Welcome to the American States Water Company Conference Call discussing the Company's First Quarter 2017 Results. The call is being recorded. If you would like to listen to the replay of the call, it will be made available today at 5 pm Eastern Time and run through May 10, 2017, on the company's website, www.aswater.com. The slides that the company will be referring to are also available on the website. 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 this conference call 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 ks and Form 10 Q on file with the the Securities and Exchange Commission. In addition, 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 in 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 would like to turn the call over to Bob Sprowls, President and Chief Executive Officer of American States Water Company. Please go ahead.
Welcome everyone and thank you for joining us today. I'll begin with some highlights for the quarter. Ivo will then discuss some first quarter details, then I'll wrap it up with some updates on various regulatory filings, the California drought, ASUS and dividends, and then we'll take your questions. I'm pleased to report that our earnings for the Q1 of 2017 increased in all three of our business segments as compared to the same period last year. Our focus on operational efficiencies has resulted in another solid quarter of earnings.
Golden State Water Company, our utility subsidiary, continue to invest in the reliability of our water and electric systems. We estimate our capital expenditures will be approximately $110,000,000 to 100 and $20,000,000 for the year, about 3 times our expected depreciation expense for 2017. On the regulatory front, we filed the cost of capital application in early April. We filed our electric rate case earlier this week and we will be filing our general rate case for the water segment in July. I'll discuss the details of these filings later in the call.
Our contracted services business, American States Utility Services or ASUS continues to work with the U. S. Government to transition operations of the water and wastewater systems at Eglin Air Force Base in Florida, a contract that was awarded to ASUS in 2016. We expect to assume operations at Eglin by mid-twenty 17. After we complete the base transition, ASUS will then be providing water and or wastewater utility services to 10 military bases, including 3 of the largest military installations in the United States, Fort Bragg, Fort Bliss and Eglin Air Force Base, as well as one of the most high profile bases, Andrews Air Force Base.
I'll now turn the call over to Eva to review the financial results for the quarter.
Thank you, Bob. Good morning, all to most of you. Good afternoon, everyone. An overview of our financial results is on Slide 7. Diluted earnings for the quarter were $0.34 per share compared to $0.28 per share for the same period in 2016, an increase of 0 point 0 $6 As Bob mentioned, all 3 of our business segments performed better than Q1 last year.
I will discuss the major items that impacted our revenue and expenses, including 2 items that related to other periods and offset each other on a quarter over quarter basis. They are shown on this slide as non GAAP adjustments. The operating income on this slide has been adjusted for those 2 items. The first item, which is discussed in Note 8 at the bottom of the slide, relates to the Q1 2016 results and was due to the delay by the California Public Utilities Commission or the CTUC in issuing a decision on the water generated Due to the uncertainties of the outcome of the water DRC at the time, the water gross margin recorded for the Q1 of 2016 reflected Golden State Water's stipulated position in the then pending water generate case. The final decision issued in December 2016 authorized 87% of our capital request and allowed a portion of the expected incentive program.
When the decision was issued in December last year, with new rates retroactive to January 1, 2016, we recorded a cumulative downward adjustment of $5,200,000 to the water gross margin in Q4 of 2016 related to the 1st 3 quarters of 2016. Of this amount, dollars 1,500,000 related to the Q1 of 2016, which would have decreased revenue by approximately $700,000 and increased supply costs by $800,000 for Q1 of last year. The second item, which affected the 2017 Q1 results It's described in those D and was due to the CPUC's approval this past February for recovery of $1,500,000 of previously incurred draw related costs. As a result, we recorded a regulatory asset and a corresponding increase to pretax earnings of approximately $1,500,000 of which $1,200,000 was recorded as a reduction to other operation related expenses and $260,000 as additional revenue. There was no similar item for the Q1 of 2016.
Please reference the appendix slide for reconciliation detail. Adjusting for these two items, revenue increased by $5,800,000 as compared to the Q1 last year, largely from higher construction revenues at ASUS. Revenues for contracted services increased $5,300,000 for the quarter due to an overall increase in construction activity as well as successful resolution of price redetermination, economic price adjustment and asset transfer findings throughout 2016. In addition, there were CCC approved 2nd year rate increases effective January 1, 2017, for the water segment. Our water and electric supply costs were approximately $18,400,000 for both periods when you exclude the impact of the delay in the water DRC decision.
Any changes in supply costs for both the water and electric segments as compared to the adopted supply costs are tracked in balancing accounts, which will be recovered from or refunded to our customers in the future. Looking at operating expenses, excluding supply costs and the 2 adjustments, consolidated expenses increased overall by $2,200,000 for the quarter. The increase was driven by a $2,800,000 increase in ASU. S. Construction expense due to an increase in construction activity during the Q1 of 2017 and costs incurred by ASUS for the Eglin Air Force Base transition activities and joint inventory studies.
ASUS received revenue to help cover much of the operation transition costs. We expect to assume operation of the water and wastewater systems at Eglin Air Force Base by mid-twenty 17. These increases were partially offset by a decrease in costs associated with defending against condemnation related actions and lower maintenance expenses at the wallet segment, a decrease in depreciation and amortization expense due to the reduction in composite rate approved in the waterway case, resulting from an updated depreciation study and lower cost incurred in 2017 associated with the CPUC approved energy efficiency and solar programs and electric segment. Slide 9 here shows the ETS bridge compared to the Q1 of 2017 with the Q1 of 2016. I'll briefly discuss our liquidity on Slide 10.
Net cash provided by operating activities for the Q1 of 2017 increased slightly to $28,000,000 due to the timing of cash receipts and disbursement related to customer receivables and accounts payable, partially offset by increases in retroactive rates receivables caused by the delay in receiving a final GRC decision and the CPUC approval of various memorandum accounts from the December 2016, while the GRC decision. There was a reduction in cash generated by ASUS due to the timing of billing off and the cash receipts for construction work at the military bases during the quarter. With the new 2017 water rates at Golden State Water as well as various surcharges that will be collected in 2017, we expect an increase in cash provided by operating activities for the remainder of 2017. Cash flows used for investing in SCC were $24,000,000 for 2017 as compared to $29,500,000 for the same period in 2016. As Bob mentioned earlier, we expect to invest $110,000,000 to $120,000,000 in capital projects at Golden State Water during 2017.
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. Following a delayed decision from the CPUC in December of 2016 to set rates for 2016, Golden State Water has received approved water rate increases for 2017, which have been reflected in the Q1 2017 financial results. 2017 adopted revenues and supply costs are expected to increase the water gross margin by approximately $3,700,000 as compared to 2016. Golden State Water will file its next water rate case in July for new rates effective 2019 through 2021.
In early April of this year, Golden State Water filed its water cost capital application with the CPUC. The application recommends an overall weighted return on rate base of 9.11 percent, 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 to become effective January 1, 2018. Early this week, we also filed our electric general rate case for rates effective 2018 through 2021.
A decision on this filing is also scheduled to be received by December. Finally, last month we entered into a settlement agreement with the CASITAS Municipal Water District or CASITAS and a group of citizens referred to as OHAI Friends of Locally Owned Water or OHAI Flow to resolve the eminent domain action and other litigation against Golden State Water. Under the terms of the settlement agreement, Casitas will acquire the operating assets of Golden State Water's 2,900 Connection, Ohio Water System by eminent domain for approximately $34,500,000 in cash. The parties have also agreed to dismiss all claims against Golden State Water. The transaction is expected to close in June 2017 following satisfaction of all closing conditions.
Upon closing, we expect to recognize a pre tax gain of approximately $8,000,000 While Ojai represents a very small portion of our total customer base and operates as an isolated standalone rate making area, we have proudly served the 2,900 customers for more than 85 years and will work closely with CECITAS to facilitate a seamless transfer of ownership. On slide 12, we discuss the drought situation in California. Last month, the Governor of California ended the drought state of emergency in most of California in response to significantly improved water supply conditions resulting from substantial rainfall and snowpack experienced this past winter. As a result, Golden State Water has ended its staged mandatory water conservation and rationing plan in nearly all of its service areas. As Eva mentioned, in February of this year, the PUC approved recovery of incremental drought related items of approximately $1,500,000 incurred in prior years.
Let's move on to ASUS on Slide 13. As I mentioned earlier, ASUS continues to work with the government to transition the operations of Eglin Air Force Base and will start operating the water and wastewater systems on the base in mid-twenty 17. Initial value of this contract is $510,000,000 over the 50 years and we still expect the contract to contribute $0.02 to $0.03 per share on an annualized basis. We have conducted a joint asset inventory with the government to ensure we have the correct inventory level before we start operations, resulting in a higher amount of assets than included in the current contract. We are also involved in various stages of the proposal process at a number of other bases considering privatization.
As you know, 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 and expertise and experience in managing bases, we believe we are well positioned to compete for these new contracts. Turning to ASUS's 1st quarter performance, our management fee revenues increased as a result of successful price redeterminations and other filings completed last year. Our construction activity increased overall and was also performed more efficiently. Similar to our regulated business, ASUS continually looks for operational efficiencies to improve earnings while still delivering quality service. We continue to work closely with the U.
S. Government on various filings for the bases we serve. During the Q1 of 2017, we submitted economic price adjustment filings for the bases in Virginia and Reserve Force Base in Maryland, Fort Jackson in South Carolina and Fort Bragg in North Carolina and expect these filings to be finalized during the Q2 of this year. Filings for these economic price adjustments, requests for Equidor adjustment, asset transfers and contract modifications awarded for new projects provide ASUS with additional revenue and margin. 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. During 2016 and through the Q1 of 2017, the U. S. Government awarded ASUS $32,000,000 in new construction projects, the majority of which expected to be completed this year.
Based on these awards, as well as carryover amounts from the larger dollar awards in 2015 that will be performed in 2017, we believe ASUS will contribute between $0.34 $0.38 per share for 2017. We also believe that the higher than anticipated water and wastewater infrastructure being managed at Eglin should result in an increase in the value of that contract over its 50 year term. So it is unclear at this time how much the value of the contract will increase. Finally, I'd like to turn our attention to dividends outlined on Slide 14. On Monday of this week, our Board of Directors approved a 2nd quarter dividend of $0.242 per share on the common shares of the company.
As you'll recall, in November of 2016, the Board increased the quarterly dividend by 8%. The November 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, the prospects for our future and its desire to have a payout ratio that is in line with utility peers. 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 about 11% for the 5 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 62 consecutive years. Given our current payout ratio compared to our peers and 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 Company. And we'll now turn the call back over to the operator for questions.
Thank you. We will now begin the question and answer session. And our first questioner today is going to be Jonathan Reeder with Wells Fargo. Please go ahead.
Hey, Bob and Eva. So I'll start with ASUS. It sounds like construction activity for the year is trending in line with your expectations. I mean is that fair? Are you trending a little higher such that the higher end of that $0.34 to $0.38 range might be achievable?
Yes, Jonathan. Hi, by the way. It's the construction is in line with our the $0.34 to $0.38 As you sort of compare it to last year, we're a little bit ahead of last year, but it really doesn't change the trends for 2017.
Okay. So I mean as far as you're concerned right now, the midpoint of the range is as good as anywhere to assume for ASUS at this juncture?
Yes, that's correct.
Got you. And then for the Eglin additional assets, do you have any idea like how large that might be from an impact perspective if you've said $0.02 to $0.03 is it something that could meaningfully move that higher or would it just be very much at the margin?
It's possible it could meaningfully move the margin. It's really hard to say. We're in negotiations at this point on it. But there's a chance it could move it up, I would say, a penny.
Yes, we'll know better the Q2.
Right. We're really working hard to get this sorted out before we take over the base. As you know, Jonathan, in past basis, this inventory adjustment has been done after we already taken over the base. But because of new technology, we've been able to isolate what the inventory is and to work through this over our transition period with the government.
Okay.
And now switching over to the regulated utility, the lower operating expenses that you discussed, both for water and electric, are those stuff that you see as being sustainable at least through the next round of general rate cases?
Yes, I think they are sustainable, Jonathan. We've I really got to take my hat off to the team here at Golden State Water Company for all their hard work and their ability to control costs. It's I've been very pleased with the work they've been able to do. We just ask them to get tighter and tighter and they seem to continue to deliver and deliver. So I'm very pleased with everything that's going on.
Okay. And then do you have the value of the rate base of the Casitas district that's being sold? I know you said it's I think, kind of a smaller one, but
The book value, Johnson, I think it's about $25,000,000
So Yes, the rate base is more like
Yes, rate base has to be net of deferred taxes. We haven't really disclosed that number, but if you look at the 34.5 with 2,900 customers, that's about you can't do the math, I think.
11,000 to 12,000 per customer. It's a pretty robust price.
Yes, we hate to lose the system that we serve for so long. But at this situation, I think we can conclude the matter hopefully in June.
Right. So you're saying in terms of the value of the rate base, I mean, it would be the book value less the deferred tax assets associated with it or?
Yes.
Okay. And then lastly on the cost of capital filing,
how do
you think like the staff's white paper on the cost of capital might influence the current proceeding, including the prospects for a settlement?
Well, as you know, Jonathan, we did take a haircut 4 or 5 years ago on our authorized ROE from 9.99 down to 9 0.43 because of the triggering of the water cost of capital adjustment mechanism. We're still we think we've got a good filing in there. We're I don't know that we can sit here and tell you that we think the ROE is going to go up. It's really hard to say, but I think we have a very solid position on our ROE.
Do you sense that, I guess, the thought process on where the ROE should be set has changed in California recently based on that white paper as well as obviously the electric utilities had a settlement agreement to extend theirs and that got pulled recently. Are the commissioners wanting to look at ROE differently?
Yes. There just doesn't seem to be
a lot
of information coming out of the commission on the electric case in terms of electric cost of capital, in terms of why they didn't approve the proposed decision. Just it's really hard to add any clarity to that because we really don't know. Anything we would add would be just pure speculation.
Okay. And then the other thing I found interest with your request to increase the equity component of the capital structure, how do you anticipate that being met?
Just to clarify, are you talking about the requested ROE or the equity layer?
Yes, going to 57% versus 55%, the equity layer.
Jonathan, the cost of capital proceeding determines the capitalization ratio between the equity and long term debt. And our request is pretty in line with our historical recorded level of these two components, so between the equity and long term debt. Currently, we have 55%. I think it would present a pretty solid case which was our requested and we'll see how the proceeding goes along. But we supported the 57% with a detailed calculation and also compared with historical equity and long term debt ratios there.
And of course, we have an expert rate of return witness that's derived these numbers. So we'll rely on his testimony in the case along with any other comments the company needs to be making as part of that.
And our next questioner today is Tim Winter with Gabelli and Company. Please go ahead with your question.
Good morning. Good afternoon, guys. Hi, Chip. I was wondering if you are sensing any major changes coming out of either the commission regarding consumption or ROE or out of any of the state water agencies in the aftermath of studying the drought conditions?
Yes. So we're kind of working through this. As you know, the governor removed the emergency drought restrictions. Of course, there's as you know, the governor is sticking with his ban on wasteful practices in terms of can't be hosing down your driveway or have a hose that's leaking, that sort of thing. One thing that's being kicked around, I guess, is whether there'll be sort of a required use per customer or use per person in the house or indoor use.
And so we'll see how that plays out. I think folks in California recognize that though we're over the hump on this drought, there are potential future droughts that we need to be sort of continually getting ready for. So we're watching very carefully the State Water Resources Control Board and their activity. As far as the PUC, I don't see a lot there. They sort of take their lead from the state board.
Okay. So there's no major movement toward like desalination plants or any other sort of supply projects that you're aware
of? Not I would say not significantly at this point.
There look to be no further questions. So this will conclude the question and answer session. I would like to turn the conference back over to Bob Sprowls for any closing remarks.
Thank you, William. I just wanted to say thank you to all of you for your participation today and I look forward to speaking with you next quarter. So thank you and have a good day.
The conference has now concluded. Thank you all for attending today's presentation and you may now disconnect.