Welcome to the American States Water Company conference call discussing the company's first quarter 2016 results. This 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 Thursday, May 12, 2016, on the company's website, www.aswater.com. The slides that the company will be referring to are also available on the website. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. This call will be limited to an hour.
Presenting today from American States Water Company is Robert Sprowls, President and Chief Executive Officer, and Eva Tang, 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-K and Form 10-Q on file with 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 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 Eva Tang, Chief Financial Officer of American States Water Company.
Thank you, Carrie. Welcome everyone, and thank you for joining us today. During today's call, I will review the company's financial results for the first quarter, and Bob will discuss liquidity and capital resources, Golden State Water's pending rate case, California drought-related matters, and our contracted services business segment at American States Utility Services, or ASUS. I'll begin with an overview of our financial results. For the first quarter, diluted earnings were $0.28 per share compared to $0.32 per share for the same period in 2015. Of the $0.28 per share earnings for the first quarter, $0.22 was from our water segment, and our electric and contracted services segments each contributed $0.03. Net income for the quarter was $10.2 million compared to $12.1 million for the first quarter last year. I'll discuss major items that impacted our revenues and expenses for the quarter.
In the first quarter of 2016, water revenues decreased by $5.2 million to $66.3 million as compared to the same period in 2015. As of today, Golden State Water has not received a decision on its pending Water General Rate Case, which will set new rates for 2016 through 2018. The revenue requirements for 2016, once the CPUC issues a final decision on the current GRC, are expected to be lower than the 2015 adopted level. Major items impacting the decrease in revenue requirements for 2016 includes a significant increase in supply costs caused by lower consumption, much lower depreciation expense resulting from an updated depreciation study filed with this rate case, and decreases in other operating expenses due to the company's improvement in operation efficiency.
As a result of anticipated reduction in the 2016 revenue level, we adjusted our water revenue downwards by $5.8 million for the three months ended March 31, 2016, with corresponding decreases to supply costs, depreciation, and other operating expenses to reflect the settled position with the CPUC's Offices of Ratepayer Advocates. The adjustments to 2016 recorded water revenue also reflects Golden State Water's position on litigated capital budget and compensation-related issues in the pending GRC. These adjustments did not have a significant impact to pre-tax operating income for the first quarter of 2016, as the overall reduction in the water growth margin is mostly offset by the lower depreciation and other operating expenses. Partially offsetting this decrease in water revenues were rate increases generated from advice letter filings for capital projects approved by the CPUC in 2015.
Revenue from electric operations for the quarter was $10.6 million as compared to $11 million for the same period in 2015. The decrease was primarily due to the termination in July 2015 of a supply surcharge to recover previously incurred energy costs. The decrease in revenue from this surcharge totaled approximately $700,000 for the quarter and was offset by a corresponding decrease in supply costs, resulting in no impact to pre-tax operating income. The decrease in electric revenue was partially offset by CPUC-approved fourth year rate increases for 2016, and rate increases generated from advice letters for capital projects approved by the CPUC during 2015. Revenues for our contracted services business, ASUS, decreased to $1.8 million to $16.6 million for the quarter. The decrease in revenue was due to lower construction work in the first quarter of this year, driven largely by the timing of engineering and bidding activities.
Construction activity is expected to increase during the remainder of 2016 as compared to the first quarter of 2016. The decrease in construction work was partially offset by increase in management fee revenues as a result of successful resolutions on price redeterminations received during the third quarter of 2015. As mentioned previously, for the first quarter of 2016, the water segment gross margin was adjusted for both lower revenues and lower supply costs in our stipulated position in the pending water rate case. Our water and electric supply costs were $17.6 million, a decrease of $4.4 million for the first quarter of 2016. 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.
Other operating expenses increased by $806,000 for the first quarter of 2016, due primarily to outside service costs at the electric segment in response to power outages caused by severe winter storms experienced in January. In addition, there was an increase in conservation and drought-related costs and higher wages. Administrative and general expenses for the first quarter of 2016 were $20.8 million as compared to $19.5 million for the same period in 2015. The increase was mainly due to higher legal and outside service costs at the water segment incurred on the condemnation matters during this first quarter. Depreciation and amortization expense decreased by $757,000, due primarily to the reduction in composite rate stipulated in the pending water GRC, resulting from an updated depreciation study. As discussed earlier, the lower depreciation has also been reflected in the lower water revenues.
The decrease was partially offset by an increase at both the water and the electric segments due to additions to utility plant during 2015. Maintenance expense increased by $593,000 due to a higher level of maintenance performed in 2016 at the water segment. ASUS's construction expense decreased by $1.3 million to $8.7 million during the first quarter of 2016 as compared to the same period in 2015, due primarily to a reduction in construction activity, as mentioned previously. We expect the construction activity will increase during the remainder of 2016 as compared to the first quarter of 2016. Interest expense increased to $5.6 million for the first quarter of 2016 as compared to $5.2 million for the same period in 2015.
This was due largely to capitalized interest recorded at the water segment during Q1 of 2015, resulting from the approval of an additional allowance of funds used during construction from advice letter filings. There was no similar filing during the first quarter of 2016. Income tax expense decreased by $2.1 million to $5.8 million, driven by a decrease in pre-tax income and a lower overall effective income tax rate. This slide shows the EPS bridge by business segment, comparing the first quarter of this year with the first quarter of 2015. For more details, please refer to the press release. With that, I'll turn the call over to Rob.
Thank you, Eva. I appreciate everyone joining us today. Moving on to liquidity and capital resources. Net cash provided by operating activities for the quarter decreased by $10.9 million to $27.6 million as compared to the first quarter of 2015. The decrease in operating cash flow was primarily due to a reduction in cash generated by contracted services due to the timing of billing and cash receipts for construction work at military bases during the three months ended March 31st, 2016. There was also a decrease in customer water usage for Golden State Water, increasing the Water Revenue Adjustment Mechanism, or RAM, regulatory assets. We implemented surcharges in March to recover our net RAM balances for 2015. In addition, tax payments during the three months ended March 31st, 2015 were lower, due in large part to the implementation of the Repair Regulations.
In regard to Golden State Water's capital expenditures, we are pleased with our first quarter spending of $29 million on company-funded capital work. Our water and electric utilities continue to invest to maintain and improve the reliability of our systems. Our capital investment program is a critical factor in delivering consistent, high-quality service to our customers. We are on track to invest $85 million-$95 million in capital projects during 2016, which may change somewhat once a decision is issued by the CPUC on the pending water rate case. In addition, Standard & Poor's Rating Services recently affirmed an A+ credit rating on both American States Water Company and Golden State Water Company. S&P also affirmed the stable rating outlook on both companies. We were pleased with the affirmation, as these ratings are some of the highest in the U.S. water utility industry.
While we continue to produce solid financial results, the first quarter performance was impacted by higher outside services and legal costs at our water segment incurred to defend ourselves against condemnation-related actions, and lower construction activity at our contracted services segment. We do expect construction activity at ASUS to increase during the next few quarters. In addition, we still await a CPUC decision on our water rate case for years 2016 through 2018. As we discussed in previous quarters, we filed our general rate case in mid-2014 for all of our water regions and the general office. The application will determine rates charged to customers for the years 2016, 2017, and 2018.
Golden State Water has settled with the CPUC's Office of Ratepayer Advocates on nearly all of the company's operating expenses, as well as the consumption levels used to calculate rates for 2016 through 2018, which reflect the state-mandated conservation targets. The primary litigated issues relate to our capital budget requests and compensation for managerial-level employees. We are not certain when in 2016 the final decision will be issued. Once issued, rates will be retroactive to January 1st, 2016. As Eva mentioned earlier, adopted revenues for 2016 are expected to be lower than the 2015 adopted levels. As you may know, a big part of the utility's revenue requirement is the recovery of projected expenses. Our projected expenses for 2016 in the rate case were lower than the 2015 adopted expense levels.
In particular, there was a decrease in supply costs resulting from lower consumption projected, lower depreciation expense resulting from a new study, and a decrease in other operating expenses in the 2016 through 2018 rate case cycle due to our cost control efforts and improvement in operation efficiency. Because of the company's efforts, we were able to propose significant increases in our capital investment with little to no effect on rates. As a reminder, we have also received approval by the CPUC to defer our electric general rate case and the cost of capital proceeding by one additional year. Both will now be filed in 2017. In regard to the drought situation in California, in February, the State Water Resources Control Board extended the Governor of California's executive order, imposing mandatory restrictions through October 31st, 2016.
In addition, the state board amended the required reductions, allowing limited allowances for warmer climate regions, increased population growth, as well as credit for certain drought-resilient water supply investments. Currently, all but one of our water systems has met the revised conservation standards. Based on our drought response actions and customers' conservation efforts to date, we do not believe we will be subject to the state board's penalties for failure to implement a water shortage contingency plan. Golden State Water has been authorized by the CPUC to track incremental drought-related costs incurred in a memorandum account for possible future recovery. We are in the process of preparing to file for recovery of drought-related items of approximately $1.3 million, incurred mostly in 2015. Incremental drought-related costs are being expensed until recovery is approved by the CPUC.
Lastly, as of April 26th of this year, the U.S. Drought Monitor estimates 74% of California in the rank of severe drought. This is down from 86% reported at the end of February. Increased rainfall and higher snowpack levels over the last few months have helped the drought situation. Turning to our contracted services business at ASUS. Construction activity in the first quarter of the year was lower, due largely to the timing of engineering and bidding activity on both renewal and replacement and new capital upgrade work. We believe construction activity will pick up during the next few quarters. We are still projecting an EPS contribution from ASUS of $0.28 to $0.32 per share for 2016, as discussed with you during our year-end call. We continue to work closely with the U.S. government on outstanding price redeterminations.
We expect the fourth quarter price redetermination for Fort Bliss to be finalized in the second quarter of 2016, and the third price redetermination for Fort Bragg to be finalized during the third quarter of 2016. 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 for improvement of the water and wastewater infrastructure at the military bases. In addition, we are actively engaged in new proposals and expect the U.S. government to release additional bases for bidding over the next several years. We remain optimistic about the future of our contracted services business. Finally, I'd like to turn our attention to dividends.
On Monday of this week, our board of directors approved a second-quarter dividend of $0.224 per share on the common shares of the company. Dividends on the common shares will be payable on June 1st to shareholders of record at the close of business on May 18th. American States Water Company has paid dividends every year since 1931, increasing the dividends received by shareholders each calendar year for 61 consecutive years. We are among less than a handful of companies on the New York Stock Exchange that can boast of such a level of dividend increases. For the five years ended December 31st, 2015, our calendar year dividend has grown at a compound annual growth rate of about 11%. Given American States' current low payout ratio compared to our peers and our earnings growth prospects, there is room to grow the dividend in the future.
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.
We will now take your questions. To ask a question, you may press star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. For the record, please state your name and your company prior to asking your question. We will begin with Jonathan Reeder of Wells Fargo. Please go ahead.
Hey, good morning, Bob and Eva. I guess on the West Coast, it's still the morning. I know, Bob, in your prepared ASUS remarks, you didn't seem to indicate that this was the case. However, your main competitor indicated they expect a slowdown on construction projects during the remainder of the year due to military budget constraints. Is this anything that you are seeing or expecting?
It is not. Our projects are funded. The slowdown in the first quarter was largely due to the fact that we had to do the engineering and the bidding on the work that we have lined up. We're expecting to really get the construction activity going here in the last three quarters of the year.
Okay. I guess in the same vein, you aren't seeing anything that would perhaps put downward pressure on the construction projects you'd be awarded for the next one-year period in the fall of this year?
We haven't seen that. I will tell you, we have a lot of projects in front of the government for the upcoming year. We've done what I think is a really good job of scoping out a lot of projects and getting that in front of the decision-makers at the military. So far, we haven't got the indication that we're going to see a slowdown.
Okay. Then, I think previously you said final GRC decision was likely in Q2. Are you implying that it's slipped further into the year now? Just not really sure?
Yeah, we're not really sure. We do know that the judge that's on our case has a couple of cases ahead of this, hopefully, he will get through those. I think he's on the Sempra case, Jonathan, you probably know.
Okay. That's enough
more about that than I do. Our sense is that may come out before ours does. We don't want to get everyone's hopes up. I understand the ALJs are a bit understaffed at this point, they're being challenged to do a lot of decisions. We're trying to be patient with them.
Sure. Okay. I don't know if you can go into a little more detail, but why do you think Golden State Water and ORA weren't able to see eye to eye on CapEx levels, because it kind of looks like the request of about $90 million a year of annual spend wasn't all that different from the amount that you expended over the 2013-2015 period.
Yeah. We were quite surprised that, particularly given the situation where we weren't asking for. In fact, in many rate-making areas, it was a small revenue requirement decrease. As you know, that's ORA's role is to work hard to kind of reduce your request, and that's what they're doing in this case. I understand some of our other colleagues at other companies are having similar issues, though. We went to litigation on our entire capital budget, and we think we put on a very good case and hopefully the judge will recognize that.
Were there any projects in there that were kind of unusual or different than the spend that you've been, I guess, undertaking the past few years? Or was it all similar type of spend?
Yeah. There weren't really any out of the ordinary type projects. I think our spend historically had been in the, I want to say $70 million-$75 million range. We came in and asked for $90 million and thought it was a reasonable request, particularly given the need to do pipe replacement and reduce unaccounted for in the state. The company's decision was to take our risk with the ALJ and the commission. It was quite surprising to us, to be honest, because for a company to come in with a flat rate request and then to have ORA push back on it is substantially just a little bit of a head scratcher. Sometimes these are a function of the analyst you get at ORA on your capital projects.
It's not unusual to have significant differences between the company and ORA's position.
It is true.
in the rate case we experienced before. We feel that we made a good showing of the need for the project and provided solid support, as Robert mentioned. We'll see. Hopefully judge will see that.
Last question, I'll hop out. What do you expect 2016 drought expenses will be?
Just for the calendar year 2016?
Yeah. Just trying to get an idea of, I think you said you're going to be filing for a little over $1 million of recovery from previous expenses and our understanding is that those, I guess, get turned around pretty quickly, kind of like a 90-day period. How that would, if that's going to offset whatever your drought expenses would be this year.
I think-
Well, I definitely expect it to offset whatever drought expenses we have this year, because
Okay
we're not adding to the account as much as we did in 2015, as we were getting our arms around the whole thing.
Okay. The heavy lifting's kind of over on that, and
At least.
staying the course, I guess.
Yeah. We still have additional costs associated with notifying customers and making sure that everybody is completely up to speed. I would expect them to be less than they were in 2015.
Yeah. John, as Bob mentioned, that we're going to file about $1.3 million drought-related costs for 2014 and 2015, pretty shortly. Once that got approved, for accounting, we have a reason to book all drought-related costs to a balance sheet as a regulatory asset from that point on. Not only we'll get recovered, reverse the expense we booked before, and we also will probably reverse what we book here today to the reg asset. That's a point.
Yeah. Good point, Eva.
Yeah.
Once you've done it once, you've convinced the accountants that it's going to happen again, I guess.
Yeah. It's a.
It's.
that there's going to be recovery.
Poor man's accounting.
All right. Well, I appreciate the additional clarity.
Yep. Thank you, John.
Our next question comes from Richard Verdi of Ladenburg. Please go ahead.
Hi, Bob and Eva. How are you guys doing?
We're doing good.
Good. Thank you.
Good. There you go. I just wanted to focus real quick on ASUS here. At least in my view, the $0.28-$0.32 guidance is kind of wide. Bob, can you give me some sort of idea of what you see maybe swaying it closer to the top versus to the bottom? Also, is there any chance that that figure could be outperformed on the upside?
Sure. Yeah. The amount of construction that we do will dictate how well we do within that range. Additionally, we do have some price redetermination requests and there is, though nothing like we've had in the past, there is some retroactivity to that which could push us more to the upper end or slightly above the upper end. That's about as good a range as we can give at this point. I know you would like to see it a little tighter, that's as good as we can do.
Okay. Yeah, sure. On the pursuit of new contracts, I understand that for competition's sake, you need to keep the commentary somewhat limited. We've been pursuing contracts here for a few years, and of course, there's going to be, as you mentioned, some new contracts, or I should say, new bases being auctioned here in the next few years. I'm wondering, can you give us a sense of maybe how deep you are in negotiations on maybe some of these contracts that you've been pursuing for some of the years?
I will tell you, it probably doesn't completely speak to your question, we view this business as a real important part of our business going forward. We've institutionalized our response to RFPs. We're working through the process. I will tell you, Richard, there was one contract that it took five years. It's something you have to have a lot of patience for, and our company does. You got to hang in there until you can get it across the finish line. We are at various stages, I would say, on some of the contracts.
Okay. That's great, Colin. That's actually great. Thank you. The last question is this. If you look at some of the legislation that's been passed in the past couple of years, I say, it's been very favorable for the privatization movement. You guys obviously do a good job of managing the company there. Any thought about pursuing a growth through acquisition strategy and really trying to move outside of California?
Are you talking about on the utilities side?
Yeah, for the water side. Yeah. For the water side.
Yeah, sure. We look at that. Of course, the things that we look at is it a favorable state regulatory environment? To the degree there are businesses for sale in those particular states, we of course, would look at that. I'll tell you though, when those things do come up for sale, there's a lot of folks that like that business, so it becomes a pretty competitive process. We're not afraid of that. It's just you've got to look at these situations and make sure there's enough scale to attract you. You'll recall, Richard, and this may have been a little bit before your time, we'd sold our business in Arizona.
That was largely because of the commission in Arizona. It didn't make sense for us to continue to spend all the time that we had on a 13,000 customer business there. However, if there's other businesses for sale in other states that have a fair regulatory environment, we'll definitely consider those.
Okay. That's great. Okay. I guess that's it for me. Thank you. I appreciate the time, guys.
Thanks, Richard.
Thank you.
This concludes our question and answer session. I would now like to turn the conference back over to Bob Sprowls for any closing remarks.
I just wanted to close today by thanking everyone for their continued interest in American States Water and wish everybody a good day.
This concludes today's American States Water Company conference call. You may now disconnect your lines. Have a great day.