms of the acquisition, among other things, include a base price of $2,500 per acre-foot of water, with payments contingent on achievement of specific milestones and events over a 10-year period after first determining whether a need for the water exists in Sutter County. ASUS may use the water rights acquired from Natomas to serve existing customers, to re-sell to other beneficial users, or to pursue and serve expanded service territories.

 

Pursuant to the marketing services agreement described above, ASUS will attempt to arrange for the sale and transfer of temporarily surplus water for beneficial use beyond the Natomas service area.  Natomas will pay to ASUS a commission of 16% of the lease or sale price for any such water successfully marketed by ASUS. At the same time that the water purchase agreement was completed, Natomas and ASUS also entered into a settlement agreement that released Natomas from previously established reimbursement obligations under prior agreements.  In accordance with the marketing agreement, Natomas shareholders voted in December 2007 to approve the sale of 8,000 to 10,000 acre-feet per year of Natomas’ Central Valley Project water to the City of Folsom, subject to certain regulatory and environmental approvals.  The base price to be paid by Folsom is $4,000 per acre-foot.

 

GSWC and Natomas have also entered into an agreement under which GSWC agreed to purchase and Natomas agreed to sell up to 30,000 acre-feet per year of water to be used exclusively by GSWC to serve customers in Sutter County, California. Additionally, GSWC filed for a Certificate of Public Convenience and Necessity with the CPUC on May 31, 2006 to provide retail water service in a portion of Sutter County, California within the Natomas service area. CPUC review of the application has been deferred pending completion of an environmental assessment for the proposed new water service. All of the agreements with Natomas are subject to receipt of various regulatory approvals required for their full implementation.

 

Certain financial information for each of AWR’s business segments: water distribution, electric distribution, and contracted services is set forth in Note 15 to the Notes to Consolidated Financial Statements of American States Water Company and its subsidiaries. AWR’s water and electric distribution segments are not dependent upon a single or only a few customers. The U.S. government is the largest customer for ASUS’ contracted services.

 

The revenue from most of AWR’s business segments is seasonal. The impact of seasonality on AWR’s businesses is discussed in more detail in Item 1A — “Risk Factors”.

 

 

4



 

Competition

 

The businesses of GSWC and CCWC are substantially free from direct and indirect competition with other public utilities, municipalities and other public agencies within their existing service territories. GSWC and CCWC compete with governmental agencies and other investor-owned utilities in connection with offering service to new real estate developments on the basis of financial terms, availability of water and ability to commence providing service on a timely basis. AWR’s other subsidiary, ASUS, actively competes for business with other investor-owned utilities, other third party providers of water and wastewater services, and governmental entities on the basis of price and quality of service.

 

Employee Relations

 

GSWC had 529 employees as of December 31, 2007 as compared to 516 at December 31, 2006.  Seventeen positions in GSWC’s Bear Valley Electric customer service area are covered by a collective bargaining agreement, which expires at the end of 2009, with the International Brotherhood of Electrical Workers.  Seventy positions in GSWC’s Region II ratemaking district are covered by a collective bargaining agreement with the Utility Workers Union of America (“UWUA”), which expired in 2007. GSWC is continuing negotiations with the UWUA and in the meantime is working under the terms of the old contract.  GSWC has no other unionized employees.

 

AWR and its other subsidiaries had 43 employees as of December 31, 2007.  Five of the employees of a subsidiary of ASUS are covered by a collective bargaining agreement which will expire in 2008.

 

Forward-Looking Information

 

Certain matters discussed in this report (including the documents incorporated herein by reference) are forward-looking statements intended to qualify for the “safe harbor” from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as Registrant “believes,” “anticipates,” “expects” or words of similar import. Similarly, statements that describe Registrant’s future plans, objectives, estimates or goals are also forward-looking statements. Such statements address future events and conditions concerning ability to raise capital, capital expenditures, earnings, litigation, rates, water sales, water quality and other regulatory matters, adequacy of water supplies, the ability of GSWC and CCWC to recover electric, natural gas and water supply costs from ratepayers, contract operations, liquidity and capital resources, and accounting matters. Actual results in each case could differ materially from those currently anticipated in such statements, by reason of factors such as changes in utility regulation, including ongoing local, state and federal activities; recovery of regulatory assets not yet included in rates; future economic conditions, including changes in customer demand and changes in water and energy supply costs; future climatic conditions; delays in customer payments or price redeterminations on contracts executed by ASUS and its subsidiaries; and legislative, legal proceedings, regulatory and other circumstances affecting anticipated revenues and costs.

 

 

5



 

Item 1A — Risk Factors

 

You should carefully read the risks described below and other information in this Form 10-K in order to understand certain of the risks of our business.

 

Our business is heavily regulated and, as a result, decisions by regulatory agencies and changes in laws and regulations can significantly affect our business

 

Our revenues depend substantially on the rates and fees we charge our customers and the ability to recover our costs on a timely basis, including the ability to recover the costs of purchased water, groundwater assessments, electric power, natural gas, chemicals, water treatment, security at water facilities and preventative maintenance and emergency repairs.  Any delays by either the CPUC or the ACC in granting rate relief to cover increased operating and capital costs or delays in obtaining approval of ASUS’ requests for equitable adjustments or price redetermination from the U.S. government may adversely affect our financial performance.  We may file for interim rates in California in situations where there may be delays in granting final rate relief.  If the CPUC approves lower rates, the CPUC will require us to refund the difference between the interim rates and the rates approved by the CPUC to customers.

 

Regulatory decisions may also impact prospective revenues and earnings, affect the timing of the recognition of revenues and expenses and may overturn past decisions used in determining our revenues and expenses.  Management continually evaluates the anticipated recovery of regulatory assets, liabilities, and revenues subject to refund and provides for allowances and/or reserves as deemed necessary.  In the event that our assessment of the probability of recovery through the ratemaking process is incorrect, we will adjust the associated regulatory asset or liability to reflect the change in our assessment or any regulatory disallowances.  As of December 31, 2007, we had net regulatory assets of approximately $87.0 million, representing future revenues we expect to recover from customers through the ratemaking process.  A change in our evaluation of the probability of recovery of regulatory assets or a regulatory disallowance of all or a portion of our costs could have a material adverse effect on our financial results.

 

We are also in some cases required to estimate future expenses and in others, we are required to incur the expense before recovering costs.  As a result, our revenues and earnings may fluctuate depending on the accuracy of our estimates, timing of our investments or expenses or other factors.  If expenses increase significantly over a short period of time, we may experience delays in recovery of these expenses, the inability to recover carrying costs for these expenses and increased risks of regulatory disallowances or write-offs.

 

Regulatory agencies may also change their rules and policies which may adversely affect our profitability and cash flows.  Changes in policies of the U.S. government may also adversely affect our military base contract operations.  In certain circumstances, the U.S. government may be unwilling or unable to appropriate funds to pay costs mandated by changes in rules and policies of state regulatory agencies or may seek bids on work that we believe is covered by the contract awarded to us, thereby reducing the returns that we anticipated at the time of execution of the contract.  The U.S. government may also delay approval of requests for equitable adjustment or redetermination of prices which will adversely affect our anticipated rates of return.

 

Our earnings are greatly affected by weather during different seasons

 

The demand for water and electricity varies by season. Therefore, the results of operations for one period may not indicate results to be expected in another period.  For instance, most water consumption occurs during the third quarter of each year when weather tends to be hot and dry.  During this period, revenues and profitability are usually higher than in other quarters. Drought or unusually wet conditions may also adversely impact our revenues and profitability.  During a drought, we may experience both lower revenues due to consumer conservation efforts and higher water and operating costs due to supply shortages.  During unusually wet weather, our customers generally use less water.  The 2006/2007 water year was the driest ever recorded in southern California since records began in 1877.  It was the third driest year in Phoenix, Arizona since records began in 1948.

 

The demand for electricity in our electric customer service area is greatly affected by winter snows.  An increase in winter snows reduces the use of snowmaking machines at ski resorts in the Big Bear area and, as a result reduces our electric revenues.  Likewise, unseasonably warm weather during a skiing season may result in temperatures too high for snowmaking conditions, which also reduces our electric revenues.

 

 

6



 

Our liquidity and earnings may be adversely affected by changes in water supply costs

 

Water supplies are obtained from a variety of sources.  For example, water is pumped from aquifers within our service areas to meet a portion of the demands of our customers.  When water produced from wells is insufficient to meet customer demand or when such production is interrupted, we have purchased water from other suppliers.  As a result, our cost of providing, distributing and treating water for our customers’ use can vary significantly.  Furthermore, imported water wholesalers, such as the Metropolitan Water District of Southern California (“MWD”) and the Central Arizona Project (“CAP”), may not always have an adequate supply of water to sell to us.

 

We have established water supply cost balancing accounts for expenses of purchased water, purchased power and groundwater related pump taxes for our water service areas in California.  Even under the water supply cost balancing account procedures, changes in water supply costs, such as those that occur due to changes in supply mix (purchased water volume vs. pumped water, for instance) compared to the authorized amount may directly affect our earnings.

 

Our liquidity and earnings could be adversely affected by increases in maintenance costs due to our aging infrastructure in California

 

Some of our systems in California are older than 50 years.  We are experiencing a high number of leaks, water quality and mechanical problems in some of these systems.   In addition, well and pump maintenance expenses continue to increase due to rising labor and material costs and more stringent water discharge requirements.  These costs can and do increase unexpectedly and in substantial amounts. During 2007, our maintenance expense increased by 27.6% at GSWC.

 

We include increases in maintenance costs in each general rate case for possible recovery.  However, we estimate the amount of expenses expected to be incurred during future years.  We may not recover overages from those estimates in rates, which may adversely affect our financial condition, results of operations, cash flow and liquidity.

 

Our liquidity and earnings may be adversely affected by our conservation efforts

 

Conservation by all customer classes is a top priority.  However, customer conservation can result in lower volumes of water sold.  We are also experiencing a decline in per residential customer water usage due to the use of more efficient household fixtures and appliances by residential consumers and a decline in household sizes.

 

Our regulated businesses are heavily dependent upon revenue generated from rates charged to our residential customers for the volume of water they use. The rates we charge for water are regulated by the CPUC and ACC and may not be unilaterally adjusted to reflect changes in demand. Declining usage also negatively impacts our long-term operating revenues if we are unable to secure rate increases or if growth in the residential customer base does not occur to the extent necessary to offset the per customer residential usage decline.

 

Our operating costs have increased and are expected to continue to increase as a result of groundwater contamination

 

Our operations are impacted by groundwater contamination in certain service territories.  We have taken a number of steps to address contamination, including the removal of wells from service, decreasing the amount of groundwater pumped from wells in order to slow the movement of plumes of contaminated water, constructing water treatment facilities and securing alternative sources of supply from other areas not affected by the contamination.

 

In some cases, potentially responsible parties have reimbursed us for our costs.  In other cases, we have taken legal action against parties believed to be potentially responsible for the contamination.  To date, the CPUC has permitted us to establish memorandum accounts in California for potential recovery of these types of costs.  As a result, our memorandum and water supply balancing accounts are high by historical standards.  We can give no assurance regarding the outcome of litigation arising out of contamination or our ability to recover these costs in the future.

 

Persons who are potentially responsible for causing the contamination of groundwater supplies have also been increasingly asserting claims against water distributors on a variety of theories and have thus far brought the water distributors (including us) within the class of potentially responsible parties in federal court actions pending in Los Angeles County.  This increases the costs of seeking recovery from the potentially responsible parties and the risks associated with seeking recovery of these costs.  Management believes that rate recovery, proper insurance coverage and reserves are in place to appropriately manage these types of claims.  However, such claims, if ultimately resolved unfavorably to us, could, in the aggregate, have a material adverse effect on our results of operations and financial condition.

 

7



 

Our costs involved in maintaining water quality and complying with environmental regulation have increased, and are expected to continue to increase

 

Our capital and operating costs have increased substantially as a result of increases in environmental regulation arising from improved detection technology and increases in the cost of disposing of residuals from our water treatment plants, upgrading and building new water treatment plants, monitoring compliance activities and removing our wells from service when necessary to address contamination issues.

 

Our regulated utilities may be able to recover these costs through the ratemaking process.  We may also be able to recover these costs under contractual arrangements.  In certain circumstances, costs may be recoverable from parties responsible or potentially responsible for contamination, either voluntarily or through specific court action.  We may incur significant costs in connection with recovery efforts and moreover, recovery of these types of costs depends upon a variety of factors, including approval of rate increases, the willingness of potentially responsible parties to settle litigation and otherwise address the contamination and the extent and magnitude of the contamination.  We can give no assurance regarding the adequacy of any such recovery to offset such costs.

 

The Military Utility Privatization Subsidiaries are also subject to increasingly stringent environmental regulations. The contracts provide various mechanisms for recovery of the costs, including increasing revenues through change in conditions provisions and equitable adjustment procedures.  Our contracts with the U.S. government are, however, subject to the Anti-Deficiency Act. As a result, our recovery of these costs may depend upon Congressional action to appropriate funds.

 

The adequacy of our water supplies depends upon a variety of uncontrolled factors

 

The adequacy of our water supplies varies from year to year depending upon a variety of factors, including:

 

·                  Rainfall, runoff, flood control and availability of reservoir storage

 

·                  Availability of Colorado River water and imported water from northern California

 

·                  The amount of useable water stored in reservoirs and groundwater basins

 

·                  The amount of water used by our customers and others

 

·                  Water quality

 

·                  Legal limitations on production, diversion, storage, conveyance and use

 

Population growth and increases in the amount of water used have caused increased stress on surface supplies and groundwater basins. The importation of water from the Colorado River, one of GSWC’s important sources of supply has decreased due to implementation of the California 4.4 Plan which limits the amount of water that the MWD is entitled to take from the Colorado River.   In addition, new court-ordered pumping restrictions on water obtained from the Sacramento-San Joaquin Delta are expected to decrease the amount of water MWD is able to import from northern California.  We are cooperating with MWD to secure additional supplies from conservation, desalination and water exchanges with agricultural water users, but it is not known to what extent these efforts will be successful and sustainable.

 

CCWC obtains its water supply from operating wells and from the Colorado River through the CAP.  CCWC’s water supply may be subject to interruption or reduction if there is an interruption or reduction in water supplies available to CAP.  In addition, CCWC’s ability to provide water service to new real estate developments is dependent upon CCWC’s ability to meet the requirements of the Arizona Department of Water Resources regarding the Company’s assured water supply account.

 

Water shortages may affect us in a variety of ways:

 

·                  They may adversely affect our supply mix, for instance, causing more reliance upon more expensive water sources

 

·                  They may adversely affect our operating costs, for instance, by increasing the cost of producing water from more highly contaminated aquifers

 

·                  They may result in an increase in our capital expenditures, for example by requiring the construction of pipelines to connect to alternative sources of supply, new wells to replace those that are no longer in service or are otherwise inadequate to meet the needs of our customers, reservoirs and other facilities to conserve or reclaim water

 

·                  They may adversely affect the volume of water sold as a result of mandatory or voluntary conservation efforts by customers

 

8



 

We may be able to recover increased operating and capital costs for our regulated systems through the ratemaking process. We may also recover costs from certain third parties that may be responsible, or potentially responsible, for groundwater contamination.

 

Our liquidity, and in certain circumstances, earnings, may be adversely affected by increases in electricity and natural gas prices in California

 

We purchase most of our electric energy sold to customers in our electric customer service area from others under contracts that expire at the end of 2008 at an average price of $74.65 per megawatt per hour (“MWh”).  In addition to the purchased power contracts, we purchase additional energy from the spot market to meet peak demand.  We may sell surplus power to the spot market during times of reduced energy demand.  We also operate a natural gas-fueled 8.4 megawatt (“MW”) generator in its electric service area.

 

During the energy crisis in late 2000 and 2001, we incurred approximately $23.1 million of additional energy purchase costs that were not covered in rates. The CPUC authorized a surcharge of 2.2¢ per kilowatt hour from our customers through August 2011 to recover this under-collected balance.  We have recovered approximately $17.1 million of the $23.1 million incurred during the energy crisis through this surcharge as of December 31, 2007.  In addition, the CPUC authorized recovery of energy purchase costs from customers, up to an annual weighted average cost of $77 per MWh each year through August 2011.  We are required to write-off costs in excess of this cap. As a result, we are at risk for increases in spot market prices of electricity purchased and for decreases in spot market prices for electricity sold.  Since the energy crisis in late 2001, we have added approximately $12.3 million of power costs in excess of the amounts authorized in rates to our electric balancing account, resulting primarily from increases in costs associated with the transportation of energy.  At December 31, 2007, approximately $18.3 million remains as an under-collection in the electric supply cost balancing account resulting from these activities.

 

Unexpected generator downtime, or a failure to perform by any of the counterparties to the electric and natural gas purchase contracts could further increase our exposure to fluctuating natural gas and electric prices.

 

Changes in electricity prices also affect the unrealized gains and losses on our block forward purchased power contracts that qualify as derivative instruments as we adjust the asset or liability on these contracts to reflect the fair market value of the contracts at the end of each month.  As a result of decreases in energy prices as of December 31, 2007, we recorded a cumulative unrealized loss of $1.6 million related to these contracts. We will recognize this cumulative unrealized loss as additions to earnings in 2008 by December 31, 2008 when the contract ends.

 

Our business requires significant capital expenditures

 

The utility business is capital intensive.  On an annual basis, we spend significant sums of money for additions to or replacement of our property, plant and equipment.  During the years ended December 31, 2007, 2006 and 2005, we spent $49.9 million, $66.6 million and $71.2 million, respectively, for these purposes.  We estimate capital expenditures for our regulated utilities for calendar year 2008 to be approximately $55.0 million to $60.0 million.

 

ASUS expects to incur capital expenditures of approximately $22.0 million in 2008.  To the extent that the U.S. government does not reimburse us for these expenditures as the work is performed, the U.S. government will repay us over time with interest.

 

We obtain funds for these capital projects from operations, contributions by developers and others and advances from developers (which are repaid over a period of time at no interest).  We also periodically borrow money or issue equity for these purposes.  In addition, we have a syndicated bank credit facility that is partially used for these purposes.  We cannot provide assurance that these sources will continue to be adequate or that the cost of funds will remain at levels permitting us to earn a reasonable rate of return.

 

The assets of our regulated businesses are subject to condemnation

 

Municipalities and other government subdivisions may, in certain circumstances, seek to acquire certain of our assets through eminent domain proceedings.  It is generally our practice to contest these proceedings which may be costly and may divert the attention of management from the operation of its business.  If a municipality or other government subdivision succeeds in acquiring our assets, there is a risk we will not receive adequate compensation for the assets acquired or be able to recover all charges associated with divesting these assets.

 

9



 

Our operations are geographically concentrated in California

 

Although we own water and wastewater facilities in a number of states, our operations are concentrated in California, particularly southern California.  As a result, our financial results are largely subject to weather, political, water supply, labor, utility cost, regulatory and other economic risks affecting California.

 

We operate in areas subject to natural disasters or that may be the target of terrorist activities

 

We operate in areas that are prone to earthquakes, fires, mudslides and other natural disasters.  While we maintain insurance policies to help reduce our financial exposure, a significant seismic event in Southern California, where our operations are concentrated, or other natural disasters in California could adversely impact our ability to deliver water and adversely affect our costs of operations.  The CPUC has historically allowed utilities to establish a catastrophic event memorandum account as another possible mechanism to recover these costs.

 

Terrorists could seek to disrupt service to our customers by targeting our assets. We also may be prevented from providing water and wastewater services in the military bases in times of military crisis affecting these bases.  We have invested in additional security for facilities throughout our regulated service areas to mitigate the risks of terrorist activities.

 

Our failure to comply with restrictive covenants under our long-term debt agreements and credit facility could trigger prepayment obligations

 

Our failure to comply with the restrictive covenants under our long-term debt agreements and credit facility could result in an event of default, which, if not cured or waived, could result in us being required to repay or refinance (on less favorable terms) these borrowings before their due dates.  If we are forced to repay or refinance (on less favorable terms) these borrowings, our results of operations and financial condition could be adversely affected by increased costs and rates.

 

We are a holding company that depends on cash flow from GSWC to meet our financial obligations and to pay dividends on our common shares

 

As a holding company, our subsidiaries conduct substantially all operations and our only significant assets are investments in our subsidiaries. This means that we are dependent on distributions of funds from our subsidiaries to meet our debt service obligations and to pay dividends on our common shares.  More than 90% of our earnings is derived from the operations of GSWC.  Moreover, none of our other subsidiaries has paid any dividends to us during the past three years.  As a result, we are largely dependent on cash flow from GSWC to meet our financial obligations and to pay dividends on our common shares.

 

Our subsidiaries are separate and distinct legal entities and generally have no obligation to pay any amounts due on our debt.  Our subsidiaries only pay dividends if and when declared by the subsidiary Board.  Moreover, GSWC is obligated to give first priority to its own capital requirements and to maintain a capital structure consistent with that determined to be reasonable by the CPUC in its most recent decision on capital structure, in order that ratepayers not be adversely affected by the holding company structure.  Furthermore, our right to receive cash or other assets in the unlikely event of liquidation or reorganization of GSWC is generally subject to the prior claims of creditors of that subsidiary.  If we are unable to obtain funds from GSWC in a timely manner, we may be unable to meet our financial obligations, make additional investments or pay dividends.

 

Additional Risks Associated with our Contracted Services

 

                We derive revenues from contract operations primarily from the operation and maintenance of water and wastewater systems at military bases and the construction of water and wastewater improvements to the infrastructure on these bases.  As a result, these operations are subject to risks that are different than those of our regulated utility operations.

 

                Our operations and maintenance contracts on military bases create certain risks that are different from that of our regulated utility operations

 

                We have entered into contracts to provide water and wastewater services at military bases pursuant to 50-year contracts, subject to termination, in whole or in part, for the convenience of the U.S. government.  In addition, the U.S. government may stop work under the terms of the contracts, delay performance of our obligations under the contracts or modify the contracts at its convenience.

 

Our contract pricing was based on a number of assumptions, including assumptions about prices and availability of labor, equipment and materials. We may be unable to recover all costs if any of these assumptions are inaccurate or if all costs that we may incur in connection with performing the work were not considered.  Our operations and maintenance

 

10



 

contracts are also subject to periodic price adjustments at the time of price redetermination or in connection with requests for equitable adjustments or other changes permitted by terms of the contracts.  The contract price for each of these contracts is subject to redetermination two years after commencement of operations and every three years thereafter to the extent provided in each of the contracts. Prices are also subject to equitable adjustment based upon changes in circumstances and changes in wages and fringe benefits to the extent provided in each of the contracts.  However, we have experienced delays in the redetermination of prices following completion of the first two years of operation and delays in obtaining an equitable adjustment of prices for the significantly higher infrastructure at Fort Bliss than that described by the U.S. government in its request for proposal.

 

                We are subject to audits, cost review and investigations by contracting oversight agencies.  During the course of an audit, the oversight agency may disallow costs.  Such cost disallowances may result in adjustments to previously reported revenues.

 

                Payment under these contracts is subject to appropriations by Congress.  We may experience delays in receiving payment or delays in redetermination of prices or other price adjustments due to cancelled or delayed appropriations specific to our projects or reductions in government spending for the military or generally.  Appropriations and the timing of payment, may be influenced by, among other things, the state of the economy, competing political priorities, budget constraints, the timing and amount of tax receipts and the overall level of government expenditures for the military.

 

                In addition, we must maintain the proper management of water and wastewater facilities, employ state-certified and other qualified employees to support the operation of these facilities and otherwise comply with contract requirements.

 

Risks associated with the collection, treatment and disposal of wastewater create risks that are different, in some respects, from that of our water utility operations

 

The wastewater collection, treatment and disposal operations of our Military Utility Privatization Subsidiaries are subject to substantial regulation and involve significant environmental risks. If collection or sewage systems fail, overflow or do not operate properly, untreated wastewater or other contaminants could spill onto nearby properties or into nearby streams and rivers, causing damage to persons or property, injury to aquatic life and economic damages, which may not be recoverable in fees. This risk is most acute during periods of substantial rainfall or flooding, which are the main causes of sewer overflow and system failure. Liabilities resulting from such damage could adversely and materially affect our business, results of operations and financial condition. In the event that we are deemed liable for any damage caused by overflow, our losses might not be covered by insurance policies and such we find it difficult to secure insurance for this business in the future at acceptable rates.

 

                Our contracts for the construction of infrastructure improvements on military bases create risks that are different, in some respects, from that of our operations and maintenance contracts

 

                We have has entered into contracts for the construction of infrastructure improvements to water and wastewater systems at military bases.  Many of these contracts are fixed-price contracts.  Under fixed-price contracts, we benefit from cost savings and earnings, but are generally unable to recover any cost overruns to the approved contract price.  Under extenuating circumstances, the U.S. government has approved increased cost change orders.

 

                We recognize revenues from these types of contracts using the percentage-of-completion method of accounting.  This accounting practice results in our recognizing contract revenues and earnings ratably over the contract term in proportion to our incurrence of contract costs.  The earnings or losses recognized on individual contracts are based on periodic estimates of contract revenues, costs and profitability as the construction projects progress.

 

                We establish prices for these types of fixed-price contracts based, in part, on cost estimates that are subject to a number of assumptions, including assumptions regarding future economic conditions.  If these estimates prove inaccurate or circumstances change, cost overruns could have a material adverse effect on our contracted business operations and results of operations for contracted services.

 

                We may be adversely affected by disputes with the U.S. government regarding our performance of contract services on military bases

 

If there is a dispute with the U.S. government regarding performance under these contracts or the amounts owed to us, the U.S. government may delay, reject or withhold payment, or assert its right to offset damages against amounts owed to us.  If we are unable to collect amounts owed to us on a timely basis or the U.S. government asserts its offset rights, profits and cash flows will be adversely affected.

 

11



 

                If we fail to comply with the terms of one or more of our U.S. government contracts, other agreements with the U.S. government or U.S. government regulations and statutes, we could be suspended or barred from future U.S. government contracts for a period of time and be subject to possible damages, fines and penalties and damage to our reputation in the water and wastewater industry.

 

                We depend, to some extent, upon subcontractors to assist us in the performance of contracted services on military bases

 

                We rely, to some extent, on subcontractors to assist us in the operation and maintenance of the water and wastewater systems at a number of military bases, subject to our existing contracts with the U.S. government.  The failure of any of these subcontractors to perform services for us in accordance with the terms of our contracts with the U.S. government could result in the termination of our contracts to provide wastewater services at these bases, a loss of revenues and increases in costs to correct, or otherwise as a result of, a subcontractor’s performance failures.  In addition, we are required to make a good faith effort to achieve our small business subcontracting plan goals pursuant to U.S. government regulation. If we fail to use good faith efforts to meet these goals, the U.S. government may assess damages against us.  The U.S. government has the right to offset claimed damages against any amounts owed to us.

 

                We also rely on third-party manufacturers as well as third-party subcontractors to complete our construction projects. To the extent that we cannot engage subcontractors or acquire equipment or materials, our ability to complete a project in a timely fashion or at a profit may be impaired.  If the amount we are paid for these projects exceeds the amount we have estimated in our bid, we could experience losses in the performance of these contracts.  In addition, if a subcontractor or manufacturer is unable to deliver its services, equipment or materials according to the negotiated terms for any reason, including the deterioration of its financial condition, we may be required to purchase the services, equipment or materials from another source at a higher price.  This may reduce the profit to be realized or result in a loss on a project for which the services, equipment or materials were needed.

 

                If these subcontractors fail to perform services to be provided to us or fail to provide us with the proper equipment or materials, we may be penalized for their failure to perform.

 

We continue to incur costs associated with the expansion of our contract activities

 

                We continue to incur additional costs in connection with the expansion of our contract operations associated with the preparation of bids and the negotiation of the terms of new contracts.  Our ability to recover these costs and to earn a profit on our contract operations will depend upon the extent to which we are successful in obtaining new contracts and recovering those costs and other costs from new contract revenues.

 

Item 1B — Unresolved Staff Comments

 

None.

 

12



 

Item 2 - Properties

 

Electric Properties

 

GSWC’s electric properties are all located in the Big Bear area of San Bernardino County, California. As of December 31, 2007, GSWC owned and operated 29 miles of overhead 34.5 kilovolt (“kv”) transmission lines, 1 mile of underground 34.5 kv transmission lines, 176 miles of 4.16 kv or 2.4 kv distribution lines, 53 miles of underground cable, 14 sub-stations and a natural gas-fueled 8.4 MW peaking generation facility.  GSWC also has franchises, easements and other rights of way for the purpose of constructing and using poles, wires and other appurtenances for transmitting electricity.

 

Water Properties

 

As of December 31, 2007, GSWC’s physical properties consisted of water transmission and distribution systems which included 2,724 miles of pipeline together with services, meters and fire hydrants and approximately 430 parcels of land, generally less than 1 acre each, on which are located wells, pumping plants, reservoirs and other water utility facilities, including five surface water treatment plants.  GSWC also has franchises, easements and other rights of way for the purpose of constructing and using pipes and appurtenances for transmitting and distributing water.

 

As of December 31, 2007, GSWC owned 243 wells. All wells are equipped with pumps with an aggregate production capacity of approximately 257 million gallons per day. GSWC has 64 connections to the water distribution facilities of the MWD and other municipal water agencies. GSWC’s storage reservoirs and tanks have an aggregate capacity of approximately 111 million gallons. GSWC owns no dams in its customer service areas. The following table provides, in greater detail, selected water utility plant of GSWC for each of its water regions:

 

 

 

Pumps

 

Distribution Facilities

 

Reservoirs

 

Region

 

Well

 

Booster

 

Mains*

 

Services

 

Hydrants

 

Tanks

 

Capacity*

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Region I

 

71

 

123

 

534

 

55,666

 

4,002

 

47

 

34,540

 

Region II

 

51

 

71

 

972

 

100,651

 

8,652

 

27

 

21,230

 

Region III

 

121

 

199

 

1,218

 

98,229

 

10,415

 

79

 

55,380

(1)

Total

 

243

 

393

 

2,724

 

254,546

 

23,069

 

153

 

111,150

 


* Reservoir capacity is measured in thousands of gallons. Mains are in miles.

 

(1) GSWC has additional reservoir capacity in its Claremont system, through an exclusive right to use all of one 8 million gallon reservoir, one-half of another 8 million gallon reservoir, and one-half of a treatment plant’s capacity, all owned by Three Valleys Municipal Water District.

 

As of December 31, 2007, CCWC’s physical properties consisted of water transmission and distribution systems, which included 184 miles of pipeline, together with services, meters, fire hydrants, wells, reservoirs with a combined storage capacity of 7.55 million gallons and other water utility facilities including a surface water treatment plant, which treats water from the CAP.

 

Adjudicated and Other Water Rights

 

GSWC

 

GSWC owns numerous water rights in California, as shown in the table below.  Water rights are divided between groundwater and surface water, and groundwater rights are further subject to classification as either adjudicated or unadjudicated rights.  Adjudicated rights have been subjected to comprehensive litigation in the courts, are typically quantified and are actively managed for optimization and sustainability of the resource.  Unadjudicated groundwater rights have not been quantified and are not subject to predetermined limitations, but are measured by maximum historical usage.  Surface water rights are quantified and managed by the State Water Resources Control Board, unless they originated prior to 1914, in which case they resemble unadjudicated groundwater rights.  A total of 118,109 acre-feet per year (“AFY”) of water rights are own by GSWC’s three regions as follows:

 

 

 

Groundwater

 

Surface Water

 

 

 

Region

 

Adjudicated Rights (AFY)

 

Unadjudicated Rights (AFY)

 

Water Rights (AFY)

 

Totals (AFY)

 

 

 

 

 

 

 

 

 

 

 

Region I

 

10,248

 

20,113

 

10,134

 

40,495

 

Region II

 

23,942

 

1,771

 

 

25,713

 

Region III

 

27,490

 

23,010

 

1,401

 

51,901

 

Total

 

61,680

 

44,894

 

11,535

 

118,109

 

 

13



 

CCWC

 

CCWC has an assured water supply designation, by decision and order of the Arizona Department of Water Resources (“ADWR”). Pursuant to a decision issued by ADWR on April 7, 2004, CCWC has demonstrated the physical, legal and continuous availability of CAP water and groundwater, in an aggregate volume of 11,759 acre-feet per year for a minimum of 100 years. The 11,759 acre-feet is comprised of existing CAP allocation of 8,909 acre-feet per year, 350 acre-feet per year groundwater allowance, incidental recharge credits of 500 acre-feet per year, and a Central Arizona Groundwater Replenishment District contract of 2,000 acre-feet per year.

 

Office Buildings

 

Registrant’s general headquarters are housed in a single-story office building located in San Dimas, California. The land and the building are owned by GSWC. GSWC also owns and/or leases certain facilities housing regional, district and customer service offices. CCWC owns its primary office space in Fountain Hills, Arizona. ASUS leases an office facility in Costa Mesa, California.

 

Mortgage and Other Liens

 

As of December 31, 2007, GSWC had no mortgage debt outstanding, encumbrances or liens securing indebtedness.

 

As of December 31, 2007, substantially all of the utility plant of CCWC was pledged to secure its Industrial Development Authority Bonds, which among other things, restricts CCWC’s ability to incur debt and make liens, sell, lease or dispose of assets, or merge with another corporation, and pay dividends.

 

As of December 31, 2007, neither AWR nor ASUS or any of its subsidiaries had any mortgage debt or liens securing indebtedness, outstanding.  However, under the terms of certain debt of AWR and GSWC, AWR and GSWC are prohibited from issuing any secured debt, without providing equal and ratable security to the holders of this existing debt.

 

Condemnation of Properties

 

                The laws of the State of California and the State of Arizona provide for the acquisition of public utility property by governmental agencies through their power of eminent domain, also known as condemnation, where doing so is necessary and in the public interest. In addition, however, the laws of the State of California provide: (i) that the owner of utility property may contest whether the condemnation is actually necessary and in the public interest, and (ii) that the owner is entitled to receive the fair market value of its property if the property is ultimately taken.

 

                Although the City of Claremont, California (the “City”) located in GSWC’s Region III, has not initiated the formal condemnation process pursuant to California law, the City has expressed various concerns to GSWC about the rates charged by GSWC and the effectiveness of the CPUC’s rate-setting procedures. The City hired a consultant to perform an appraisal of the value of GSWC’s water system serving the City. The value was estimated in 2004 by the City’s consultant at $40—$45 million. GSWC disagrees with the consultant’s valuation assessment. As of December 31, 2007, management believes that the fair market value of the Claremont water system exceeds the $38.0 million recorded net book value and also exceeds the consultant’s estimates of its value. In addition, GSWC believes the value of its groundwater rights has significant value.  The Claremont City Council held a project priorities workshop in April 2007. The council members agreed that the acquisition of GSWC’s water system was to remain a priority and authorized staff to obtain updated appraisals for the value of the water systems. Requests for proposals have been sent to consulting firms by the City.  In a recent meeting held in February 2008, the Claremont City Council stated that they had decided to authorize additional studies of the acquisition of GSWC’s water system.

 

                The Town of Apple Valley (the “Town”) is located in GSWC’s Region III and was evaluating the potential takeover of GSWC’s Apple Valley water systems as well as the water systems of another utility serving the Town. On March 13, 2007, the Town Council voted to formally abandon its review of the potential acquisitions. GSWC was notified of the Town Council’s action by a letter from the Town Manager dated April 3, 2007.

 

                Except for the City of Claremont and the Town of Apple Valley, Registrant has not been involved within the last three years in activities related to the potential condemnation of any of its other customer service areas. No formal condemnation proceedings have been filed against any of the Registrant’s service areas during the past three years.

 

14



 

Item 3 - Legal Proceedings

 

Water Quality-Related Litigation:

 

                Perchlorate and/or Volatile Organic Compounds (“VOC”) have been detected in five wells servicing GSWC’s South San Gabriel System. GSWC filed suit in federal court, along with two other affected water purveyors and the San Gabriel Basin Water Quality Authority (“WQA”), against some of those allegedly responsible for the contamination of two of these wells. Some of the other potential defendants settled with GSWC, other water purveyors and the WQA (the “Water Entities”) on VOC related issues prior to the filing of the lawsuit. In response to the filing of the lawsuit, the Potentially Responsible Party (“PRP”) defendants filed motions to dismiss the suit or strike certain portions of the suit. The judge issued a ruling on April 1, 2003 granting in part and denying in part the PRP’s motions. A key ruling of the court was that the water purveyors, including GSWC, by virtue of their ownership of wells contaminated with hazardous chemicals are themselves PRPs under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”).

 

                GSWC has, pursuant to permission of the court, amended its suit to claim certain affirmative defenses as an “innocent” party under CERCLA. Registrant is presently unable to predict the outcome of this ruling on its ability to fully recover from the PRPs future costs associated with the treatment of these wells. In this same suit, the PRPs have filed cross-complaints against the Water Entities, the MWD, the Main San Gabriel Basin Watermaster and others on the theory that they arranged for and did transport contaminated water into the Main San Gabriel Basin for use by GSWC and the other two affected water purveyors and for other related claims.

 

                On August 29, 2003, the US Environmental Protection Agency (“EPA”) issued Unilateral Administrative Orders (“UAO”) against 41 parties deemed responsible for polluting the groundwater in that portion of the San Gabriel Valley from which two of GSWC’s impacted wells draw water. GSWC was not named as a party to the UAO. The UAO requires that these parties remediate the contamination. The judge in the lawsuit has appointed a special master to oversee mandatory settlement discussions between the PRPs and the Water Entities. EPA is also conducting settlement discussions with several PRPs regarding the UAO. The Water Entities and EPA are working to coordinate their settlement discussions under the special master in order to arrive at a complete resolution of all issues affecting the lawsuit and the UAO. Settlements with a number of the PRPs are being finalized; however, Registrant is presently unable to predict the ultimate outcome of these settlement discussions.

 

Santa Maria Groundwater Basin Adjudication:

 

In 1997, the Santa Maria Valley Water Conservation District (“plaintiff”) filed a lawsuit against multiple defendants, including GSWC, the City of Santa Maria, and several other public water purveyors. The plaintiff’s lawsuit sought an adjudication of the Santa Maria Groundwater Basin (the “Basin”). A stipulated settlement of the lawsuit has been reached, subject to CPUC approval. The settlement, among other things, if approved by the CPUC, would preserve GSWC’s historical pumping rights and secure supplemental water rights for use in case of drought or other reductions in the natural yield of the Basin.  GSWC, under the stipulation, has a right to 10,000 acre-feet of groundwater replenishment provided by the Twitchell Project, a storage and flood control reservoir project operated by the Santa Maria Valley Conservation District.  A monitoring and annual reporting program has been established to allow the parties to responsibly manage the Basin and to respond to shortage conditions.  If severe water shortage conditions are found over a period of five years, the management area engineer will make findings and recommendations to alleviate such shortages.  In the unlikely case that the Basin experiences severe shortage conditions, the court has the authority to limit GSWC’s groundwater production to 10,248 acre-feet per year, based on developed water in the Basin.

 

On February 11, 2008, the court issued its final judgment, which approves and incorporates the stipulation.  The judgment awards GSWC prescriptive rights to groundwater against the non-stipulating parties.  In addition, the judgment grants GSWC the right to use the Basin for temporary storage and to recapture 45 percent of the return flows that are generated from its importation of State Water Project water.  Pursuant to this judgment, the court retains jurisdiction over all of the parties to make supplemental orders or to amend the judgment as necessary.

 

Other Litigation:

 

Two former officers of GSWC filed a lawsuit against both AWR and GSWC alleging among other things, wrongful termination and retaliation against the former officers.  The lawsuits were filed on November 15, 2007 in the Los Angeles Superior Court: Conway, et al. v. Golden State Water Company, et al., Case No. BC380721.  Management believes that the allegations are without merit and intends to vigorously defend against them. Based on our understanding of all the claims, management does not believe that the ultimate resolution of this matter will have a material adverse effect on GSWC’s financial position, results of operations, or cash flows.

 

15



 

Registrant is also subject to ordinary routine litigation incidental to its business. Other than those disclosed above, no other legal proceedings are pending, which require disclosure. Management believes that rate recovery, proper insurance coverage and reserves are in place to insure against property, general liability and workers’ compensation claims incurred in the ordinary course of business

 

Item 4. Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of security holders through the solicitation of proxies or otherwise during the fourth quarter of the fiscal year covered by this report.

 

16



 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Stock Performance Graph

 

The graph below compares American States Water Company’s cumulative five-year total shareholder return on  Common Shares with the cumulative total returns of the S & P 500 index and a customized peer group of six companies that includes: Artesian Resources Corp., California Water Service, Connecticut Water, Middlesex Water Company, SJW Corp. and Southwest Water Company. The graph tracks the performance of a $100 investment in our Common Shares, in the index and in the peer group (with the reinvestment of all dividends) from December 31, 2002 to December 31, 2007.

 

 

 

 

12/02

 

12/03

 

12/04

 

12/05

 

12/06

 

12/07

 

American States Water Company

 

100.00

 

111.97

 

120.88

 

147.89

 

190.16

 

190.02

 

S&P 500

 

100.00

 

128.68

 

142.69

 

149.70

 

173.34

 

182.87

 

Peer Group

 

100.00

 

122.36

 

147.86

 

160.13

 

191.86

 

183.05

 

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

 

17



 

Market Information Relating to Common Shares

 

Common Shares of American States Water Company are traded on the New York Stock Exchange (“NYSE”) under the symbol AWR. The intra-day high and low NYSE prices on the Common Shares for each quarter during the past two years, as reported by the Wall Street Journal’s website, were:

 

 

 

Stock Prices

 

 

 

High

 

Low

 

2007

 

 

 

 

 

First Quarter

 

$

41.12

 

$

35.36

 

Second Quarter

 

38.84

 

33.57

 

Third Quarter

 

44.84

 

35.06

 

Fourth Quarter

 

46.14

 

36.77

 

 

 

 

 

 

 

2006

 

 

 

 

 

First Quarter

 

$

37.61

 

$

30.30

 

Second Quarter

 

43.79

 

33.18

 

Third Quarter

 

39.18

 

34.91

 

Fourth Quarter

 

42.31

 

35.89

 

 

The closing price of the Common Shares of American States Water Company on the NYSE as reported on the Wall Street Journal’s website on March 12, 2008 was $34.11.

 

Approximate Number of Holders of Common Shares

 

As of March 12, 2008, there were 3,134 holders of record of the 17,242,917 outstanding Common Shares of American States Water Company. AWR owns all of the authorized and outstanding Common Shares of GSWC, CCWC and ASUS. ASUS owns all of the outstanding stock of the Military Utility Privatization Subsidiaries.

 

Frequency and Amount of Any Dividends Declared and Dividend Restrictions

 

For the last two years, AWR has paid dividends on its Common Shares on March 1, June 1, September 1 and December 1. The following table lists the amount of dividends paid on Common Shares of American States Water Company:

 

 

 

2007

 

2006

 

First Quarter

 

$

0.235

 

$

0.225

 

Second Quarter

 

$

0.235

 

$

0.225

 

Third Quarter

 

$

0.235

 

$

0.225

 

Fourth Quarter

 

$

0.250

 

$

0.235

 

Total

 

$

0.955

 

$

0.910

 

 

AWR’s ability to pay dividends is subject to the requirement in the Company’s $85 million revolving credit facility for AWR to maintain compliance with all covenants described in footnote (15) to the table in the section entitled “Contractual Obligations, Commitments and Off Balance Sheet Arrangements” included in Part II, Item 7 in Management’s Discussion and Analysis of Financial Condition and Results of Operation. GSWC’s maximum ability to pay dividends is restricted by certain Note Agreements to the sum of $21 million plus 100% of consolidated net income from certain dates plus the aggregate net cash proceeds received from capital stock offerings or other instruments convertible into capital stock from various dates. Under the most restrictive of the Note Agreements, $222.7 million was available from GSWC to pay dividends to AWR as of December 31, 2007. GSWC is also prohibited under the terms of a senior note issued in October 2005 from paying dividends if, after giving effect to the dividend, its total indebtedness to capitalization ratio (as defined) would be more than .6667 to 1.  GSWC would have to issue additional debt of $260.9 million to invoke this covenant as of December 31, 2007.

 

The ability of AWR, ASUS and GSWC to pay dividends is also restricted by California law. Under restrictions of the California tests, approximately $120.3 million of AWR’s retained earnings was available to pay dividends to common shareholders at December 31, 2007. Approximately $115.3 million was available from the retained earnings of GSWC at December 31, 2007 to pay dividends to AWR.  At December 31, 2007, ASUS was unable to pay dividends to AWR under the California tests.

 

18



 

CCWC is subject to contractual restrictions on its ability to pay dividends. CCWC’s maximum ability to distribute dividends is limited to maintenance of no more than 55% debt in the capital structure for the quarter immediately preceding the distribution. The ability of CCWC to pay dividends is also restricted under Arizona law. Under restrictions of the Arizona tests, approximately $7.1 million was available to pay dividends to AWR at December 31, 2007. See footnote (6) to the table in the section entitled “Contractual Obligations and Other Commitments” included in Part II, Item 7 in Management’s Discussion and Analysis of Financial Conditions and Results of Operation.

 

AWR paid $16.3 million in common dividends to shareholders for the year ended December 31, 2007, as compared to $15.4 million for the year ended December 31, 2006. GSWC paid dividends of $17.2 million to AWR in 2007 and 2006. CCWC and ASUS did not pay any dividends to AWR in 2007 or 2006.

 

Other Information

 

The shareholders of AWR have approved the material features of all equity compensation plans under which AWR directly issues equity securities. AWR did not directly issue any unregistered equity securities during 2007.

 

The following table provides information about Company repurchases of its Common Shares during the fourth quarter of 2007:

 

 

 

 

 

 

 

 

Total Number of

 

Maximum Number

 

 

 

 

 

 

 

Shares Purchased as

 

of Shares That May

 

 

 

 

 

 

 

Part of Publicly

 

Yet Be Purchased

 

 

 

Total Number of

 

Average Price Paid

 

Announced Plans or

 

under the Plans or

 

Period

 

Shares Purchased

 

per Share

 

Programs (1)

 

Programs (3)

 

October 1 - 31, 2007

 

81

(2)

$

43.46

 

 

NA

 

November 1 - 30, 2007

 

2,070

(2)

$

40.63

 

 

NA

 

December 1 - 31, 2007

 

2,641

(2)

$

42.21

 

 

NA

 

TOTAL

 

4,792

 

$

41.55

 

 

NA

 

 


(1)             None of the Common Shares was purchased pursuant to any publicly announced stock repurchase program.

 

(2)             Of this amount, 4,500 Common Shares were acquired on the open market for employees pursuant to the Company’s 401(k) Plan.  The remainder of the Common Shares were acquired on the open market for participants in the Company’s Common Share Purchase and Dividend Reinvestment Plan.

 

(3)             None of these plans contain a maximum number of Common Shares that may be purchased in the open market under the plans.

 

 

19



 

Item 6. Selected Financial Data

 

 

 

AWR

 

(in thousands, except per share amounts)

 

2007(2)

 

2006(2)

 

2005

 

2004

 

2003

 

Income Statement Information

 

 

 

 

 

 

 

 

 

 

 

Total Operating Revenues

 

$

301,370

 

$

268,629

 

$

238,128

 

$

229,090

 

$

212,779

 

Total Operating Expenses

 

233,638

 

212,023

 

176,068

 

179,033

 

176,074

 

Operating Income

 

67,732

 

56,606

 

62,060

 

50,057

 

36,705

 

Interest Expense

 

21,582

 

21,121

 

14,657

 

18,095

 

18,070

 

Interest Income

 

2,371

 

2,818

 

1,103

 

44

 

9

 

Net Income

 

$

28,030

 

$

23,081

 

$

26,766

 

$

18,541

 

$

11,892

 

Basic Earnings per Common Share (1)

 

$

1.62

 

$

1.34

 

$

1.58

 

$

1.19

 

$

0.78

 

Dividends Declared per Common Share

 

$

0.955

 

$

0.910

 

$

0.900

 

$

0.888

 

$

0.884

 

Average Shares Outstanding

 

17,121

 

16,934

 

16,778

 

15,633

 

15,200

 

Average Number of Diluted Shares Outstanding

 

17,177

 

17,101

 

16,809

 

15,663

 

15,227

 

Fully Diluted Earnings per Common Share

 

$

1.61

 

$

1.33

 

$

1.57

 

$

1.18

 

$

0.78

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Information

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

963,898

 

$

936,955

 

$

873,135

 

$

810,277

 

$

758,818

 

Common Shareholders’ Equity

 

302,129

 

283,734

 

264,094

 

251,465

 

212,487

 

Long-Term Debt

 

267,226

 

267,833

 

268,405

 

228,902

 

229,799

 

Total Capitalization

 

$

569,355

 

$

551,567

 

$

532,499

 

$

480,367

 

$

442,286

 

 


(1)            In accordance with Emerging Issues Task Force No. 03-06, “Participating Securities and the Two-Class Method under FASB Statement No. 128” which was effective in the second quarter of 2004, AWR uses the “two-class” method of computing EPS for the affects of participating securities. 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 stock options and stock units that earn dividend equivalents on an equal basis with Common Shares. Registrant determined that the effect on 2004 and 2003 was immaterial. Basic EPS in 2007, 2006 and 2005 was computed, utilizing the “two-class” method, by dividing net income available for common shareholders by the weighted-average number of Common Shares outstanding. Net income available for common shareholders excluding earnings available and allocated to participating securities, was $27,723,000, $22,623,000 and $26,468,000 for the years ended December 31, 2007, 2006 and 2005, respectively.

 

 

 

GSWC

 

(in thousands)

 

2007(2)

 

2006(2)

 

2005

 

2004

 

2003

 

Income Statement Information

 

 

 

 

 

 

 

 

 

 

 

Total Operating Revenues

 

$

258,752

 

$

244,425

 

$

225,872

 

$

220,769

 

$

205,600

 

Total Operating Expenses

 

194,046

 

189,123

 

163,230

 

167,164

 

166,415

 

Operating Income

 

64,706

 

55,302

 

62,642

 

53,605

 

39,185

 

Interest Expense

 

20,063

 

19,186

 

13,288

 

17,168

 

17,060

 

Interest Income

 

2,111

 

2,670

 

1,047

 

30

 

9

 

Net Income

 

$

26,900

 

$

23,258

 

$

27,828

 

$

20,911

 

$

13,885

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Information

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

889,973

 

$

867,661

 

$

807,249

 

$

756,276

 

$

705,563

 

Common Shareholder’s Equity

 

278,441

 

266,965

 

255,518

 

243,848

 

206,047

 

Long-Term Debt

 

260,941

 

261,248

 

261,540

 

221,697

 

221,996

 

Total Capitalization

 

$

539,382

 

$

528,213

 

$

517,058

 

$

465,545

 

$

428,043

 

 


(2)            Effective December 31, 2006, Registrant adopted SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)”.  Because pensions and other postretirement costs have historically been recovered through rates, upon implementing SFAS No. 158, a regulatory asset has been recorded for the costs that would otherwise be charged to common shareholder’s equity in accordance with SFAS No. 158.  At December 31, 2007 and 2006, $11.4 million and $22.8 million, respectively, has been recorded as a regulatory asset related to pension and other postretirement costs, with a corresponding amount to pension and postretirement liabilities.  Decreases in 2007, were caused by increases in the discount rates used to measure the pension and postretirement obligations.

 

20



 

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, CCWC, ASUS and its subsidiaries.

 

Overview

 

                Registrant’s revenues, operating income, and cash flows are earned primarily through delivering potable water to homes and businesses through approximately 2,900 miles of water distribution pipelines. Rates charged to customers of GSWC and CCWC are determined by the CPUC and ACC, respectively. These rates are intended to allow recovery of operating costs and a reasonable rate of return on capital. Factors recently affecting financial performance 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; weather; the impact of increased water quality standards on the cost of operations and capital expenditures; pressures on water supply caused by population growth, more stringent water quality standards, deterioration in water quality and water supply from a variety of causes; 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 Registrant to protect its water supply and delays in receiving payments from the U.S. government and the filing for redetermination and equitable adjustment of prices under contracts with the U.S. government.

 

                Registrant plans to continue to seek additional rate increases in future years to recover operating and supply costs and receive reasonable returns on invested capital. Capital expenditures in future years are expected to remain at much higher levels than depreciation expense. Cash solely from operations is not expected to be sufficient to fund Registrant’s needs for capital expenditures, dividends, investments in Registrant’s contract business and other cash requirements. Registrant expects to fund a portion of these needs through a combination of debt and common stock offerings in the ensuing years. AWR expects to issue equity in 2008, which will be included in the rate setting process.

 

                Operating revenues and income from contracted services at ASUS and its subsidiaries are earned primarily from the operation and maintenance of water and wastewater systems for the U.S. government at various military bases. All of the operations and maintenance contracts with the U.S. government are 50-year firm, fixed-price contracts with prospective price redeterminations. ASUS also may generate revenues from the construction of infrastructure improvements at these bases pursuant to the terms of these 50-year contracts or pursuant to supplemental contracts. Revenues generated by contract operations are primarily dependent on these new business activities, including military base operations and the construction of new and/or replacement infrastructure at these military bases. As a result, ASUS is subject to risks that are different than those of Registrant’s regulated water and electric activities.  ASUS plans to continue seeking contracts for the operation and maintenance of water and wastewater services at military bases.

 

For 2007, net income was $28.0 million compared to $23.1 million in 2006, an increase of 21.4%. Diluted earnings per share for 2007 were $1.61 compared to $1.33 in 2006.  One reason for this increase is the derivative accounting required for the purchased power contracts at GSWC’s Bear Valley Electric Service (“BVES”) division.  Unrealized gains and losses on purchased power contracts have been impacting GSWC’s earnings since 2002 when GSWC entered into certain purchase power contracts.  These contracts qualified as derivative instruments under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  Due to increasing energy prices, the pretax unrealized gain on purchased power contracts of $2.1 million increased net income by $0.07 per share during 2007 in contrast to a pretax unrealized loss of $7.1 million which decreased net income by $0.24 per share for the same period of 2006.  The net effect was an increase in net income of $9.2 million, or $0.31 per share, between the two periods.

 

The purpose of the purchased power contract, which qualifies as a derivative instrument, is to stabilize Registrant’s purchased power costs.  The power purchased under the contract is only used to service electric customers’ demand and Registrant does not engage in trading of purchased power.   Although the unrealized gains and losses result in significant fluctuations to the income statement, there is no effect on Registrant’s cash flows.  When analyzing the financial performance of AWR, Registrant excludes the effect of unrealized derivative gains or losses, as they are not reflective of day-to-day operations.  The unrealized derivative gains and losses are reflective of changes in future electricity costs that are outside of management’s control.  Eliminating the effects of unrealized derivative gains and losses on purchased power contracts, diluted earnings per share for 2007 would have actually decreased by $0.03 per share as compared to 2006.  Several operating reasons which are responsible for this overall decrease are discussed below in more detail, including a favorable decision issued by the CPUC on April 13, 2006 regarding GSWC’s water rights lease revenues received from the City of Folsom, which generated a one-time revenue increase in 2006. This CPUC decision added about $2.3 million of additional revenues, or $0.08 per share, in the first quarter of 2006 for amounts that had been received from the City of Folsom in 2004 and 2005.  There was no such one-time revenue recognition amount in 2007.  Based on the decision, GSWC has recorded the on-going annual Folsom lease revenues of approximately $1.3 million and $1.2 million for 2007 and 2006, respectively.

 

21



 

Summary Results by Segment

 

                AWR has three reportable segments: water, electric and contracted services. Within the segments, AWR has three principal business units: water and electric service utility operations conducted through GSWC, a water-service utility operation conducted through CCWC, and a contracted services unit conducted through ASUS and its subsidiaries. The tables below set forth summaries of the results by segment (in thousands) for the years ended December 31, 2007 and 2006:

 

 

 

Operating Revenues

 

 

 

Pretax Operating Income

 

 

 

 

 

Year

 

Year

 

 

 

 

 

Year

 

Year

 

 

 

 

 

 

 

Ended

 

Ended

 

$

 

%

 

Ended

 

Ended

 

$

 

%

 

 

 

12/31/2007

 

12/31/2006

 

CHANGE

 

CHANGE

 

12/31/2007

 

12/31/2006

 

CHANGE

 

CHANGE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Water

 

$

237,882

 

$

222,912

 

$

14,970

 

6.7

%

$

62,622

 

$

60,133

 

$

2,489

 

4.1

%

Electric

 

28,574

 

29,268

 

(694

)

-2.4

%

3,274

 

(3,525

)

6,799

 

192.9

%

Contracted services

 

34,914

 

16,449

 

18,465

 

112.3

%

2,045

 

101

 

1,944

 

1924.8

%

AWR parent

 

 

 

 

 

(209

)

(103

)

(106

)

-102.9

%

Totals from operation

 

$

301,370

 

$

268,629

 

$

32,741

 

12.2

%

$

67,732

 

$

56,606

 

$

11,126

 

19.7

%

 

                Water—For the year ended December 31, 2007, pretax operating income for water increased by $2.5 million, or 4.1%, compared to the same period in 2006, as a result of a $13.2 million increase in water margin as compared to the same period of 2006 due to increased water rates approved by the CPUC that were effective January 1, 2007 and a favorable change in the water supply mix.  This comparative increase was partially offset by the non-recurrence in 2007 of a favorable decision issued by the CPUC on April 13, 2006 regarding GSWC’s water rights lease revenues received from the City of Folsom, which generated a one-time revenue increase in 2006. This decision added about $2.3 million of additional revenues in the first quarter of 2006 for amounts that had been received from the City of Folsom in 2004 and 2005. Prior to the decision, these amounts had been recorded as regulatory liabilities. There was no such one-time revenue recognition amount in 2007. Based on the decision, GSWC has recorded the on-going annual Folsom lease revenues of approximately $1.3 million and $1.2 million for 2007 and 2006, respectively.  The increase in margin for 2007 compared to 2006 was also partially offset by higher operating, maintenance, administrative and general, and other expenses, which decreased pretax operating income by $10.7 million, as more fully described below.

 

                Electric—For the year ended December 31, 2007, pretax operating income for electric increased by $6.8 million, due in large part to an unrealized gain on BVES’ purchased power contracts during the year ended December 31, 2007 as a result of increasing energy prices versus an unrealized loss on purchased power contracts in the same period of 2006, as previously discussed. The unrealized gain for the year ended December 31, 2007 increased operating income by approximately $2.1 million as compared to an unrealized loss decreasing operating income by $7.1 million for the same period in 2006. The net effect was an increase in electric operating income of $9.2 million between the two periods. Without the effects of the derivative, pretax electric operating income decreased by $2.4 million in 2007 due to a $890,000 decrease in electric margin caused by lower consumption and the recording of a regulatory liability of approximately $178,000 with a corresponding reduction in electric revenues for probable refunds to customers related to the 8.4 MW natural gas-fueled generation plant. In April 2005, new customer rates went into effect related to this generation plant, which resulted in an increase of approximately $2.3 million in annual revenue based on an estimated total capital-related cost of $13 million. The rates are subject to refund pending the CPUC’s final cost review, which is scheduled to occur in 2008 as part of  the filing of BVES’s general rate case. The CPUC also ordered GSWC to establish a memorandum account to track the capital-related costs of the generation plant. If actual recorded costs in the memorandum account are less than the costs authorized by the CPUC of $13 million, the revenue requirement for the difference is to be refunded to customers. During the third quarter of 2007, GSWC received vendor credits of approximately $851,000, which reduced the actual recorded costs of the generation plant below $13 million.  Finally, increases in maintenance, depreciation, administrative and general, and other operating expenses further decreased electric’s pretax operating income by $1.4 million.

 

                Contracted Services—For the year ended December 31, 2007, pretax operating income for contracted services increased by $1.9 million. This was primarily due to the supplemental construction contract for improvements to the existing wastewater infrastructure located at Fort Bliss associated with a wastewater expansion project. As a result of this construction project, pretax operating income increased by $4.9 million during 2007. The project was completed in August 2007 and there will be no further construction revenues associated with this project. The year over year increase to pretax income due to this project was partially offset by other non-recurring construction projects that were completed in 2006. Earnings and cash flows from amendments or supplements to the original 50-year contracts with the U.S. government are sporadic and may or may not continue in future periods.

 

22



 

Revenues from contracted services are comprised of: 1) management fees for operating and maintaining the water and wastewater systems (“O&M”) at the military bases; 2) construction revenues for contractual renewal and replacements (“R&R”) and initial capital upgrades (“ICUs”) of the existing infrastructure facilities, and 3) construction revenues under firm-fixed and cost-plus arrangements for projects requested by the U.S. government beyond those identified in the 50-year privatization contract.  While the on-going R&R, ICU’s and supplemental construction activities have produced positive operating income results from the cost-plus and firm-fixed construction contracts, the O&M aspect of the business has  resulted in shrinking margins, and in some cases losses, due primarily to delays in filing timely price redeterminations and equitable adjustments.  Registrant’s contract pricing on each of the contracts was based on a number of assumptions, including assumptions about prices and availability of labor, equipment and materials, the condition of the systems and the actual amount of assets being operated and maintained.

 

The contract price for each of these military contracts is subject to price redetermination two years after commencement of operations and every three years thereafter to the extent provided in each of the contracts.  However, ASUS has experienced delays in the redetermination of prices at Fort Bliss following completion of the first two years of operation in October 2006 and expects delays in redetermination of prices at bases in Virginia and Maryland following the completion of the first two years of operations in February 2008.  Delays may also occur at additional bases in Virginia following completion of the first two years of operations in April 2008.  At Fort Bliss, management fees for operation and maintenance of the water and wastewater systems, which were based on cost levels prevailing in 2002 when the contract was first being negotiated, have not been adjusted as yet to adequately cover increased operating costs.  Further, the contract pricing was also based on assumptions about the size and age of the infrastructure being operated and maintained over the 50-year contract.  An adjustment is necessary to adequately reflect the amount of assets included in the infrastructure at Fort Bliss, which is substantially more than originally estimated by the U.S. government as part of its solicitation for this contract.   Price redeterminations are expected to occur in 2008 at Fort Bliss, the four bases in Virginia and Andrews Air Force Base.  These price redeterminations, which should include adjustments to reflect changes in operating conditions and infrastructure levels from that assumed at the time of the execution of the contracts as well as inflation in costs, are expected to provide added revenues prospectively to help offset increased costs and provide Registrant the opportunity to generate positive operating income from O&M activities.

 

                Also partially offsetting the increase in pretax operating income due to construction activities, was the non-recurrence of recovery and reimbursement in 2006 of transition period operating expenses of about $672,000 as a result of operating and maintaining the water and wastewater systems at military bases in Virginia and Maryland pursuant to the contracts with the U.S. government commencing during 2006. ASUS took over the operation and maintenance of the water and wastewater systems at Andrews Air Force Base in Maryland on February 1, 2006 and commenced operation of these systems on that date. In addition, ASUS assumed the operation and maintenance of the wastewater systems at Fort Lee in Virginia on February 23, 2006 and the water and wastewater systems at Fort Eustis, Fort Monroe and Fort Story in Virginia on April 3, 2006 and commenced operation and maintenance of these systems on those dates. Therefore, ASUS operated these bases partially during 2006 and entirely during 2007.  As well, final decisions on the general rate case for GSWC’s Region II and the application to recover general office expenses at the corporate headquarters allocated to Regions II and III were approved on November 16, 2007.  The decisions also imposed an increased allocation of corporate headquarters’ expenses to the Military Utility Privatization Subsidiaries, which decreased contracted services’ 2007 pretax operating income by an additional $526,000.  This higher allocation of expenses was not contemplated at the time the contracts for FBWS, ODUS and TUS were negotiated.

 

23



 

Consolidated Results of Operations - Years Ended December 31, 2007 and 2006 (dollars in thousands)

 

 

 

Year

 

Year

 

 

 

 

 

 

 

Ended

 

Ended

 

$

 

%

 

 

 

12/31/2007

 

12/31/2006

 

CHANGE

 

CHANGE

 

OPERATING REVENUES

 

 

 

 

 

 

 

 

 

Water

 

$

237,882

 

$

222,912

 

$

14,970

 

6.7

%

Electric

 

28,574

 

29,268

 

(694

)

-2.4

%

Contracted services

 

34,914

 

16,449

 

18,465

 

112.3

%

Total operating revenues

 

301,370

 

268,629

 

32,741

 

12.2

%

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

Water purchased

 

45,439

 

44,641

 

798

 

1.8

%

Power purchased for pumping

 

10,591

 

10,007

 

584

 

5.8

%

Groundwater production assessment

 

9,944

 

9,033

 

911

 

10.1

%

Power purchased for resale

 

14,199

 

14,383

 

(184

)

-1.3

%

Unrealized (gain) loss on purchased power contracts

 

(2,100

)

7,071

 

(9,171

)

-129.7

%

Supply cost balancing accounts

 

(1,962

)

(1,835

)

(127

)

6.9

%

Other operating expenses

 

27,375

 

24,134

 

3,241

 

13.4

%

Administrative and general expenses

 

52,637

 

47,110

 

5,527

 

11.7

%

Depreciation and amortization

 

28,941

 

26,272

 

2,669

 

10.2

%

Maintenance

 

15,779

 

12,254

 

3,525

 

28.8

%

Property and other taxes

 

11,254

 

10,187

 

1,067

 

10.5

%

Construction expenses

 

22,125

 

9,024

 

13,101

 

145.2

%

Net gain on disposal of property

 

(584

)

(258

)

(326

)

126.4

%

Total operating expenses

 

233,638

 

212,023

 

21,615

 

10.2

%

 

 

 

 

 

 

 

 

 

 

OPERATING INCOME

 

67,732

 

56,606

 

11,126

 

19.7

%

 

 

 

 

 

 

 

 

 

 

OTHER INCOME AND EXPENSES

 

 

 

 

 

 

 

 

 

Interest expense

 

(21,582

)

(21,121

)

(461

)

2.2

%

Interest income

 

2,371

 

2,818

 

(447

)

-15.9

%

Other

 

299

 

459

 

(160

)

-34.9

%

 

 

(18,912

)

(17,844

)

(1,068

)

6.0

%

 

 

 

 

 

 

 

 

 

 

INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE

 

48,820

 

38,762

 

10,058

 

25.9

%

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

20,790

 

15,681

 

5,109

 

32.6

%

 

 

 

 

 

 

 

 

 

 

NET INCOME

 

$

28,030

 

$

23,081

 

$

4,949

 

21.4

%

 

                Net income for the year ended December 31, 2007 increased by 21.4% to $28.0 million, equivalent to $1.62 and $1.61 per common share on a basic and fully diluted basis, respectively, compared to $23.1 million or $1.34 and $1.33 per basic and diluted common shares, respectively, for the year ended December 31, 2006. Impacting the comparability in the results of the two periods are the following significant items:

 

24



 

·                  There was an unrealized gain on purchased power contracts in 2007 due to increasing energy prices versus an unrealized loss on purchased power contracts in 2006. The cumulative unrealized gain on purchased power contracts increased pretax income by approximately $2.1 million, or $0.07 per share, for the year ended December 31, 2007, as compared to a cumulative unrealized loss on purchased power contracts that decreased pretax income by $7.1 million, or $0.24 per share in 2006.

 

·                  A decision issued by the CPUC on April 13, 2006 regarding the accounting treatment of GSWC’s water rights lease revenues, increased pretax operating income by about $2.3 million in March 2006, or approximately $0.08 per share, when compared to the same period in 2007. Pursuant to a March 2004 CPUC order, the apportionment of any Folsom lease revenues that GSWC may collect commencing in January 2004 was to be determined by a later decision. Pending that later decision and beginning in the first quarter of 2004, all amounts billed to the City of Folsom had been included in a regulatory liability account and no amounts were recognized as revenue until uncertainties about this matter were resolved with the CPUC. On April 13, 2006, the CPUC authorized GSWC to reinvest all lease revenues since January 2004, inclusive of the balances in the regulatory liability accounts established by GSWC for this matter, in water system infrastructure. These investments will be included in the rate base upon which GSWC earns a rate of return. In accordance with California law, GSWC has eight years in which to reinvest the proceeds, after which any amount remaining would inure to the customer’s benefit. As a result, in the first quarter of 2006, GSWC transferred about $2.3 million of water rights lease revenues received from the City of Folsom in 2004 and 2005 from the regulatory liability account, into water revenues.

 

·                  An increase, excluding the $2.3 million of water right lease revenues as discussed above, in the margin for the water segment of $15.5 million, or $0.52 per share, as compared to the same period of 2006 due to increased water rates approved by the CPUC that were effective January 1, 2007, an increase in water consumption over that in the prior period, and a favorable supply mix change.

 

·                  An increase in pretax operating income from contracted services at ASUS of $1.9 million, or $0.07 per share, as compared to the same period of 2006 for operating, maintaining and improving the water and wastewater systems at military bases for the U.S. government. The increases include revenue recognized for certain special projects under the percentage-of-completion method of accounting.

 

·                  An increase in GSWC’s other operating and maintenance expenses of $5.3 million, or $0.18 per share, as compared to the same period of 2006, resulting from higher chemical and water treatment costs along with  an increase in required and emergency maintenance on GSWC’s wells and water supply sources.

 

·                  Higher other expenses primarily consisting of administrative and general expenses, a change in the effective income tax rate, as well as other items described below, contributed to an overall decrease of $0.36 per basic share to the results of operations.

 

Operating Revenues

 

Water

 

For the year ended December 31, 2007, revenues from water operations increased by 6.7% to $237.9 million, compared to $222.9 million for the year ended December 31, 2006. Contributing to this increase were rate increases approved by the CPUC effective January 1, 2007, which added approximately $13.0 million in 2007 to water revenues. Included in the rate increases for 2007 were $6.4 million for Region II and $3.0 million to recover general office expenses allocated to Region III. These increases were approved by the CPUC on November 16, 2007 and were retroactive to January 1, 2007.  In addition, an increase of about 2.6% in the volume of billed water consumption resulting from much warmer and drier weather conditions increased revenues by approximately $3.8 million. Differences in temperature and rainfall in Registrant’s service areas impact sales of water to customers, causing fluctuations in Registrant’s revenues and earnings between comparable periods. Partially offsetting these increases was the fact that operating revenues for 2006 were positively impacted by a CPUC decision issued on April 13, 2006 enabling GSWC to record $2.3 million of water rights lease revenues from the City of Folsom for the period from January 2004 to December 2005. Prior to this decision, the apportionment of any lease revenues that GSWC collected in 2004 and 2005 had been included in a regulatory liability account and no amounts were recognized as revenues until regulatory uncertainties about this matter were resolved. There was no such adjustment in 2007. In addition, the increases in revenues are partially offset by the expiration in October 2006 of the surcharge that was in rates to recover Region III’s under-collection in supply costs. This decrease in revenues is offset by a corresponding amount in the supply cost balancing accounts discussed below, resulting in no impact to pretax operating income.

 

 

25



 

                Electric

 

For the year ended December 31, 2007, revenues from electric operations decreased by 2.4% to $28.6 million compared to $29.3 million for the year ended December 31, 2006 due primarily to lower electric usage and the recording of a regulatory liability of approximately $178,000, with a corresponding decrease in revenues, for probable refunds to customers related to the 8.4 MW natural gas-fueled generation plant, previously discussed in the segment results.

 

Contracted Services

 

                Revenues from contracted services are comprised of construction revenues and management fees for operating and maintaining the water and wastewater systems at military bases. For the year ended December 31, 2007, revenues from contracted services increased by $18.5 million, or 112.3%, to $34.9 million compared to $16.4 million for the year ended December 31, 2006 due primarily to an increase of approximately $18.9 million related to construction revenues earned from the U.S. government and recognized on the percentage-of-completion method of accounting. The revenues earned were for the construction of certain improvements, renewals and replacements to the existing water and wastewater infrastructure at Fort Bliss and at the military bases located in Virginia and Maryland pursuant to new contracts entered into in early 2006. Certain of the construction projects are fixed-price contracts and are supplements to ASUS’ 50-year contracts with the U.S. government. In particular, ASUS entered into a $20.6 million project for the construction of certain improvements to the existing wastewater infrastructure located at Fort Bliss in El Paso, Texas. The project was a firm-fixed price contract and was an amendment and supplement to the 50-year contract with the U.S. government to manage the entire water and wastewater systems at Fort Bliss. Revenues from this agreement have been recognized under the percentage-of-completion method of accounting. As a result of this new project, which began in early 2007, revenues for contracted services increased by $20.6 million during 2007. The project was completed in August 2007 and there will be no further construction revenues associated with this project. The year over year revenue increase resulting from this project was partially offset by the non-recurrence of revenues for other one-time construction projects that were completed in 2006. Earnings and cash flows from amendments and modifications to the original 50-year contracts with the U.S. government are sporadic and may or may not continue in the future periods.

 

There were also additional management fee revenues totaling $539,000 during 2007 generated from operating and maintaining the water and wastewater systems under the new contracts in Virginia and Maryland. Offsetting these increases was a decrease in management fees totaling $938,000 related to contracts with various municipalities to provide billing and meter reading services. Effective January 1, 2007, ASUS assigned these service contracts with the various municipalities to GSWC.  These management fees are now earned by GSWC so there was no impact on Registrant’s consolidated earnings as a result of this assignment.

 

Registrant relies upon rate approvals by state regulatory agencies in California and Arizona and price redeterminations and equitable adjustments by the U.S. government in order to recover operating expenses and provide for a return on invested and borrowed capital used to fund utility plant. Without such adequate rate relief granted in a timely manner, operating revenues and earnings can be negatively impacted.

 

 

26



 

Operating Expenses:

 

                Supply Costs

 

                Supply costs for the water segment consist of purchased water, purchased power for pumping, groundwater production assessments and water supply cost balancing accounts. Supply costs for the electric segment consist of purchased power for resale and the electric supply cost balancing account. Water and electric margins are computed by taking total revenues, less total supply costs. Registrant uses these 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 utility business performance within its water and electric segments. Registrant reviews these measurements regularly and compares them to historical periods and to our operating budget as approved. However, this measure, which is 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, which is determined in accordance with GAAP, as an indicator of operating performance.

 

                Total supply costs comprise the largest segment of total operating expenses. Supply costs accounted for approximately 33.5% and 36.0% of total operating expenses for the years ended December 31, 2007 and 2006, respectively. The table below provides the amount of increases (decreases), percent changes in supply costs, and margins during the years ended December 31, 2007 and 2006 (amounts in thousands):

 

 

 

Year

 

Year

 

 

 

 

 

 

 

Ended

 

Ended

 

$

 

%

 

 

 

12/31/2007

 

12/31/2006

 

CHANGE

 

CHANGE

 

WATER OPERATING REVENUES (1)

 

$

237,882

 

$

222,912

 

$

14,970

 

6.7

%

WATER SUPPLY COSTS:

 

 

 

 

 

 

 

 

 

Water purchased (1)

 

$

45,439

 

$

44,641

 

$

798

 

1.8

%

Power purchased for pumping (1)

 

10,591

 

10,007

 

584

 

5.8

%

Groundwater production assessment (1)

 

9,944

 

9,033

 

911

 

10.1

%

Water supply cost balancing accounts (1)

 

(3,648

)

(3,141

)

(507

)

16.1

%

TOTAL WATER SUPPLY COSTS

 

$

62,326

 

$

60,540

 

$

1,786

 

3.0

%

WATER MARGIN (2)

 

$

175,556

 

$

162,372

 

$

13,184

 

8.1

%

PERCENT MARGIN - WATER

 

73.8

%

72.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ELECTRIC OPERATING REVENUES (1)

 

$

28,574

 

$

29,268

 

$

(694

)

-2.4

%

ELECTRIC SUPPLY COSTS:

 

 

 

 

 

 

 

 

 

Power purchased for resale (1)

 

$

14,199

 

$

14,383

 

(184

)

-1.3

%

Electric supply cost balancing accounts (1)

 

1,686

 

1,306

 

380

 

29.1

%

TOTAL ELECTRIC SUPPLY COSTS

 

$

15,885

 

$

15,689

 

$

196

 

1.2

%

ELECTRIC MARGIN (2)

 

$

12,689

 

$

13,579

 

$

(890

)

-6.6

%

PERCENT MARGIN - ELECTRIC

 

44.4

%

46.4

%

 

 

 

 

 


(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 ($1,962,000) and ($1,835,000) for the years ended December 31, 2007 and 2006, respectively.

 

(2)                                  Water and electric margins do not include any depreciation and amortization, maintenance expense, unrealized gains and losses on purchased power contracts, or other operating expenses.

 

 

27



 

Two of the principal factors affecting water supply costs and gross margin 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. In addition, GSWC is authorized to establish water and electric supply cost balancing accounts for increases and/or decreases in costs due to changes in rates charged by its suppliers which provide our purchased water and purchased power, and by agencies assessing groundwater related pump taxes for our water service areas in California. Higher or lower actual costs as compared to costs authorized by the CPUC will either be recovered from or refunded to customers in the future. However, changes in the water resource mix between water supplied from purchased sources and that supplied from Registrant’s own wells can increase/decrease actual supply-related costs relative to the mix approved for recovery through rates, thereby impacting earnings either negatively or positively. GSWC has the opportunity to change the supply-related costs recovered through rates, by application to the CPUC through a general rate case proceeding. GSWC believes that its applications for recovery of supply-related costs accurately reflect the water supply situation as it is known at the time. Without a “full-cost” balancing account authorized by the CPUC, earnings may fluctuate from adverse changes in supply costs related to unforeseen contamination or other loss of water supply.

 

                For the year ended December 31, 2007, 42% of the Company’s water supply mix was purchased as compared to 44% purchased for the year ended December 31, 2006. This change in mix resulted in improved margins in 2007 compared to the same period in 2006. Water gross margin for the year ended December 31, 2006 included the $2.3 million water rights lease revenues from the City of Folsom. Without the $2.3 million water rights lease revenues in 2006, water gross margin for the year ended December 31, 2006 would have been 71.8%.

 

                Purchased water costs for the year ended December 31, 2007 increased by 1.8% to $45.4 million compared to $44.6 million for the year ended December 31, 2006. The increase is due primarily to higher water rates charged by wholesale suppliers and higher customer consumption.  In general, the supply cost balancing account as discussed above allows GSWC to track incremental rate changes from suppliers, for future recovery in water rates. These increases in purchased water costs were offset by a favorable change in the supply mix discussed above.  The favorable change in supply mix allowed GSWC to serve a portion of the increased customer demand from groundwater production rather than wholesale purchases, primarily because of the 2007 return to service or replacement of wells which had been removed from service in 2006 as a result of water quality issues and mechanical problems.

 

                For the year ended December 31, 2007, the increases in power purchased for pumping and groundwater production assessments were due to higher customer demand and an increase in pumping volume resulting from the favorable supply mix change as discussed. There were also increases in assessment rates (pump tax rates) levied against groundwater production, effective July 2006 and 2007.  Average 2007 pump tax rates increased in Region II and III by approximately 8% and 6%, respectively.  Again, the supply cost balancing account tracks the increases in pump tax rates for future recovery in water rates.

 

                The supply cost balancing account tracks differences between the current cost for supply items (water, power, and pump taxes) charged by GSWC’s suppliers and the cost for those items incorporated into GSWC’s rates. Overcollections occur when the current cost of these items is less than the amount in rates which has the effect of increasing the supply cost balancing account in the Statements of Income. Undercollections occur when the current cost exceeds the amount in rates for these items and, conversely, will have the effect of decreasing the supply cost balancing account in the Statements of Income. Typically, overcollections or undercollections, when they occur, are tracked in the supply cost balancing accounts for future refund or recovery through a surcredit (in the event of an overcollection) or surcharge (in the event of an undercollection) on customers’ bills. Once in rates, the amortization of surcharges that are in place to recover under-collections from customers have the effect of increasing the supply cost balancing account and increasing revenues in the Statements of Income, resulting in no earnings impact. Conversely, the amortization of surcredits that are in rates to refund over-collections to customers have the effect of decreasing the supply cost balancing account and decreasing revenues, also resulting in no earnings impact.

 

A decrease of $507,000 during 2007 in the water supply cost balancing account provision as compared to 2006 was primarily caused by a $2.1 million decrease due to the expiration in October 2006 of the surcharge that was in rates to recover previously incurred supply costs in GSWC’s Region III service areas.  This decrease was partially offset by an overall increase of $1.6 million in the provision as compared to the same period of 2006.  On November 16, 2007, the CPUC approved general rate case increases, retroactive to January 1, 2007, for GSWC’s Region II service area.  The decision reflects the revenue requirement for supply costs that included recent rate increases from GSWC’s suppliers.  As a result,  there was less undercollection in supply costs to record as compared to 2006, resulting in an increase to the supply cost balancing account as discussed.

 

                For the year ended December 31, 2007, the cost of power purchased for resale to customers in GSWC’s BVES division decreased slightly by 1.3% to $14.2 million compared to $14.4 million for the year ended December 31, 2006 reflecting primarily lower customer demand and kilowatt-hour usage.

 

 

28



 

Unrealized (Gain) Loss on Purchased Power Contracts

 

                Unrealized (gain) and loss on purchased power contracts represent gains and losses recorded for GSWC’s purchased power agreements with Pinnacle West Marketing & Trading Company, LLC (“PWMT”) (formerly Pinnacle West Capital Corporation), which qualify as derivative instruments under SFAS No. 133.  In June 2007, PWMT sold many of its wholesale power contracts to Morgan Stanley Capital Group, Inc. (“MSCG”). The sale included the contract between PWMT and GSWC. GSWC was notified by PWMT about the sale of its contracts, and in September 2007 an assignment agreement was executed by GSWC, PWMT and MSCG that became effective November 1, 2007. The assignment agreement retained the identical terms and conditions of the original contract.

 

                The $2.1 million pretax unrealized gain on purchased power contracts for the year ended December 31, 2007 is due to an increase in the current forward market prices since December 31, 2006. There was a $7.1 million pretax unrealized loss on purchased power contracts for the year ended December 31, 2006. Unrealized gains and losses at BVES will continue to impact earnings positively or negatively during the life of the contract, which terminates at the end of 2008.  As of December 31, 2007, there is an accumulated unrealized loss of $1.6 million which will be recognized in income by December 31, 2008.

 

                Other Operating Expenses

 

The components of other operating expenses include primarily payroll, materials and supplies, chemicals and water treatment, and contract 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. For the years ended December 31, 2007 and 2006, other operating expenses by segment consisted of the following (amounts in thousands):

 

 

 

Year

 

Year

 

 

 

 

 

 

 

Ended

 

Ended

 

$

 

%

 

 

 

12/31/2007

 

12/31/2006

 

CHANGE

 

CHANGE

 

Water Services

 

$

21,721

 

$

19,846

 

$

1,875

 

9.4

%

Electric Services

 

1,927

 

1,789

 

138

 

7.7

%

Contracted Services

 

3,727

 

2,499

 

1,228

 

49.1

%

Total other operating expenses

 

$

27,375

 

$

24,134

 

$

3,241

 

13.4

%

 

                For the year ended December 31, 2007, other operating expenses for water services increased by $1.9 million due primarily to higher chemicals and water treatment costs, including supplies and materials, of $1.2 million in particular at GSWC’s Region II and III services areas. Region II incurred additional costs primarily for the removal of arsenic and volatile organic compounds at six of its wells, while Region III incurred additional costs primarily for two of its treatment plants. There was also an increase in labor costs of $399,000 due to higher wages and related benefits, and an increase of $738,000 in conservation costs at GSWC’s Region II service area.  In 2007, GSWC began expensing conservation costs in Region II pursuant to an agreement reached with the CPUC during its recent general rate case.  Some of the 2007 Region II conservation expenses were recovered in rates.   Previously, conservation costs in Region II were capitalized and recovered in rate base.  These expense increases in 2007 were offset, in part, by a decrease of $343,000 in bad debt expense.

 

There was also an increase in other operating expenses of $1.2 million for contracted services primarily due to the commencement of the operation of water and wastewater systems at military bases in Maryland and Virginia. ASUS operated these bases during the full year ended December 31, 2007, whereas, with service commencement dates in the first four months of 2006, they were only operated by ASUS during part of 2006.  Other operating expenses increased by approximately $573,000 at these bases.  There was also an increase of $654,000 in bad debt expense primarily related to aged accounts receivable balances from the U.S. government.  As of December 31, 2007, approximately $2.1 million of amounts due from the U.S. government is significantly past due.  ASUS has been working and continues to work with U.S. government personnel to effect payment of these amounts.  Should these efforts be unsuccessful in whole or in part, ASUS, pursuant to Federal regulations, is permitted to file and anticipates filing claims with the respective contracting officer for payment of these amounts.  If these claims are rejected by the contracting officer, ASUS may appeal the denial to either the Armed Services Board of Contract Appeals or the United States Court of Federal Claims.  ASUS will continue to make every effort to collect any and all amounts legitimately due from the U.S. government.

 

 

29



 

Administrative and General Expenses

 

Administrative and general expenses include payroll related to administrative and general functions, all employee benefits charged to expense accounts, insurance expenses, outside legal and consulting fees, regulatory utility commission expenses, expenses associated with being a public company, and general corporate expenses. For the years ended December 31, 2007 and 2006, administrative and general expenses by segment consisted of the following (amounts in thousands):

 

 

 

Year

 

Year

 

 

 

 

 

 

 

Ended

 

Ended

 

$

 

%

 

 

 

12/31/2007

 

12/31/2006

 

CHANGE

 

CHANGE

 

Water Services

 

$

40,735

 

$

37,995

 

$

2,740

 

7.2

%

Electric Services

 

5,744

 

5,013

 

731

 

14.6

%

Contracted Services

 

6,158

 

4,102

 

2,056

 

50.1

%

Total administrative and general expenses

 

$

52,637

 

$

47,110

 

$

5,527

 

11.7

%

 

For the year ended December 31, 2007, administrative and general expenses increased by $3.5 million in water and electric services compared to the year ended December 31, 2006 due primarily to: (i) an increase of $470,000 in outside services relating primarily to additional tax, accounting and legal services; (ii) an approximate $1.9 million increase in labor costs due to higher wages largely related to Registrant’s annual performance-based salary review program; (iii) an agreement with the City of Folsom to dismiss all opposition to GSWC’s providing service to the proposed Westborough development; the agreement requires GSWC to pay the City of Folsom $550,000 with Aerojet reimbursing GSWC for 50%, or $275,000, of the settlement payment; as of and for the year ended December 31, 2007, GSWC has recorded an obligation to the City of Folsom for $550,000, an additional receivable of $275,000 from Aerojet for the amount to be reimbursed and a net charge to administrative and general expenses in the amount of $275,000 for its share of the settlement payment; (iv) an increase in insurance premiums of approximately $610,000; (v) a $351,000 increase in rent expense for office space and the telephone system; (vi) an increase in regulatory commission expenses of approximately $149,000, and (vii) a $494,000 net increase in other miscellaneous expenses primarily related to bank fees, postage, supplies and other general corporate expenses. These increases were offset by a decrease of $741,000 in pension costs as a result of favorable changes to actuarial assumptions.

 

There was also an increase of $2.1 million in contracted services administrative and general expenses due primarily to: (i) the recovery in 2006 of transition period operating expenses of about $672,000 at the various military bases pursuant to the contracts with the U.S. government; there was no such recovery in 2007; (ii) an increase of approximately $367,000 in outside services including legal and consulting costs; (iii) an approximate $402,000 increase in labor and employee benefit costs; and (iv) an increase of $526,000 in allocation from the corporate headquarters to the Military Utility Privatization Subsidiaries. A final decision on the general rate case for GSWC’s Region II and the application to cover general office expenses allocated to Regions II and III were approved on November 16, 2007 and imposed an increased allocation of corporate headquarters’ expenses to contracted services. This adjustment was retroactive to January 1, 2007 and was made in the fourth quarter of 2007, thus negatively impacting contracted services’ pretax income and positively impacting water and electric services’ pretax income by the same amount.

 

Depreciation and Amortization

 

For the year ended December 31, 2007, depreciation and amortization expense increased by 10.2% to $28.9 million compared to $26.3 million for the year ended December 31, 2006 reflecting, among other things, the effects of closing approximately $73 million of additions to utility plant during 2006, depreciation on which began in January 2007. Registrant anticipates that depreciation expense will continue to increase due to Registrant’s on-going construction program at its regulated subsidiaries. Registrant believes that depreciation expense related to property additions approved by the appropriate regulatory agency will be recovered through water and electric rates.

 

30



 

Maintenance

 

For the year ended December 31, 2007, maintenance expense increased by 28.8% to $15.8 million compared to $12.3 million for the year ended December 31, 2006 due principally to an increase in planned and emergency maintenance on GSWC’s water supply and distribution facilities.  A significantly higher than anticipated number of water main repairs were completed during 2007, many of which were attributed to much colder than average temperatures reacting with the cast iron pipe materials in older sections of GSWC’s distribution system.  In January 2007, GSWC’s largest distribution system in Los Angeles County experienced over 200 leaks due to the colder than normal temperatures.  In addition to the increase in repairs to the distribution systems owned by GSWC, an increased effort in 2007 was focused on planned maintenance of fire hydrants, gate valves and flushing dead-end water lines compared to 2006.

 

GSWC also experienced an increase in planned and unplanned maintenance of its water supply sources, namely company-owned wells.  Many planned well treatment and rehabilitation projects were deferred in 2006 due to unanticipated water quality and mechanical problems in many wells discussed above.  In 2007, a number of new wells and treatment facilities were placed into service allowing GSWC to continue with the well maintenance projects originally scheduled for 2006 without experiencing a decline in groundwater production.  In general, well and pump maintenance expenses continue to increase due to rising labor and material costs and more stringent water discharge requirements.

 

These maintenance increases are included in each general rate case and are generally recovered in rates.  However, amounts included in each general rate case are estimated for future years and overages from those estimates may not be covered in rates.

 

Property and Other Taxes

 

For the year ended December 31, 2007, property and other taxes increased by 10.5% to $11.3 million compared to $10.2 million for the year ended December 31, 2006 reflecting additional property taxes resulting from higher assessed values, and increases in payroll taxes based on increased labor costs.

 

Construction Expenses

 

For the year ended December 31, 2007, ASUS construction expenses increased to $22.1 million compared to $9.0 million for the same period in 2006 reflecting the costs incurred for the construction of various improvements, renewals and replacements to the existing water and wastewater infrastructures at Fort Bliss and at the military bases located in Virginia and Maryland pursuant to new contracts entered into in early 2006. The increase in construction activity resulted from amendments to the original 50-year contracts with the U.S. government which required the construction of additional improvements at the various military bases. As previously mentioned, ASUS entered into a $20.6 million project for the construction of certain improvements to the existing wastewater infrastructure located at Fort Bliss in El Paso, Texas. As a result of this new project, construction expenses increased by $15.7 million during 2007. The project was completed in August 2007. The increase in construction expenses because of this project was partially offset by other non-recurring construction projects that were completed in 2006.

 

Net Gain on Disposal of Property

 

For the year ended December 31, 2007, Registrant recorded a net pretax gain of $584,000 on the disposal of property. This gain includes a settlement of $325,000 reached with the Los Angeles Unified School District in connection with the condemnation of a parcel of land for the purpose of constructing a high school. This parcel of land had not been used for a number of years in GSWC’s public utility operations. In addition, there was a gain of $238,000 related to the sale of property in the City of Claremont. Earnings and cash flows from these transactions are sporadic and may or may not continue in future periods.

 

Interest Expense

 

For the year ended December 31, 2007, interest expense increased by 2.2% to $21.6 million compared to $21.1 million for the year ended December 31, 2006 primarily reflecting higher interest rates. There was also an increase in short-term borrowings. Average bank loan balances outstanding under an AWR credit facility for the year ended December 31, 2007 were approximately $32 million, as compared to an average of $28 million during the same period of 2006.

 

31



 

Interest Income

 

Interest income decreased by $447,000 for the year ended December 31, 2007 due primarily to the initial recording in the first quarter of 2006 of interest accrued on the uncollected balance of the Aerojet litigation memorandum account authorized by the CPUC. As a result, the interest income accrued on the memorandum account decreased by $355,000 between the two periods. In addition, interest income decreased reflecting the receipt of interest amounting to $381,000 related to a $3.0 million Internal Revenue Service refund received in May 2006. These decreases were partially offset by an increase in interest earned on short-term cash surplus.

 

Other

 

For the years ended December 31, 2007 and 2006, Registrant recorded other income of $299,000 and $459,000, respectively, as a result of its ownership interest in a non-operating equity investment.

 

Income Tax Expense

 

For the year ended December 31, 2007, income tax expense increased by 32.6% to $20.8 million compared to $15.7 million for the year ended December 31, 2006 due, in part, to an increase in pretax income of 25.9%. In addition, the effective tax rate (“ETR”) for the year ended December 31, 2007 was 42.6% as compared to a 40.5% ETR applicable to the year ended December 31, 2006. The variance between the ETR and the statutory tax rate primarily results from differences between book and taxable income that are treated as flow-through adjustments in accordance with regulatory requirements.  The increase in the ETR in 2007 is principally due to a net increase in compensatory-related flow-through adjustments.  Flow-through adjustments increase or decrease tax expense in one period, with an offsetting increase or decrease occurring in another period. In addition, during the third quarter of 2005, AWR filed an amended tax return for 2001 with the IRS which was subject to IRS and Congressional Joint Committee of Taxation (“JCT”) review. During the second quarter of 2006, the IRS and JCT reviews were completed and AWR received a refund in the amount of its original claim of $3.0 million, with interest. Consequently, in the second quarter of 2006, AWR recorded a tax benefit of $400,000, of which $351,000 was attributable to GSWC.  There was no such corresponding benefit in 2007.

 

32



 

Consolidated Results of Operations - Years Ended December 31, 2006 and 2005 (dollars in thousands)

 

 

 

Year

 

Year

 

 

 

 

 

 

 

Ended

 

Ended

 

$

 

%

 

 

 

12/31/2006

 

12/31/2005

 

CHANGE

 

CHANGE

 

OPERATING REVENUES

 

 

 

 

 

 

 

 

 

Water

 

$

222,912

 

$

205,691

 

$

17,221

 

8.4

%

Electric

 

29,268

 

27,224

 

2,044

 

7.5

%

Contracted services

 

16,449

 

5,213

 

11,236

 

215.5

%

Total operating revenues

 

268,629

 

238,128

 

30,501

 

12.8

%

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES

 

 

 

 

 

 

 

 

 

Water purchased

 

44,641

 

46,326

 

(1,685

)

-3.6

%

Power purchased for pumping

 

10,007

 

8,488

 

1,519

 

17.9

%

Groundwater production assessment

 

9,033

 

8,318

 

715

 

8.6

%

Power purchased for resale

 

14,383

 

13,238

 

1,145

 

8.6

%

Unrealized loss (gain) on purchased power contracts

 

7,071

 

(5,445

)

12,516

 

-229.9

%

Supply cost balancing accounts

 

(1,835

)

(4,425

)

2,590

 

58.5

%

Other operating expenses

 

24,134

 

21,202

 

2,932

 

13.8

%

Administrative and general expenses

 

47,110

 

45,255

 

1,855

 

4.1

%

Depreciation and amortization

 

26,272

 

21,962

 

4,310

 

19.6

%

Maintenance

 

12,254

 

10,727

 

1,527

 

14.2

%

Property and other taxes

 

10,187

 

9,412

 

775

 

8.2

%

Construction expenses

 

9,024

 

1,770

 

7,254

 

409.8

%

Net gain on disposal of property

 

(258

)

 

(258

)

100.0

%

Gain on settlement for removal of wells

 

 

(760

)

760

 

-100.0

%

Total operating expenses

 

212,023

 

176,068

 

35,955

 

20.4

%

 

 

 

 

 

 

 

 

 

 

OPERATING INCOME

 

56,606

 

62,060

 

(5,454

)

-8.8

%

 

 

 

 

 

 

 

 

 

 

OTHER INCOME AND EXPENSES

 

 

 

 

 

 

 

 

 

Interest expense

 

(21,121

)

(14,657

)

(6,464

)

44.1

%

Interest income

 

2,818

 

1,103

 

1,715

 

155.5

%

Other

 

459

 

 

459

 

100.0

%

 

 

(17,844

)

(13,554

)

(4,290

)

31.7

%

 

 

 

 

 

 

 

 

 

 

INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE

 

38,762

 

48,506

 

(9,744

)

-20.1

%

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

15,681

 

21,740

 

(6,059

)

-27.9

%

 

 

 

 

 

 

 

 

 

 

NET INCOME

 

$

23,081

 

$

26,766

 

$

(3,685

)

-13.8

%

 

Net income decreased by 13.8% for the year ended December 31, 2006, to $23.1 million, which is equivalent to $1.34 and $1.33 per common share on a basic and fully diluted basis, respectively, compared to $26.8 million or $1.58 and $1.57 per share on a basic and fully diluted basis, respectively, for the year ended December 31, 2005. Impacting the comparability in the results of the two periods are the following significant items:

 

33



 

·                     A favorable decision issued by the CPUC on July 21, 2005 regarding the Aerojet memorandum account which added about $4.3 million to net income in July 2005 or approximately $0.25 per share. GSWC was authorized to collect the balance of the Aerojet litigation memorandum account of approximately $21.3 million, through a rate surcharge, which will continue for no longer than 20 years.  As a result of this decision, in July 2005 GSWC recorded an increase of approximately $6.2 million to the Aerojet regulatory asset to include previously expensed carrying and other costs, and recorded a corresponding pre-tax gain.  In addition, GSWC was ordered to restore to the appropriate plant accounts, those amounts that have been reimbursed by Aerojet pursuant to the settlement. This resulted in GSWC recording an approximate $1.0 million decrease to depreciation expense during the third quarter of 2005.  There were no similar entries during the year ended December 31, 2006.  The following is a summary of the impact on the results of operations for the year ended December 31, 2005 resulting from this decision (in thousands):

 

 

 

Amount

 

Operating Expenses

 

Increase / (Decrease)

 

Power purchased for resale

 

$

(31

)

Other operating expenses

 

(460

)

Administrative and general expenses

 

(17

)

Depreciation and amortization

 

(992

)

Total pre-tax impact to operating expenses

 

(1,500

)

 

 

 

 

Interest

 

 

 

Interest expense

 

(5,085

)

Interest income

 

607

 

Total net interest charges

 

(5,692

)

 

 

 

 

Total pre-tax impact to results of operations

 

$

7,192

 

Impact to taxes on income

 

2,930

 

Total impact to net income

 

$

4,262

 

 

 

 

 

Impact to Basic Earnings per Share

 

$

0.25

 

Impact to Diluted Earnings per Share

 

$

0.25

 

 

·                   There was an unrealized loss on purchased power contracts in 2006 due to decreasing energy prices versus an unrealized gain on purchased power contracts in 2005. The cumulative unrealized loss on purchased power contracts decreased pretax income by approximately $7.1 million, or $0.24 per share, for the year ended December 31, 2006, as compared to a cumulative unrealized gain on purchased power contracts that increased pretax income by $5.4 million, or $0.19 per share increase to income, for the same period in 2005.

 

Eliminating the effects of the two items discussed above, basic and diluted earnings per share for 2006 would have increased by $0.44 per share as compared to 2005, resulting primarily from the following:

 

·                   A decision issued by the CPUC on April 13, 2006 regarding the treatment of GSWC’s water rights lease revenues added about $3.5 million to pretax income for the year ended December 31, 2006 or approximately $0.12 per share. In this decision, the CPUC authorized GSWC to reinvest all lease revenues since January 2004, inclusive of the balances in the regulatory liability accounts established by GSWC for this matter, in water system infrastructure. These investments will be included in the rate base upon which GSWC earns a rate of return. In accordance with California law, GSWC will have 8 years in which to reinvest the proceeds. As a result, GSWC transferred about $2.3 million of water rights lease revenues received from the City of Folsom in 2004 and 2005 from the regulatory liability account into other operating revenues. GSWC also recorded pretax income of $1.2 million reflecting water rights lease revenues for the year ended December 31, 2006.

 

·                   Water rate increases contributed approximately $11.1 million to revenues, or $0.38 per share for the year ended December 31, 2006. This was partially offset by higher expenses as described below.

 

·                    An increase in pretax operating income from contracted services at ASUS of $2.8 million, or $0.10 per share, as compared to the same period of 2005 by operating and maintaining the water and wastewater systems for the U.S. government. The increases included revenue recognized for certain special projects and reimbursement of various operating costs incurred during the period of transition of the operation and maintenance of the water and wastewater systems at military bases in Maryland and Virginia formerly owned and operated by the U.S. government.

 

34



 

·                    A $2.3 million increase in interest income, excluding the impact of the Aerojet decision in July 2005 mentioned above, or $0.08 per share, resulting from interest accrued on the uncollected balance of the Aerojet litigation memorandum account authorized by the CPUC and interest income related to a $3.0 million Internal Revenue Service refund received in May 2006.

 

·                   A lower effective tax rate increased earnings by $0.10 per share resulting primarily from: (i) a $400,000 tax benefit relating to a $3.0 million IRS refund received in May 2006, and (ii) differences between book and taxable income, which are treated as flow-through adjustments in accordance with regulatory requirements.

 

·                    Higher operating expenses as described below.

 

Operating Revenues

 

Water:

 

For the year ended December 31, 2006, revenues from water operations increased by 8.4% to $222.9 million, compared to $205.7 million for the year ended December 31, 2005. Higher water revenues reflect rate increases since 2005 covering almost all water customers, which contributed $11.1 million in increased revenues. In addition, an increase of about 2.3% in billed water consumption resulting from changes in weather conditions between the two periods, also increased revenues by approximately $2.6 million. Differences in temperature and rainfall in Registrant’s service areas impact sales of water to customers, causing fluctuations in Registrant’s revenues and earnings between comparable periods.

 

Furthermore, there was an increase of $3.5 million in GSWC’s water revenues due to a decision issued by the CPUC on April 13, 2006 enabling GSWC to record $3.5 million, or 100%, of water rights lease revenues from the City of Folsom from January 2004 to December 2006. Prior to this decision, the apportionment of any lease revenues that GSWC collected in 2004 and 2005, totaling $2.3 million, had been included in a regulatory liability account and no amounts were recognized as revenues until regulatory uncertainties about this matter were resolved. Registrant also recorded additional revenue of $1.2 million, reflecting the 2006 annual water rights lease revenues.

 

Electric:

 

For the year ended December 31, 2006, revenues from electric operations increased by 7.5% to $29.3 million compared to $27.2 million for the year ended December 31, 2005. The increase reflects primarily a 7.0% increase in kilowatt-hour (“KWh”) usage, due to changes in weather conditions which caused the usage of snow-making machines to increase in 2006. The cooler 2006 winter weather as compared to the same period in the prior year allowed the ski resorts (industrial customers) to remain open well into May, operating their lifts and some snow-making in the evening hours. New rates authorized by the CPUC for the investment in an 8.4 megawatt (“MW”) natural gas-fueled generation facility also contributed to the increase. The new rates went into effect on April 15, 2005 and have generated approximately $2.7 million in additional annual revenues, subject to refund pending the CPUC’s final cost review.

 

Registrant relies upon rate approvals by state regulatory agencies in California and Arizona in order to recover operating expenses and provide for a fair return on invested and borrowed capital used to fund utility plant. Without adequate rate relief granted in a timely manner, revenues and earnings can be negatively impacted.

 

Contracted Services:

 

For the year ended December 31, 2006, revenues from contract services increased by 215.5% to $16.4 million compared to $5.2 million for the year ended December 31, 2005 due primarily to an increase of $8.4 million related to construction revenues with the U.S. government based on the percentage-of-completion method of accounting for the construction of certain improvements, renewal and replacements to the existing water and wastewater infrastructures at Fort Bliss and at the new military bases located in Virginia and Maryland pursuant to new military contracts entered into in early 2006.  Some of the construction projects in 2006 were firm fixed price contracts and supplemental to ASUS’ 50-year contracts with the U.S. government. There were also additional revenues totaling $3.2 million generated from operating and maintaining the water and wastewater systems under the new military contracts in Virginia and Maryland.

 

35


 


 

Operating Expenses:

 

Supply Costs

 

For general discussion on supply costs, see discussion in the 2007 versus 2006 results. Supply costs accounted for approximately 36% and 41% of total operating expenses for the years ended December 31, 2006 and 2005, respectively.

 

The table below provides the amount of increases (decreases), percent changes in supply costs, and margins during the years ended December 31, 2006 and 2005 (amounts in thousands):

 

 

 

Year

 

Year

 

 

 

 

 

 

 

Ended

 

Ended

 

$

 

%

 

 

 

12/31/2006

 

12/31/2005

 

CHANGE

 

CHANGE

 

WATER OPERATING REVENUES (1)

 

$

222,912

 

$

205,691

 

$

17,221

 

8.4

%

WATER SUPPLY COSTS:

 

 

 

 

 

 

 

 

 

Water purchased (1)

 

$

44,641

 

$

46,326

 

$

(1,685

)

-3.6

%

Power purchased for pumping (1)

 

10,007

 

8,488

 

1,519

 

17.9

%

Groundwater production assessment (1)

 

9,033

 

8,318

 

715

 

8.6

%

Water supply cost balancing accounts (1)

 

(3,141

)

(6,382

)

3,241

 

-50.8

%

TOTAL WATER SUPPLY COSTS

 

$

60,540

 

$

56,750

 

$

3,790

 

6.7

%

WATER MARGIN (2)

 

$

162,372

 

$

148,941

 

$

13,431

 

9.0

%

PERCENT MARGIN - WATER

 

72.8

%

72.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ELECTRIC OPERATING REVENUES (1)

 

$

29,268

 

$

27,224

 

$

2,044

 

7.5

%

ELECTRIC SUPPLY COSTS:

 

 

 

 

 

 

 

 

 

Power purchased for resale (1)

 

$

14,383

 

$

13,238

 

$

1,145

 

8.6

%

Electric supply cost balancing accounts (1)

 

1,306

 

1,957

 

(651

)

-33.3

%

TOTAL ELECTRIC SUPPLY COSTS

 

$

15,689

 

$

15,195

 

$

494

 

3.3

%

ELECTRIC MARGIN (2)

 

$

13,579

 

$

12,029

 

$

1,550

 

12.9

%

PERCENT MARGIN - ELECTRIC

 

46.4

%

44.2

%

 

 

 

 


(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 ($1,835,000) and ($4,425,000) for the years ended December 31, 2006 and 2005, respectively.

 

(2)                                  Water and electric margins do not include any depreciation and amortization, maintenance expense, unrealized gains and losses on purchased power contracts, or other operating expenses.

 

For the year ended December 31, 2006, 44% of the Company’s water supply mix was purchased as compared to 47% purchased for the year ended December 31, 2005. This change in mix resulted in improved percent margins in 2006 compared to the same period in 2005. In addition, water gross margin for the year ended December 31, 2006 included the $2.3 million water rights lease revenues from the City of Folsom. Without the $2.3 million of water rights lease revenues in 2006, water gross margin for the year ended December 31, 2006 would have been 72.6%.  Furthermore, water gross margin for the year ended December 31, 2005 included $4.3 million under-collections approved by the CPUC in 2005 related to Region III’s 2001-2004 supply cost memorandum accounts, which reduced the 2005 expense.  Without the $4.3 million in 2005, water gross margin for the year ended December 31, 2005 would have been 70.3%.

 

36



 

For the year ended December 31, 2006, purchased water costs decreased by 3.6% to $44.6 million compared to $46.3 million for the year ended December 31, 2005. The decrease is due primarily to a change in the supply mix caused by less purchased water needed to replace groundwater supply lost in 2005 due to wells being removed from service. The wells were removed from service in 2005 as a result of water quality issues and mechanical problems, particularly in GSWC’s Foothill district. The cost of purchased water in this district decreased by approximately $2.1 million as a result of the wells being returned to operation in 2006. This decrease was partially offset by an increase in customer demand resulting from higher consumption and increased water rates by imported water suppliers.

 

For the year ended December 31, 2006, the increases in power purchased for pumping and groundwater production assessments were due to higher water supply demand and an increase in pumping volume resulting from the favorable supply mix change as previously discussed. There were also increases in assessment rates (pump tax rates) levied against groundwater production, effective July 2005 and 2006.  Average pump tax rates increased in Regions II and III in July 2006 by approximately 2% and 4%, respectively, and 5% and 11% in July 2005, respectively. Again, the supply cost balancing account tracks the increases in pump tax rates for future recovery in water rates.

 

For a general discussion on increases and decreases to the supply cost balancing accounts in the Statements of Income, see 2007 versus 2006 results.  For the year ended December 31, 2006, the provision for water supply cost balancing accounts increased by $3.2 million as compared to the year ended December 31, 2005.  The increase was primarily due to the approval by the CPUC and recording in June and October 2005 of $4.3 million under-collections related to Region III’s 2001-2004 supply cost memorandum accounts, which reduced the 2005 expense.  GSWC began recording under- and over- collections on a monthly basis for 2006 pursuant to a CPUC decision issued in 2006.  This increase as compared to 2005 was partially offset by a $1.0 million net decrease in the provision for water supply cost balancing accounts due to an increase in under-collections in 2006.

 

For the year ended December 31, 2006, cost of power purchased for resale to customers in GSWC’s BVES division increased by 8.6% to $14.4 million compared to $13.2 million for the year ended December 31, 2005, primarily reflecting higher customer demand during the year ended December 31, 2006.  In addition, in November of 2004 the Federal Energy Regulatory Commission (“FERC”) ordered Mirant Americas Energy Marketing (“Mirant Marketing”) to reimburse $247,000 of the amount GSWC had refunded to Mirant Marketing in previous years. GSWC received and recorded the reimbursement of $247,000, plus interest, from Mirant Marketing in May of 2005. GSWC recorded the Mirant Marketing reimbursement in its supply cost balancing account which also resulted in no net impact on earnings in 2005.  There was also a net decrease of $651,000 in the 2006 electric supply cost balancing account due to an increase in net under-collections of $404,000 for 2006, and the refund payment of $247,000 received in 2005 from Mirant Marketing for purchased energy cost.

 

Unrealized Loss (Gain) on Purchased Power Contracts

 

The $7.1 million pretax unrealized loss on purchased power contracts for the year ended December 31, 2006 was due to a decrease in the then current forward market prices since December 31, 2005. There was a $5.4 million pretax unrealized gain on purchased power contracts for the year ended December 31, 2005. Unrealized gains and losses at BVES will continue to impact earnings during the life of the contract with PWMT (assigned to Morgan Stanley Capital Group, Inc. in 2007) which terminates in 2008. As a result, GSWC has recognized these contracts at fair market value on its balance sheets resulting in a cumulative unrealized loss of $3.7 million as of December 31, 2006.  Gains or losses on these contracts will be recognized in earnings through the expiration of the contracts on December 31, 2008.

 

37



 

Other Operating Expenses

 

For the years ended December 31, 2006 and 2005, other operating expenses by segment consisted of the following (amounts in thousands):

 

 

 

Year

 

Year

 

 

 

 

 

 

 

Ended

 

Ended

 

$

 

%

 

 

 

12/31/2006

 

12/31/2005

 

CHANGE

 

CHANGE

 

Water Services

 

$

19,847

 

$

18,110

 

$

1,737

 

9.6

%

Electric Services

 

1,789

 

1,763

 

26

 

1.5

%

Contracted Services

 

2,498

 

1,329

 

1,169

 

88.0

%

Total other operating expenses

 

$

24,134

 

$

21,202

 

$

2,932

 

13.8

%

 

For the year ended December 31, 2006, other operating expenses for water services increased by 9.6% to $19.8 million compared to $18.1 million for the year ended December 31, 2005 due primarily to: (i) a $460,000 downward adjustment in July of 2005 reflecting the approval from the CPUC of previously incurred operating expenses in the Aerojet matter, previously discussed; (ii) higher chemicals and water treatment costs of $445,000; (iii) an increase of $289,000 in bad debt expense relating to miscellaneous accounts receivable balances, and (iv) approximately $468,000 of higher other operating material and service expenses.

 

There was also an increase in other operating expenses of $1.2 million for contracted services primarily due to higher operating expenses of $1.7 million at ODUS and TUS due to the commencement of operation of the water and wastewater systems at military bases in Maryland and Virginia in early 2006. These increases were partially offset by a decrease in other operating expenses at FBWS of $463,000 due primarily to an increase in reimbursements from the U.S. government and contractors, for operating expenses incurred at Fort Bliss.

 

Administrative and General Expenses

 

For the years ended December 31, 2006 and 2005, administrative and general expenses by segment consisted of the following (amounts in thousands):

 

 

 

Year

 

Year

 

 

 

 

 

 

 

Ended

 

Ended

 

$

 

%

 

 

 

12/31/2006

 

12/31/2005

 

CHANGE

 

CHANGE

 

Water Services

 

$

37,995

 

$

36,143

 

$

1,852

 

5.1

%

Electric Services

 

5,013

 

4,813

 

200

 

4.2

%

Contracted Services

 

4,102

 

4,299

 

(197

)

-4.6

%

Total administrative and general expenses

 

$

47,110

 

$

45,255

 

$

1,855

 

4.1

%

 

For the year ended December 31, 2006, administrative and general expenses for water and electric services increased by $2.1 million primarily due to increases in: (i) pensions and benefits of $211,000 caused by actuarial assumption changes in the mortality tables; (ii) stock-based compensation expense of $511,000 due to the adoption of SFAS No. 123(R) effective January 1, 2006; (iii) labor cost increases of $924,000 due to higher wages, and (iv) various other benefits, office, supplies and rent expenses of $461,000.

 

Administrative and general expenses decreased by $197,000 for contracted services due to: (i) an increase of $253,000 in reimbursements by the U.S. government of indirect costs incurred by FBWS, and (ii) lower outside services and other expenses at ASUS totaling $485,000.  These decreases were offset by higher administrative and general expenses of approximately $541,000 at ODUS and TUS due to the commencement of operation of the water and wastewater systems at military bases in Maryland and Virginia in early 2006.  This increase at ODUS and TUS is net of the recovery of transition period operating expenses of about $672,000 at these military bases.

 

38



 

Depreciation and Amortization

 

For the year ended December 31, 2006, depreciation and amortization expense increased by 19.6% to $26.3 million compared to $22.0 million for the year ended December 31, 2005 reflecting, among other things, the effects of closing approximately $100 million of additions to utility plant during 2005, depreciation on which began in January 2006.  In addition, there was a decrease in depreciation expense in 2005 resulting from the favorable CPUC decision on the Aerojet matter, discussed previously, which ordered GSWC to restore approximately $1.0 million to the appropriate plant accounts and decrease depreciation expense in July of 2005.  There was no such adjustment in 2006.  Finally, there was an increase in CCWC’s depreciation expense of $501,000 as a result of new rates approved by the ACC that went into effect October 1, 2005.  Registrant anticipates that depreciation expense will continue to increase due to Registrant’s on-going construction program at its regulated subsidiaries. Registrant believes that depreciation expense related to property additions approved by the appropriate regulatory agency will be recovered through water and electric rates.

 

Maintenance

 

For the year ended December 31, 2006, maintenance expense increased by 14.2% to $12.3 million compared to $10.7 million for the year ended December 31, 2005 due principally to an increase in required maintenance on GSWC’s wells and water supply sources in all Regions. There were also increases in well treatment and emergency repair costs.  Furthermore, there was an increase in maintenance expense of: (i) $331,000 at GSWC’s electric division due to the new 8.4 MW natural gas-fueled generation facility, and (ii) $210,000 at ODUS and TUS due to the commencement of the operations of the water and wastewater systems pursuant to new military contracts in Maryland and Virginia.

 

Property and Other Taxes

 

For the year ended December 31, 2006, property and other taxes increased by 8.2% to $10.2 million compared to $9.4 million for the year ended December 31, 2005 reflecting additional property taxes resulting from higher assessed values, and increases in payroll taxes based on increased labor costs.

 

Construction Expenses

 

For the year ended December 31, 2006, ASUS’ construction expenses increased to $9.0 million compared to $1.8 million for the year ended December 31, 2005 reflecting the costs incurred for the construction of various improvements, renewals and replacements to the existing water and wastewater infrastructures at Fort Bliss and at the military bases located in Virginia and Maryland pursuant to new military contracts entered into in early 2006.  The increase resulted from amendments to the original 50-year contracts with the U.S. government which required the construction of additional improvements at the various military bases.

 

Net Gain on Disposal of Property

 

For the year ended December 31, 2006, Registrant recorded a net pretax gain of $258,000 on the sale of non-utility property.  There was no similar gain in the same period of 2005.

 

Gain on Settlement for Removal of Wells

 

For the year ended December 31, 2005, Registrant also recorded a net pre-tax gain of $760,000 on a settlement reached with the Fountain Hills Sanitary District (“FHSD”) in February 2005 for the capping of two CCWC wells in order to facilitate FHSD’s ability to secure certain permits. Pursuant to the settlement agreement, CCWC agreed to permanently remove from service and cap one of its wells, and cap another well which had never been used as a potable source of supply. There was no similar gain in the same period of 2006.

 

Interest Expense

 

For the year ended December 31, 2006, interest expense increased $6.5 million as compared to the same period in 2005 reflecting primarily the approval from the CPUC in 2005 for the recovery of previously incurred and expensed interest costs totaling $5.1 million in the Aerojet memorandum account, discussed previously.  In addition, the increase also reflects increases in long-term debt interest expense of $1.8 million primarily due to the placement of $40.0 million of notes in October 2005 coupled with increases in short-term bank loan interest rates. Partially offsetting this increase was a decrease in short-term cash borrowings. Average bank loan balances outstanding under an AWR credit facility for the year ended December 31, 2006 were approximately $28 million, as compared to an average of $43 million during the same period of 2005.

 

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Interest Income

 

For the year ended December 31, 2006, interest income increased by 155.5% to $2.8 million compared to $1.1 million for the year ended December 31, 2005 due primarily to: (i) interest of $1.4 million accrued on the uncollected balance of the Aerojet litigation memorandum account authorized by the CPUC; (ii) interest income of $381,000 related to a $3.0 million IRS refund received in May 2006, and (iii) interest earned on short-term cash surplus. These 2006 increases were partially offset by the recognition in July 2005 of approximately $607,000 in int