Welcome to the American States Water Company conference call discussing the company's third quarter 2017 results. The call is being recorded. 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 November 14th, 2017, on the company's website, www.aswater.com. The slides that the company will be referring to are also available on the website. This call will be limited to an hour. Presenting today from American States Water Company is Bob Sprowls, President and Chief Executive Officer, and Eva Tang, Senior Vice President of Finance and Chief Financial Officer. As a reminder, certain matters discussed during the conference may be forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995.
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. This conference call will include a discussion of certain measures that are not prepared in accordance with generally accepted accounting principles, or GAAP, in the United States and constitute non-GAAP financial measures under SEC rules. These non-GAAP financial measures are derived from consolidated financial information but are not presented in our financial statements that are prepared in accordance with GAAP. For more details, please refer to the press release. At this time, I will turn the call over to Bob Sprowls, President and Chief Executive Officer of American States Water Company. Please go ahead, sir.
Thank you, Rachel. Welcome, everyone, and thank you for joining us today. I'll begin with some highlights for the quarter. Eva will then discuss some third quarter and year-to-date details, and then I'll wrap it up with some updates on various regulatory filings, ASUS, and dividends, and then we'll take your questions. I'm pleased to report another quarter of solid earnings, mostly due to our hard work on regulatory and U.S. government filings over the past year, in conjunction with our focus on operational efficiencies. Our regulated utilities continue to invest in the reliability of our water and electric systems. We are on target to finish the year with approximately $110 million-$120 million spent on capital projects, about three times our expected depreciation expense for the year. We're also excited about expanding our service to the U.S. government yet again.
Our contracted services business, American States Utility Services, or ASUS, had a big win during the quarter when it was awarded a new 50-year contract to provide services for the water distribution, wastewater collection, and treatment facilities at Fort Riley, a United States Army installation located in Kansas. The initial value of the contract is estimated at approximately $601 million over the 50-year period and is subject to annual economic price adjustments. Like Eglin Air Force Base, on which we commenced operations in June, Fort Riley is also one of the largest military installations in the United States, covering over 100,000 acres of land, and it has a daytime population of 25,000 people. It is currently home to the 1st Infantry Division. We expect to assume the water and wastewater operations at Fort Riley following a six- to 12-month transition period currently underway.
With the addition of Fort Riley, ASUS will be providing water and/or wastewater utility services to 11 military bases, including four of the largest military installations in the U.S.: Fort Bragg, Fort Bliss, Eglin Air Force Base, and Fort Riley, as well as one of the most high-profile bases, Andrews Air Force Base. I will now turn the call over to Eva to review the financial results for the quarter.
Thank you, Bob. An overview of our financial results is on slide seven. Diluted earnings for the quarter as reported were $0.57 per share, compared to $0.59 per share for the same period in 2016. I will discuss the major items that impacted our revenue and expenses, including certain items that affect the comparability of our quarterly results. The sum of these items are shown on this slide as non-GAAP adjustments, which, excluded from 2016 earnings, would have resulted in adjusted earnings per share of $0.56 for the third quarter of 2016. Adjusted earnings per share for the third quarter of 2017 of $0.57 per share were $0.01 per share higher than adjusted earnings per share for the third quarter of 2016. The operating income on this slide eight, has been adjusted for two items.
The first item relates to the delay by the California Public Utilities Commission in issuing a decision on the Water General Rate Case. Due to the uncertainties of the outcome of the Water General Rate Case at the time, the water gross margin recorded for the third quarter of 2016 reflected Golden State Water's litigated position in the then-pending Water General Rate Case. When the decision was issued in December 2016 with new rates retroactive to January 1, 2016, we recorded a cumulative downward adjustment of $5.2 million to the water gross margin in Q4 of 2016 related to the first three quarters of the year. Of this amount, $2.2 million related to the third quarter of 2016, which would have decreased revenue by approximately $1 million, an increased supply cost by $1 million for the third quarter of last year.
The second item relates to CPUC-approved surcharges implemented in 2017 to recover previously incurred costs approved by the CPUC as part of the final decision on the Water General Rate Case. An increase in revenues and water gross margin totaling $1.9 million for these surcharges was offset by an equal and corresponding increase in operating expenses, primarily in the administrative and general expense, resulting in no impact to earnings for the three months ended September 30, 2017. Please reference the appendix slides for reconciliation details. Adjusting for those items, revenue decreased by $300,000 as compared to the third quarter of last year, primarily from cessation of Golden State Water Ojai operations, which you'll recall was sold this past June to resolve the eminent domain action, and a decrease in ASUS construction activity.
This was largely offset by increased management fees at ASUS as a result of successful resolution of price adjustments and asset transfer filings throughout 2016 and 2017. As well as revenue generated from Eglin Air Force Base, and increased revenue from CPUC-approved second-year rate increases effective January 1, 2017, for the water segment. Our water and electric supply costs were $27.2 million and $26.3 million for the third quarter of 2017 and 2016, respectively, when you exclude the impact of the delay in the Water General Rate Case decision. Any changes in supply costs for both the water and electric segments as compared to the adopted supply costs are tracked in balancing account, which will be recovered from or refunded to our customer in the future. Looking at operating expenses, excluding supply costs and the adjustments previously discussed, consolidated expenses decreased overall by $2 million for the quarter.
The decrease was mainly due to lower construction activity at ASUS, as well as lower planned maintenance activity and lower legal expenses related to condemnation activity for Golden State Water Utility. These decreases were partially offset by costs incurred at ASUS to operate the systems at Eglin Air Force Base and an increase in depreciation expense. Slide nine shows EPS bridge compared to the third quarter of 2017 with the third quarter of 2016. Slide 10. This slide reflects our year-to-date earnings per share by segment, including the impact of certain items we have previously discussed on this call, and also from last quarter. For more details, please refer to yesterday's press release and Form 10-Q. I'll briefly discuss our liquidity on slide 11.
Net cash provided by operating activities for the nine months of 2017 increased to $120 million, due in part to an increase in operating cash flow for Golden State Water due to various CPUC-approved surcharges implemented this year to recover previously incurred costs, as well as federal income tax refunds received in 2017. We also saw an increase due to the timing associated with the billing of a cash receipt for construction work by ASUS during the nine months ended September 30, 2017. Net cash used in investing activity was $44.9 million for the nine months ended September 30, 2017, as compared to $101.4 million for the same period in 2016. Cash paid for capital expenditures during the nine months of 2017 was partially offset by $34.3 million in pre-tax cash proceeds generated from the sale of Golden State Water's Ojai water system.
As Bob mentioned earlier, we expect to invest $110 million-$120 million in capital projects at Golden State Water this year. With that, I'll turn the call back to Bob.
Thank you, Eva. I'd like to provide an update on our recent regulatory activity. Excuse me. In September 2017, Golden State's water segment implemented surcharges to recover the $9.9 million revenue shortfall between actual rates billed from January 2016 through April 2017, and the new rates adopted in the delayed final decision on the Water General Rate Case. These surcharges will run from 12 to 36 months for Golden State Water's various water rate-making areas. In July 2017, Golden State Water filed its Water General Rate Case application, which will determine new water rates for the years 2019, 2020, and 2021. Among other things, Golden State Water requested capital budgets in this application average approximately $125 million per year for the three-year rate cycle. A decision from the CPUC in this general rate case is scheduled to be finalized in the fourth quarter of 2018.
In April of this year, Golden State Water filed its Water Cost of Capital application. The application recommends an overall weighted return on rate base of 9.11%, including an updated cost of debt of 6.6% and a return on equity, or ROE, of 11%. The current authorized return on rate base is 8.34%, including an ROE of 9.43%. A decision on the application is scheduled to be received by the end of this year and become effective January 1st, 2018. In May of this year, we also filed our Electric General Rate Case for rates effective 2018 through 2021. A final decision on this rate case is expected in 2018, with rates effective January 1st, 2018. Let's move on to ASUS on slide 13.
As I mentioned at the beginning of our call, ASUS was awarded a new 50-year contract by the U.S. government to provide services for the water distribution and wastewater collection and treatment facilities at Fort Riley in Kansas. The initial value of the contract is approximately $601 million over the 50-year period and is subject to annual Economic Price Adjustments, as well as an adjustment based on the results of a joint inventory of assets to be performed. ASUS will assume operations at Fort Riley following the completion of a six to 12-month transition period currently underway. While we don't expect a significant contribution from the new base in 2018, due to this transition period, we expect the contract to contribute $0.03 to $0.05 per share on an annualized basis beginning in 2019, the first full year of operations.
ASUS began operations at Eglin Air Force Base in June of this year. After the completion of a joint inventory study conducted with the U.S. government, the Eglin contract is valued at approximately $702 million over the 50-year term, subject to annual Economic Price Adjustments. We are currently involved in various stages of the proposal process at a number of other bases considering privatization. This is a key focus for us, as the U.S. government is expected to release additional bases for bidding over the next several years. Due to our strong relationship with the U.S. government, as well as our expertise and experience in managing bases, we are well-positioned to compete for these new contracts.
Turning to ASUS's third quarter performance, our management fee revenues increased as a result of various successful price adjustments and asset transfer filings during 2016 and 2017, and the revenue generated from Eglin since commencing operations in June. We also continue to work closely with the U.S. government for contract modifications relating to potential capital upgrade work as deemed necessary for improvement of the water and wastewater infrastructure at the military bases we serve. During the first nine months of 2017, the U.S. government awarded ASUS $20.1 million in new construction projects, the majority of which are expected to be completed through 2018. We reached a successful resolution with the U.S. government on various filings for the bases we serve.
Economic Price Adjustment filings for Fort Jackson in South Carolina, Fort Bragg in North Carolina, the three bases in Virginia, and Andrews Air Force Base in Maryland have all been finalized during 2017. An Economic Price Adjustment filing for Fort Bliss in Texas and New Mexico was submitted to the U.S. government during the third quarter of this year and is expected to be completed by year-end. Completion of filings for these Economic Price Adjustments, requests for equitable adjustment, asset transfers, and contract modifications awarded for new projects provide ASUS with additional revenues and dollar margin. We believe ASUS is still on target to contribute between $0.34 and $0.38 per share for calendar 2017.
In order to project for 2018, we will need to continue to evaluate the amount of capital work that we expect to complete, which includes discussions with the respective contracting officers and the Directorate of Public Works at the various bases. Taking into account the $20.1 million in new construction projects awarded through September 30th, 2017, with more expected to be awarded in the fourth quarter, as well as operating Eglin for a full year next year, we believe ASUS's earnings for 2018 will be in the $0.37 to $0.41 per share range. Finally, I'd like to turn our attention to dividends outlined on slide 14. We recently announced a dividend of $0.255 per share on the common shares of the company. If you'll recall, in August, our board approved a 5.4% increase in the quarterly dividend.
The August increase in our quarterly dividend reflects our board's confidence in the sustainability of the company's earnings at both our Golden State Water and ASUS subsidiaries, as well as the prospects for our future. We believe that prudently increasing dividends enhances our ability to attract capital in the future to fund necessary infrastructure investments in our utility operations. We're also confident that ASUS, along with Golden State Water, will be a continued source of dividends for our shareholders. Our calendar year dividend has grown at a compound annual growth rate of 11% for the five years ended 2016. American States Water Company has paid dividends every year since 1931 and has increased dividends paid to shareholders every calendar year for 63 consecutive years. Given our earnings growth prospects, there's room to grow the dividend in the future.
I'd like to thank you for your interest in American States Water, will now turn the call over to the operator for questions.
We will now take your questions. To ask a question, you may press star one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star two. At this time, we will pause momentarily to assemble our roster. At this time, we have no questions, I would like to turn the conference back over to Bob Sprowls for any Oh, pardon me. We do have somebody who entered the question queue. The first question comes from Richard Verdi with Atwater Thornton . Please go ahead.
Hi, Bob and Eva. How are you guys doing?
Good, Richard. Hi, Richard. Nice to hear your voice.
Hi.
Yeah.
It's nice to hear your voice as well. Thank you. I just have a couple of quick questions here. Bob, I wanted to be clear about something from your prepared remarks. You had mentioned there is about a 6 to 12-month operational transition at Riley, which by the way, congratulations on that. I was wondering, when we're thinking about modeling, could we think that the price redetermination would come 2 to 3 years after that 6 to 12-month transition, or should we be thinking that part of that maybe let's say if it's 3 years, could be represented by that 6 to 12-month transition?
Yeah. With any new contract we get these days, they're on an Economic Price Adjustment model, which is different than the price redetermination model that we had gone through at many of the bases that we currently have.
Okay.
Under the Economic Price Adjustment model, it's annual increases for inflation. We expect to get those annual increases without much delay. It won't be as difficult as it was going through the price redetermination process.
Okay, thank you. I had a question on a high level here. Looking back over, let's say, the past 10 or 15 years, either Bob or Eva, early on, you guys were clearly the winner on the military base front, then we kind of went into a drought there. Now all of a sudden, the company's announced a couple of contracts here the past 12 or 15 months. Bob or Eva, maybe can one of you talk a little bit about why all of a sudden-- what changed at American States for the, let's call it, the heat up all of a sudden where you guys are winning contracts here?
Sure. I'd be happy to start, Eva, and then you can chime in and add where needed. Well, we did have a little bit of a drought there. We won a number of bases in 2004, we won 1, in 2006 we won 3 or 4, in late 2007, we won 2 bases, one of which was Fort Bragg. We got a lot of bases all at once, and we took a little bit of a timeout to assimilate the bases that we had. Back during that time, there was also difficulty getting price redetermination done because this was new to the government as well as it was to us. It did take a while to get those resolved. We got out of the bidding for a bit of the time.
Richard, as you know, these RFP can be out there for quite a long time, as long as 5 years. We may have taken a little bit of a hiatus there, but then we got back into the bidding, and we've been pretty aggressive on our bids and have been very successful. Though we've only won 2 contracts in the last couple of years, both of the contracts are, I think, the 2 largest contracts that have been given.
Right
Glad to win the big bases. If we're going to win contracts, we like to win the big bases, but we'd like to win as many contracts as we can win. I don't know, Eva, if you have anything to add?
That's pretty accurate, Bob.
Okay. Does that answer your question, Richard?
It does. Thank you very much.
You're welcome.
I was wondering, Bob, if maybe you discussed the dividend a little bit, and there's quite the opportunity with ASUS, and I'm wondering if you could maybe discuss, just on a high level, how American States approaches the cash that is generated from ASUS and potentially allocating that towards the dividend in the sense of it gives American States the opportunity to plow back more money into the regulated side and then still grow the dividend. I'm wondering, could you just talk a little bit about how American States approaches paying that dividend?
Sure. With regard to ASUS, it is not as cash intensive or capital intensive as the utility business is sort of on a per dollar of earnings. There is certain working capital dollars that have to be committed because there are times when the government owes us money, and a scheduled payment does take some time. Now, I'm not suggesting that they're ever late. It's just the payment schedule does take some time. There is some working capital that has to be devoted to ASUS, but though not as capital intensive as the utility. We tend to look at what a representative payout ratio might be for the companies with whom we compete, and we've been talking a bit lately about whether that group should be expanded to include natural gas companies and those electric companies that are highly regulated.
We look at what our representative payout ratio is, and based upon that, we determine how much we can grow the dividend, also based upon what our projected earnings are. Now, the last several years, the ASUS business has paid for one quarter, one fourth of the annual dividend or one quarterly dividend. We would expect that to continue going forward. That's probably more than you wanted, but hopefully I answered.
No, it's helpful. Thank you. Just a couple more questions. I don't mean to interrogate you guys. Can you just give us a sense of maybe what I guess a better way to put it is, what is the threshold from the credit rating agencies where ASUS would get to a point where it could damage your credit rating? Is that on a top line or bottom line?
Yeah. We've had a couple of discussions with the credit rating agencies over this non-regulated business, ASUS, and we believe at this point we have convinced them that it's no riskier than the utility business. It's taken some time because it's a complicated business and difficult to understand by outside parties. There was concern because ASUS represents between 20% and 25% of the company's revenues and income. That was a large amount. We believe we've got them over the hump on that, and I think their hesitancy early on was that they just didn't have a good understanding of how the contracts worked, and that was probably mostly our fault for not understanding what they were misunderstanding.
Okay.
I think if I don't know what % this is going to grow to over time. I can't ever see it being 50/50 because our utility business is growing. At the same time, the contracted services business is growing. If it got to be 30%-40%. I have no sense that the rating agencies would have a problem with that.
I would.
Okay, great. Thank you.
Go ahead, it's fine.
Yeah. I would hope they would have.
Eva does a lot of the yeoman's work in terms of getting them up to curve on how these things work. Go ahead, Eva.
I concur with what you said, Bob and Richard. We have had couple of calls with rating agencies because they're concerned, but I think at the end of the meetings, and they were very comfortable about the business, dealing with the federal government and no more risky than dealing with the state agencies at a PUC. I think they have a very good comfort level at this point.
Okay, great.
I think going to this Economic Price Adjustment model, it's a lot easier to get increases taken care of. It creates less volatility than what we were seeing historically. As you know, rating agencies-
They do not like volatility.
We haven't really had any pushback, I would say, in the last year from either of the two agencies.
That's great. Okay. I think that's about it. Listen, guys, I really appreciate it. Thank you for the time.
Thank you, Richard.
Thank you, Richard. Nice talking to you.
Yes.
Again, if you have a question, please press star, then one. At this time, we will pause for just a moment to gather any additional questions. This concludes our question and answer session. I would like to turn the conference back over to Robert Sprowls for any closing remarks.
Thank you, Rachel, and thank you all for your participation today, and I look forward to speaking with you next quarter, as does Eva.
Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.