Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company conference call discussing the company's Third Quarter 2014 results. If you would like to listen to the replay of this call, it will begin this afternoon at approximately 5:00 P.M. Eastern Time and run through Wednesday, November 12th, 2014, on the company's website, www.aswater.com. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, please press star then two on your telephone keypad. As a reminder, this call will be recorded and be limited to no more than one hour.
At this time, I'd like to turn the conference over to Eva Tang, Chief Financial Officer of American States Water Company. Please go ahead.
Thank you, Amelie. Welcome everyone, and thank you for joining us today. On the call with me is our President and CEO, Bob Sprowls. As a reminder, certain matters discussed during this conference call may be forward-looking statements intended to qualify for the safe harbor from the liability established by the 1995 Private Securities Litigation Reform Act. Please review a description of the company's risks and uncertainties in our most recent Form 10-K and Form 10-Q on file with the Securities and Exchange Commission. With that, I will now discuss the Third Quarter financial results. Diluted earnings for the Third Quarter 2014 were $0.54 per share, compared to $0.53 per share for the same period in 2013. Net income for the quarter was $21.2 million, compared to $20.8 million last year.
The increase in our consolidated earning was primarily driven by the recording of retroactive revenue based on various price rate determinations approved by the U.S. government and higher construction activity at our contracted service segment. Earnings at our water segment decreased by $0.02 per share compared to the third quarter of last year, while our earnings for the electric segment remained flat. Additionally, earnings per share at our AWR parent company decreased by $0.03 per share this quarter due primarily to a cumulative tax benefit recorded during the third quarter of last year for a deduction taken related to an employee benefit program. There was no similar cumulative tax benefit recorded in 2014. For the quarter, water revenue increased by $2.8 million to $96.7 million as compared to the same period in 2013.
During 2014, the CPUC approved an increase in rates to specifically cover increases in supply cost experienced in certain customer service areas. This revenue increase is offset by a corresponding increase in supply costs, resulting in no impact in the water gross margins. There was also an increase in water revenues due to second-year rate increases approved by the CPUC effective January 2014. Revenue from electric operations decreased slightly to $8.6 million for the quarter. Pending a final decision on the electric general rate case, our electric revenues have been recorded using 2012 adopted levels authorized by the CPUC. Revenues for our contracted services business, American States Utility Services, increased $4.9 million to $33 million for the third quarter.
The increase was partially due to the resolution of price redeterminations for the military subsidiaries serving Andrews Air Force Base, Fort Bragg, and Fort Jackson during this past quarter, which resulted in the recording of retroactive revenues of $2.6 million this quarter. There was also an increase in construction activities at these bases as compared to the same period in 2013. Our water and electric supply costs were $31.6 million for the third quarter of 2014. Any changes in supply costs for both the water and electric segments as compared to the adopted water supply costs and electric supply costs are tracked in balancing accounts, which will be recovered from or refunded to our customers in the future.
Other operation expenses decreased by $227,000 for the third quarter of 2014, mostly due to a $203,000 decrease in surcharges for recovery of costs previously incurred, with a corresponding decrease in revenues in the water segment. As we have mentioned before, these surcharges have no impact on pre-tax operating income. Administrative and general expenses for the third quarter of 2014 were $20.2 million as compared to $20.1 million for the same period in 2013. During the third quarter of 2014, there was an $820,000 reduction in surcharges billed at our water segment for recovery of various A&G costs previously incurred as compared to the same period in 2013. Again, surcharges have no impact on pre-tax operating income. Excluding this decrease in surcharges, overall A&G expenses increased by $915,000, due in large part to increases in legal and outside services costs.
Maintenance expense decreased by $276,000, driven by a higher level of planned maintenance performed in 2013 at our water segment. We expect maintenance expense for the water segment to be lower in 2014 as compared to 2013. Depreciation and amortization expense increased by $796,000 to $10.59 for the third quarter of 2014, due mostly to approximately $93 million of additions to the plant during 2013. Property and other taxes increased by $251,000 compared to the same quarter in 2013 as a result of an increase in property taxes for the water segment. SG&S construction expenses increased by $1.2 million to $20.4 million during the third quarter of 2014 due to an increase in construction activities. Other income and expenses, including interest expense, decreased slightly to $5.3 million for this quarter.
Income tax expense increased by $3.6 million to $13.5 million as compared to the third quarter of 2013, driven by an increase in pre-tax income and a higher effective income tax rate. Moving on to liquidity and capital resources. Net cash provided by operating activities increased by $32.8 million to $120.1 million for the nine months ended September 30, 2014. This increase was primarily due to an increase in cash generated by contracted services resulting from the timing of billing and cash receipts for construction work at military bases. In addition, there were water rate increases in May 2013 and January 2014, and the collection of various surcharges implemented in mid-2013 in connection with the CPUC's final decision on the water rate case.
These increases in cash flow from operating activities were partially offset by tax refunds received during the first quarter of last year, for which no similar refund amounts were received in 2014. The timing of cash receipts and disbursements related to other working capital items also affected the change in net cash provided by operating activities. In regards to Golden State Water's capital expenditures, we spent $44 million on company-funded capital work during the nine months ended September 30, 2014. The capital expenditures were lower than we expected, mainly due to delays in certain pipeline projects as a result of excessive paving requirements and permits from local cities, and delays in a new groundwater well project due to difficulties in finding suitable groundwater in the area. As a result, capital expenditures for the full year of 2014 are now estimated to be between approximately $70 million and $75 million.
Portion of the capital work delayed in 2014 are now expected to be completed in 2015. We estimate 2015's capital expenditures to be $85 million-$90 million. For additional details on our third quarter and year-to-date performance, please refer to our earnings release and Form 10-Q issued this morning. With that, I'll turn the call over to Bob.
Thank you, Eva. I appreciate everyone joining us today. I will begin with an update on our water and electric general rate cases. First, for our water segment. As we discussed during last quarter's call, Golden State Water Company filed a general rate case in July for all of our water regions and the general office. The application will determine the water rates for the years 2016, 2017, and 2018. Golden State Water requested overall capital budgets in the application, which averages approximately $90 million a year for the three-year period. 2016 adopted water gross margin is expected to decrease by approximately $700,000 as compared to the currently adopted levels, due in part to decreases in annual depreciation expenses resulting from an updated depreciation study. The new water rates are expected to become effective in January 2016.
For our electric general rate case, which was filed in 2012 for new rates in years 2013 through 2016, the CPUC issued a proposed decision in September 2014, adopting a settlement agreement reached with all parties on the revenue requirement. The final decision is expected in the fourth quarter of 2014. We do not expect this proposed decision, if approved in its current form by the CPUC, to have a significant impact on Golden State Water's net income for 2014. Before I move on to our contracted services business at ASUS, let me address the company's water supply and drought situation in California and provide an update on a potential condemnation of one of our water systems.
As we discussed in our previous call, the State Water Resources Control Board, in July, approved emergency regulations that implement mandatory restrictions on certain outdoor urban water use to further reduce water use throughout the state. The regulations call for mandatory water use restrictions, such as eliminating hosing of driveways, prohibiting irrigation runoff, et cetera. We are regulated by the CPUC on such matters, and our water conservation and rationing plan approved by the CPUC is aligned with the emergency regulations. If dry conditions continue in our service areas, we may implement additional steps as outlined in our CPUC-approved plans consistent with the water supply situation for a particular service area. These steps may include mandatory rationing with penalties for non-compliance.
Also, in the event of water supply shortages in certain of our service areas, Golden State Water would need to transport additional water from other areas, increasing the cost of water supply. Since water supply cost is a pass-through expense to our customers, these additional costs would result in higher costs to customers, which, taken together with mandatory water rationing, may lead to customer criticism. Let me provide you an update on potential condemnation of our water system. In yesterday's general election, a bond measure was passed in the city of Claremont within our service territory, which authorizes the city to issue up to $135 million in water revenue bonds to fund a potential acquisition of our water system in Claremont.
For the acquisition of public utility property, the laws of the state of California provide that we may contest in court whether the condemnation is actually necessary and in the public interest, and that we are entitled to receive the fair market value of our water system if it is ultimately taken. While we are disappointed with the outcome of the vote, we are committed to providing excellent service to our customers and will continue to defend our Claremont system from condemnation and work with the city to address their concerns. Now, let's turn our attention to the company's contract and services business at ASUS. As Eva mentioned, in September 2014, the U.S. government issued contract modifications to ASUS, approving price redeterminations related to the operations at Fort Bragg, Fort Jackson, and Andrews Air Force Base.
As a result of these contract modifications, ASUS recorded approximately $2.6 million of retroactive revenues and pre-tax operating income during the three and nine months ended September 30th, 2014. Approximately $6 million of renewal and replacement funds were also recorded as billings in excess of costs on the balance sheet. This $6 million will be recognized in construction revenues along with the related construction cost when the work is performed. ASUS continues to work closely with the government on the remaining price redeterminations. We expect the third price redetermination for Andrews Air Force Base in Maryland and the second price redeterminations for the military bases in Virginia to be completed during the fourth quarter of 2014. Additionally, we expect the second price redetermination for Fort Jackson, South Carolina, to be completed in the first quarter of 2015.
Filings for these price redeterminations, requests for equitable adjustment, and contract modifications awarded for new projects provide ASUS with additional revenues and margin and the opportunity to consistently generate positive earnings. We also continue to work closely with the U.S. government for contract modifications relating to potential capital upgrade work as deemed necessary to improve the water and wastewater infrastructure at the military bases. During the Third Quarter 2014, the U.S. government awarded ASUS approximately $27 million in new construction projects, the majority of which are expected to be completed during the next 12 months. We are actively engaged in new proposals and expect the U.S. government to release additional bases for bidding over the next several years.
In regard to ASUS's outlook for the remainder of 2014, we are still anticipating that earnings per share for the full year 2014 could come out close to ASUS's 2013 results of $0.27 per share after the removal of the one-time tax benefit from 2013's earnings. I'd like to turn our attention to dividends. On October 28th, 2014, the board of directors approved a fourth-quarter dividend of $0.213 per share for shareholders of record at the close of business on November 14th, 2014. American States Water Company has paid dividends every year since 1931, increasing the dividend received by shareholders each calendar year since 1954. Given American States' current low payout ratio compared to our peers, there is room to grow the dividend in the future.
Before I finish my prepared remarks, I'd like to thank you for your interest in American States Water, and will now turn the call over to the operator for questions.
Thank you. We will now take your questions. If you would like to ask a question during this time, simply press star then number 1 on your telephone keypad. If you would like to withdraw your question, please press star and then 2. For the record, please state your name and your company prior to asking your question. We'll begin with Jonathan Reeder of Wells Fargo. Please go ahead.
Hey, Bob and Eva. Got a couple questions. First, Eva, did I hear correctly that the CapEx shortfall in 2014, that you're essentially shifting that to 2015, and thus there'd be no change overall for the two years cumulatively?
I believe so.
Okay. Bob, maybe you can drill down a little more on the $2.6 million of retroactive price redeterminations. How much of that was for periods prior to 2014? Was that the majority of it, or how would you, I guess, parse out what wouldn't be for 2014?
Yeah, I would say majority of it is for periods prior to 2014.
Okay.
Some of it, of course, is related to 2014 as it's retroactive back to basically when the redetermination, if it was done on time, would've been done.
It's like our rate case cycle, Jonathan. Every three years we file. If the government delaying giving us the rate increases, then it's retroactive to the day it's supposed to be effective.
Right. I guess you want us to think of it similar to, I guess, ASUS's $0.27 last year, this year, think of it as ASUS less this $0.04 amount? Is that kind of fair?
I guess where I would sort of parse it would probably be 27 less maybe $0.03.
Okay.
Some of it is related to the first nine months of 2014. If that helps.
Yeah. Okay. You said the government awarded $27 million of new construction projects expected to be done mostly over the next 12 months. That seems to be a step up from what you had last year. I guess, what do you attribute that to, what do you expect the full year 2015 construction budget will look like at ASUS?
Well, the company works with the Department of Public Works at each of the bases to try to determine what additional work needs to be done at the bases. We work very closely with this group, and we're able to convince the government that additional work needed to be done. The $27 million is a bit of a step up from last year, because I think it was $18 million last year, if I'm not mistaken, Eva.
That's correct. Yes.
It's an effect of a 50% increase. When we think about construction work going forward, we've got the $27 million. However, in 2014, of course, we had some major projects that were completed. The water and wastewater project at Fort Bragg, the additional projects at Fort Bragg. As we look out into the future, we've really hesitated to try to give revenue estimates for construction because it's pretty unpredictable as to the timing of this. I guess we're not ready to sort of give a revenue estimate on the construction side.
Well, maybe you can talk a little bit, I guess, the $27 million of construction projects awarded, that's not the only construction projects we'll see in 2015, right? There's another component, like a base component to the construction projects?
Yes.
Is that it?
The renewal and replacement work, that's sort of ongoing. This $27 million is not renewal and replacement, it's other types of projects. It's really on top of the renewal and replacement. We also have the $6 million of the retroactive renewal and replacement that would go into over the next 12 months that we got as part of the price redeterminations.
Okay, that $6 million you would think would be something you'd recognize and get done in 2015 then?
Yeah, maybe even a little bit in the fourth quarter of 2014, a good part of it, most of it would roll over into 2015.
Okay. Then, I guess, have you guys said what you believe the fair market value of Claremont is? I guess, just wondering where the city came up with the $135 million. What that might mean for you all?
Yeah. We've not put a value out there. I think the $135 is sort of the city's way of trying to determine an amount that would not only cover the cost of the system, but sort of getting through the process between now and then, and maybe reimbursing the city for litigation, that sort of thing. We've not put a valuation out at this point, and do not plan to until we're basically forced to in the court process, if it comes to that.
Okay. All right. I guess last question, I don't know to what extent the other bases that you currently have RFPs out there that you're pursuing or ones that you come up. Any sense when we might see another government decision?
Very hard to predict, Jonathan. The government seems to be moving very slowly in this particular area. We are out there bidding, though, on a number of bases, and hopefully we can break through with a win here soon, but it's really hard to predict.
Okay, and the last one that they've made a determination on was that one, I believe it was last January in Utah. That was the last time the government's made a decision on a privatization contract?
Well, you sort of have to look at the various branches of Department of Defense. You've got the Army bases that seem to be sort of moving down a path a little more quickly or have moved more quickly down the path, and the Air Force bases are more slowly. I believe one of our competitors won a base in New Jersey. It was an Army base, as I recall, more recently than last January, if I'm not mistaken.
Yeah. We didn't participate-
Right
in the bidding process for either of the bases.
That's right. Those were not bases that we had on our list. Army seems to be moving more quickly than Air Force at this point.
Okay. I appreciate the additional color.
Okay. Thank you, Jonathan.
Again, if you'd like to ask a question, please press star and then one. Our next question is from Tim Winter of Gabelli. Please go ahead.
Good afternoon, Bob and Eva.
Hi, Tim.
I was wondering, can you give a little more background or metrics associated with Claremont? How many customers served, or property, plant, and equipment and what the issue is with the folks?
Sure. 11,000 of our customers in that town. The issue generally has been rate levels and the fact that rates have been going up over time because we've been replacing capital. The city generally compares our rates to municipalities surrounding the city of Claremont, and our rates are higher according to the city. Couple of things going on there. One is in many cases, municipalities do not necessarily reflect on the water bill the true cost of operating a water system. Sometimes that can be in other forms, like property tax bills, et cetera. Secondly, our company has felt that we needed to consistently replace infrastructure to keep a very good system operating, and I'm not sure other municipalities have been doing that. As you know, Tim, I think that the rate-setting process for a city becomes very political.
City council folks, in many cases, have a difficult time approving rate increases to then be used to replace infrastructure. We've always sort of had the view that if you have sort of regular small rate increases to keep your system upgraded, that's been the best way to run a water system, and that's the way we've done things. The other things that have sort of come through here is we did implement the tiered rates in late 2008, early 2009. Customers are not all that happy with the fact that as they use less water, in some cases, their bills go up. That's been sort of a bone of contention in the city of Claremont. As you know, our system is such that 70% of our costs are fixed and 30% are variable.
However, to really be able to get conservation to kick in, our rates are designed sort of just the opposite. Rates are sort of designed assuming 70% are variable and 30% are fixed. As a result, as customers use less water, our costs do not go down as great as one might expect. So because of the Water Revenue Adjustment Mechanism, company has kept whole through that. However, the customers are not happy with the fact that, "Gee, I used less, and I'm still having to pay these surcharges, even though if their next-door neighbor is not using less, the next-door neighbor also has to pay the surcharges, so they are, in fact, better off than their neighbor. Anyway, that's raised some concern there.
City of Claremont, I think, understands that it's going to cost them considerably more to buy the system and run it than what their situation is with our company. However, according to the more vocal people at Claremont, it's no longer an issue of rates, it's more of an issue of local control. That may be more than you wanted to know, but.
No, that's helpful.
Yep.
Is there anything extraordinary about the property, plant, and equipment there? Is there any extra facilities there, or can I sort of just do the math with 11,000 customers off your customer base to try to get a rate base number?
No. There's really nothing unique about Claremont.
We do have water rights in Claremont. That is not on our book.
Yeah, the water rights would also be considered market value, perhaps?
We believe it would be, yes.
That would be a considerable dollar amount.
It would be, yes. The $135 million is not our number, I can tell you that.
Okay. Can you quantify what the water rights are associated with that property?
I cannot.
Understood. Okay. Thanks, Bob. Thanks, Eva.
Okay.
Again, if you'd like to ask a question, please press star and then one at this time.
Just to comment here, I don't really want our analysts to get really concerned about the Claremont situation. We believe ultimately that if this gets condemned, that the valuation we get will be at least what's currently in our stock price. This is not something that's going to be of financial harm to the company. It is, though, from a strategy standpoint, our goal in life is to get bigger, not smaller, and we've told the city that. From that perspective, we're going to, of course, fight the condemnation.
Yeah. No problem.
At this time, I'm not showing any additional questions.
Okay. I'm going to go ahead and wrap it up then, if that's okay, Amelie.
This concludes today's American States Water Company conference call. As a reminder, the call will be archived on our website and can be replayed beginning Wednesday, November 5th, 2014 at 5:00 P.M. Eastern Time, 2:00 P.M. Pacific Time, and will run through Wednesday, November 12th, 2014. Thank you for your participation. You may now disconnect.
Thank you, everyone.