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American States Water (NYSE:AWR)

Q2 2014 Earnings Call

August 06, 2014 2:00 pm ET

Executives

Eva G. Tang - Chief Financial Officer, Principal Accounting Officer, Senior Vice President of Finance, Treasurer and Corporate Secretary

Robert J. Sprowls - Chief Executive Officer, President, Director, Member of ASUS Committee, Chief Executive Officer of Golden State Water Company, Chief Executive Officer of Chaparral City Water Company, President of Golden State Water Company and President of Chaparral City Water Company

Analysts

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Richard A. Verdi - Ladenburg Thalmann & Co. Inc., Research Division

Timothy M. Winter - G. Research, Inc.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the American States Water Company Conference Call discussing the company's second 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 August 13, 2014, on the company's website, www.aswater.com. [Operator Instructions] As a reminder, this call will be recorded and will be limited to no more than one hour.

At this time, I would like to turn the call over to Ms. Eva Tang, Chief Financial Officer of American States Water Company. Please go ahead.

Eva G. Tang

Thank you, Gary. 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 in this 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 10-Q on file with the Securities and Exchange Commission. With that, I will now discuss the second quarter's financial results.

Diluted earnings for the second quarter of 2014 were $0.39 per share compared to $0.43 per share for the same period in 2013. Net income for the quarter was $15.4 million compared to $16.6 million for the same period last year. The decrease in our consolidated earnings was primarily driven by lower construction activity at our contracted services segment. Earnings at our water segment remained flat compared to the same period last year, while our earnings at the electric segment decreased slightly due to the approval in 2013 for recovery of previously incurred costs that did not recur in 2014.

So for the quarter, water revenues at Golden State Water increased by $2.2 million to $86.2 million as compared to the same period in 2013. $1.2 million of the revenue increase represented surcharges billed to customers during the second quarter of '14, with a corresponding increase in operating expenses to recover previously incurred costs. These surcharges had no impact to net earnings.

There were also second year rate increases for 2014 approved by the California Public Utilities Commission. The impact to operating revenue associated with the rate increases is anticipated to be about $1.6 million for the full year of 2014.

Electric revenues at Golden State Water remains relatively unchanged at approximately $8.3 million, as compared to the same period in 2013. Pending a final decision on the electric general rate case, electric revenues has been recorded using 2012 adopted levels authorized by the CPUC.

Revenues for our contracted services business, American States Utility Services, decreased $7.1 million to $21.1 million for the second quarter of 2014, primarily driven by anticipated reduction in construction activities at Fort Bliss and Fort Bragg military bases.

We had several large projects with significant activities during 2013 were either completed or near completion in 2014. The decrease in capital upgrade projects was partially offset by increased in renewal and replacement capital work during the quarter.

As we have stated in previous calls, renewal and replacement construction will continue to vary from year-to-year over the remaining terms of the 50-year contract with the government. Overall, construction activity is expected to increase during the remainder of 2014 as compared to the first half of this year.

Our water and electric supply costs were $25.6 million for the second quarter. Any changes in supply costs for both the water and electric segments, as compared to the adopted supply costs, were tracked in balancing accounts, which will be recovered from or refunded to our customer in the future. Other operation expenses increased by $566,000 for the second quarter of 2014 as compared to the same period in 2013. There was a $209,000 increase in surcharges for recovery of costs previously incurred. This amount was part of the $1.2 million surcharges recorded in revenue, as I discussed earlier.

As these costs were recovered in revenues through surcharges, the corresponding dollar amount was recorded to other operation expenses, having no impact on pretax operating income. The remaining increase as compared to the second quarter of last year was due to higher operation-related labor costs and bad debt expense in the water segment.

Administrative and general expenses for the second quarter of 2014 were $19.4 million as compared to $18.1 million for the same period in 2013. During the second quarter of 2014, there was a $685,000 increase in surcharges billed at our water segment for recovery of previously incurred A&G costs as compared to the same period in 2013. Again, surcharges has no impact on pretax operating income.

Additionally, in May 2013, the CPUC approved the recovery of $834,000 in legal and outside services costs at our electric segment in connection with CPUC's renewable portfolio standard. There was no similar reduction in 2014.

Excluding this 2 items, overall, A&G expenses actually by $225,000 during the second quarter of 2014, as compared to the same period last year, as we continue our cost control efforts.

Maintenance expense decreased by $586,000 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 $757,000 to $10.5 million for the second quarter of 2014 as compared to the same quarter last year, driven mostly by approximately $93 million of capital addition to utility plants last year.

Property and other taxes increased by $217,000 compared to the same quarter in 2013 due to increases in property taxes, franchise fees and payroll taxes.

ASUS' construction expenses decreased by $5.3 million to $13.8 million during the second quarter as compared to the same period in 2013, primarily due to several major projects, either completed in 2013 or near completion during '14, as previously discussed. These projects has much more activities in 2013.

Other income and expenses, including interest expense, decreased slightly to $5.4 million for the second quarter of 2014 as compared to the same period last year. Income tax expense decreased by $886,000 to $10.3 million as compared to the same period in 2013, driven by a lower pretax income, partially offset by a higher effective tax rate for the quarter due to changes between book and taxable income from compensation-related items that are treated as flow-through adjustments.

Moving on to liquidity and capital resources. Net cash provided by operating activities increased by $57.3 million to $90.9 million for the 6 months ended June 30, 2014, as compared to $33.6 million for the same period last year. This increase was primarily due to an increase in cash generated by contracted services, driven by the timing of building 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 CPUC's final decision on the water rate case. These increases in cash flow for 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 changes in net cash provided by operating activities.

In regards to Golden State Waters capital expenditures, we incurred about $27 million, excluding work funded by others during the 6 months ended June 30, 2014. We expect to invest approximately $80 million to $85 million in capital project due in 2014.

Finally, I'm pleased to know that last month, Standard & Poor's revised its rating outlook on American States Water Company and Golden State Water, from stable to positive. S&P also affirmed A+ corporate credit rating on both companies.

For additional details on our second quarter and year-to-date information, please refer to our earnings release and Form 10-Q issued yesterday.

With that, I'll turn the call over to Bob.

Robert J. Sprowls

Thank you, Eva, and I appreciate everyone joining us today. I'd like to begin by providing an update on significant regulatory matters. Our largest subsidiary, Golden State Water Company, filed a general rate case last month 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 Waters requested overall capital budgets in the application average approximately $90 million a year for the 3-year period.

The 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 will allow Golden State Water to earn its 8.34% authorized return on rate base and are expected to become effective in January 2016.

With regard to our electric division, Golden State Water filed a settlement agreement with the California Public Utilities Commission or CPUC in May 2014 that had been reached with all parties involved in the electric general rate case on the revenue requirement. The settlement agreement, if approved, would resolve all matters in the pending electric rate case for rates in years 2013 through 2016.

A final decision from the CPUC is expected in late 2014. Pending a final decision on this rate case, electric revenues have been recorded using 2012 adopted levels, authorized by the PUC.

I'm also pleased to discuss that in June, Golden State Water received approval from the PUC to provide water services for a new development in Northern California, in an area near Sacramento in Sutter County called Sutter Pointe. With the PUC's approval, Golden State Water will create a water service district to supply the Sutter Pointe development for groundwater and surface water from the Sacramento River.

The project will involve a construction of underground infrastructure and groundwater wells with a treatment plant in storage facility to serve retail, industrial and approximately 17,000 residential customers at final build-out, which will take a number of years. We were very pleased to receive approvals to serve this new development as we look for ways to expand our customer base.

On a smaller scale, in July, Golden State Water filed a motion to adopt the settlement resolving all issues in Golden State's application to acquire the assets of Rural Water Co., which serves approximately 900 customers.

Before I move on to discussing our contracted services business at ASUS, I'd like to talk a bit about our water supply and the drought situation in California. In April of this year, the Governor of California signed an executive order to address continuing drought conditions by directing urban water suppliers to implement plans to limit outdoor irrigation and wasteful water activities.

In July, the State Water Resources Control Board 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 usage restrictions such as eliminating hosing of driveways, prohibiting irrigation runoff, et cetera.

We are regulated by the CPUC on such matters.

As part of the CPUC's rules, Golden State Water has filed documents in order to implement mandatory water use restrictions, and will comply with PUC directives to implement the emergency regulations. If dry conditions continue at our service areas, Golden State Water may also need to implement mandatory water rationing to its customers.

Also, in the event of water supply shortages, 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.

Now let's turn our attention to the company's contracted services business at ASUS. For the second quarter of 2014, earnings from ASUS decreased as compared to the same period in 2013, primarily due to lower construction activities related to capital upgrade projects at Fort Bliss and Fort Bragg. Major capital upgrade projects, including the $58 million water and wastewater pipeline replacement project and the $23 million backflow preventer and meter project at Fort Bragg are nearing completion and work on several other projects was completed in 2013. This has resulted in expected lower revenue during the first half of 2014 as compared to the same period in 2013.

While renewal and replacement work increased during the second quarter 2014 compared to 2013, it was overall lower for the first 6 months of 2014 compared to 2013. However, we expect that overall construction activity will increase for the remainder of 2014 as compared to the first half of this year.

ASUS continues to work closely with the government on the various price redeterminations for each of the military bases. We expect the second price redetermination at Fort Bragg in North Carolina; the first price redetermination for Fort Jackson, South Carolina; the second and third price redeterminations for Andrews Air Force Base in Maryland; and the second price redeterminations for the military bases in Virginia, to all be completed during the third quarter of 2014.

Filings for these price redeterminations requests for equitable adjustment and contract modifications awarded for new projects to 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.

In regard to ASUS' outlook for the remainder of 2014, there are several variables that impact this business, which makes it difficult to predict its earnings with much certainty. With that said, we still think earnings per share for the full year 2014 could come out close to ASUS' 2013 results. Excluding a onetime tax benefit of $0.03 per share, earnings from ASUS were $0.27 per share for the full year 2013.

While we have a few large projects winding down in 2014, we anticipate renewal and replacement activity to increase throughout the remainder of 2014, as previously discussed. In addition, we expect to have a number of new construction projects for 2014, though individually and probably not as large in size as the ones rolling off.

ASUS is also expecting various price redeterminations to be finalized in 2014, as I've just mentioned, which could result in retroactive revenues included in our estimates for 2014. Assuming successful resolution of these redeterminations, including anticipated retroactive revenues and the anticipated increase in overall construction activity during the second half 2014, we continue to believe full year 2014 earnings should look a lot like 2013 after removal of the onetime tax benefit from 2013's earnings.

Turning our attention to dividends. On May 19, 2014, the Board of Directors approved a 5.2% increase in the corporation's quarterly cash dividend, from $0.2025 per share to $0.2130 per share. This quarterly dividend will be payable on September 2 to shareholders of record at the close of business on August 15, 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 its peers, there is room to grow the dividend in the future.

Before I close with my prepared remarks, I'd like to thank you for your interest in American States Water. And we'll now turn the call over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Ryan Connors with Janney Montgomery Scott.

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

Ryan Connors with Janney. I had a question. Your prepared remarks are very comprehensive, so thanks for that. I have kind of more philosophical question for you, Bob, about kind of the drought. I know you touched on this when you talked about the usage restrictions and so forth. But when it comes to the decoupling system and the way that it's constructed today, and you look at the drought of this kind of severity, which doesn't look like it's getting better anytime soon, can the system still function effectively in your view if this severity of drought continues over an extended period? I know that there's always concern about consumers being asked to conserve and therefore, pay more for less water. And I think you kind of mentioned that, that sometimes create some pushback. So can you just kind of your give us your expanded thoughts on this particular acute drought situation, and how it impacts the decoupling system?

Robert J. Sprowls

Sure. Well, first of all, the whole decoupling was tied into, as you know, Ryan, the tiered rates. The tiered rates have worked to reduce consumption, which have helped the situation. In fact, our demand, I think, is down -- I want to say roughly 15% since we put the tiered rates in place. So all of a sudden, we have a pretty good reduction in demand. You are correct in that customers have given pushback because of surcharges with the sort of view that, "Hey, I've used less, and then I get these surcharges." I do think they're starting to understand though that while they conserve and, let's say, their neighbor does not, their ultimately still paying less than their neighbor. The neighbor gets the same surcharges as they got, and so their original bill is actually -- the conserving customer is actually less than the neighbor. So I don't think the decoupling will hamper or has hampered the situation in terms of the drought. I mean, I think it's good system that it works for the company, and it works for sort of reducing demand. Because conservation really is the least cost way of sort of solving some of the water supply issues we have. It doesn't completely solve the issues, there's a number of other things the state is doing and the company is doing.

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

And then -- and you feel pretty good about where you are in terms of your demand forecasts and those not creating excessive WRAM balances and that sort of thing. How do you feel about that as part of the ledger?

Robert J. Sprowls

Yes. Some tough sledding early on here because there was the -- initially the water consumption went down more quickly than what we had anticipated because of the tiered rates. As a result, our WRAM balances had been built up to the tune of almost $60 million, $65 million. We're kind of now on the collecting side of that and our WRAM balances have come down considerably. In the most recent rate case that we have filed, we've been at adjust our sales forecast to take into account all that. So we don't feel like we're going to have the kinds of surcharges we've had in the past, and so we think that's -- the customer -- we won't have sort of the same kind of customer pushback we've had in the past.

Eva G. Tang

And Ryan, for the rate case cycle 2013 through '15, the consumption we projected in the rate case are pretty close to our actual consumption.

Robert J. Sprowls

That's right.

Eva G. Tang

So our accrual WRAM balance has been much lower in the last rate case cycle. Going to the next GRC filing, I think our assumption level will adjust a little bit, but not so far off from our current consumption level. So I think that's a good sign.

Robert J. Sprowls

Yes. It may be that a lot of the low-hanging fruit has been gotten at this point and we're not predicting substantial reductions in sales going forward.

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

Got it. I'll have to borrow that forecasting model to try to predict the stock price, Eva. Then one last question, just...

Eva G. Tang

We can talk later.

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

Inverting that discussion on the drought in terms from going from risk to opportunity. Does the drought -- is the drought sort of pushing some privately held and/or municipal systems to the brink in terms of their own ability to meet their supply and so forth? And is that creating any needle moving opportunities for you in terms of acquisitions?

Robert J. Sprowls

We haven't seen a lot of that to be honest, Ryan. The municipalities that own water systems tend to really like to keep their water systems. And the difficulty is when you have rates that are somewhat subject to political pressures, it is difficult to keep systems reliable. And I think the investor-owned, we don't have those political issues because we invest and sort of have modest rate increases periodically that our systems -- we're able to attract capital and be able to make timely infrastructure change out.

Operator

The next question comes from Jonathan Reeder with Wells Fargo.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Bob and Eva, I was hoping you could discuss in further detail the components of your recently filed GRC, in particular, when you kind of discussed the gross margin. I thought that was typically just revenues less supply costs, or in other words, kind of prior to depreciation?

Robert J. Sprowls

Right. Yes. And generally, your margin is supposed to kind of cover your increases in expenses, as well as growth in rate base. And so the comment in the materials about depreciation was that to sort of let the folks know that we did have this depreciation study that was completed, and they have lengthened the lives of the assets and -- now this has to all be approved by the PUC. But as a result, our depreciation expense is going to be lower in 2016 than what we are currently are seeing in our financials, which allows us to sort of get by with a gross margin that maybe isn't growing as much as some might expect. So that was sort of the kind of a tie-in there between depreciation expense and the gross margin change.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

So when you talk about gross margin, I mean, are we talking revenues less all operating expenses then not just supply cost?

Robert J. Sprowls

No, no, no. Just supply cost. So it's revenue less supply costs.

Eva G. Tang

So without that -- so a more meaningful information because supply cost is kind of the pass-through item for us. And we usually update that even before the decision issued.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

So I mean in the rate case, are you still filing for, I guess, a rate increase to cover the operating expenses x supply costs, or are you saying depreciation, the decrease is offsetting the increase in other accounts?

Robert J. Sprowls

Yes. The decrease in depreciation is offsetting increases in other accounts. And in terms of the overall revenue increase, I mean the -- in some areas, it's not an increase. In other areas, it is, depends what rate making area we're looking at.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

But in total, is there a revenue increase that you're requesting?

Robert J. Sprowls

Well, and again...

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

If you added all your jurisdictions together?

Robert J. Sprowls

From a -- I guess, from a revenue requirement standpoint, that's a small decrease.

Eva G. Tang

Yes. The main reason, Jonathan, is the supply cost in this filing about $2.7 million lower in the last adopted number because we have improved our supply mix. That's the main reason. We've been able to pump more from our own water source. So since supply cost is a pass-through, so you're kind of adding back to your revenues -- actually a lower revenue than the currently adopted rate.

Robert J. Sprowls

And this is why we focus -- try to get the market to focus on the gross margin rather than on revenue. Because when you do have sort of sales that are declining, that's going to bring, in some cases, your supply cost down, absent inflation. So that's why we sort of start at the gross margin line.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Right. I'm just trying to fully understand, I guess, how that accounts for the growth in rate base over that time.

Robert J. Sprowls

Yes. So we're going to sort of manage the operating expenses. We have this sort of reduction in depreciation expense, and then we've got to cover the increase in rate base as part of the plan.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Okay. And then you all talked about the Sutter Pointe development. When will we start to see some of the growth from the new service area kind of flowing through the financials? What's kind of a CapEx expected to build out this new system and would that be embedded in that CapEx projections for the new rate case?

Robert J. Sprowls

No. It's not -- we don't expected the CapEx to start within that period. So in terms of us -- the company having to spend money. So it's several years out. It's just -- we talk about it now because it is something that's going to happen, we believe, eventually. It's just -- then it's a bit of a function of how quickly the real estate market moves.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Okay. And then my last question is on ASUS. How many, I guess, open bids on bases does ASUS have? And are all these water or have you made some electric at this point? And then the last part of the question would just be, when might we see the next contract awarded by the government? Do you have any ideas or any clarity there?

Robert J. Sprowls

Yes. I guess, the official bids we have outstanding are all for water and wastewater. We bid on -- or actually, I don't think we've shared with the market how many bases we bid on, and there's a reason for that, it's highly competitive. So I mean we are gearing up to bid on the electric. We have not submitted a bid there, but water and wastewater, there's a number of bases we're bidding on. We take it very seriously. We've in-sourced sort of the whole bidding process, that's how important this is to us. Let's see if there was another piece to your question, Jonathan.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Yes. Just if you have any clarity as to when they might act on some of these open bids?

Robert J. Sprowls

Yes. To be honest, Jonathan, it's going more slowly than what we thought. Our personal view is the whole DoD budget issues, we think, are having an impact, a bit, on the privatization of some of the bases. So it's more -- it's slower than what we thought it would be at this point. And it makes it more difficult to predict when. But we've been in there bidding and bidding hard to get new bases, it's just the government is going to move at a pace that the government wants to move.

Eva G. Tang

And they have been delayed again and again on certain RFPs that they said they're going to issue. So each RFP issued will evaluate to see whether it's a valuable base for us to go in or not.

Robert J. Sprowls

Yes. We've found that the lengths of time from when you start bidding to when base is awarded is lengthening as well. So it's a little frustrating, I mean, it's a very good business. We like it, we think we do a great job. The government is a very good payer of their bills and there are a lot of good things to like about the business. The only frustrating part is it's always slower than what you think it should be. And this is no criticism to the government, I mean, they've got a lot of things to manage. But -- so it makes it very hard for us to predict when these new bases are going to sort of cross the finish line.

Operator

[Operator Instructions] The next question comes from Richard Verdi with Ladenburg.

Richard A. Verdi - Ladenburg Thalmann & Co. Inc., Research Division

My question is pretty much been answered, but I want to follow-up on the last caller's question. There are approximately 20-or-so bases that are expected to be auctioned in the next, let's say, 12 to 24 months. Could you just give us a little color on maybe how many bids you have outstanding right now?

Robert J. Sprowls

Yes. Well, when Jonathan sort of asked that same question we kind of said that it's -- because of the highly competitive nature of this business, we're really trying to avoid putting out there sort of what our strategy is and how many bases we bid on. So we have not published that. All I can tell you, Richard, is we view this as a pretty good growth vehicle for the company and we are spending the time and the money to put forth a number of bids on substantial bases.

Richard A. Verdi - Ladenburg Thalmann & Co. Inc., Research Division

Okay. And I know when we were on the road, you gave a number a while back. Could you just share with us what you think the market share might be right now between yourselves and as well as American Water Works?

Robert J. Sprowls

Yes. I think I have done this in previous conference calls, but I've always caveated it as being a very loose estimation, very rough estimation. And this is really in terms of sort of size of the business, et cetera. My personal view is we have about 40% of the market in the water and wastewater space and American has about 40% of the market and that the other 20% is made up of -- by regional players.

Richard A. Verdi - Ladenburg Thalmann & Co. Inc., Research Division

Okay. That's helpful. And what about the electricity side exploring the military bases that have, not only water, but electric. You have the electric side of your business. Could that be a possibility for American States?

Robert J. Sprowls

Right. We are -- in some select areas, we are looking to bid on the electric operation.

Richard A. Verdi - Ladenburg Thalmann & Co. Inc., Research Division

And can you give us any sort of color on when that we might see it first type of contract materialize?

Robert J. Sprowls

Yes. It's going to be -- it won't be within the next year in terms of getting a contract, I don't think. The lead time on these things are -- they're beyond a year and we really haven't submitted a bid on the electric at this point. But we're gearing up to submit one. Now I don't want you to think the electric component is going to be, for us, as substantial as the water, wastewater. I mean, we're focused on water and wastewater and the electric allows us the opportunity to possibly provide the electric service on the bases we serve or on other bases. But one of these things we want to get our sort of feet wet first on the electric before we decide to go sort of full force into that.

Operator

The next question comes from Tim Winter with Gabelli & Company.

Timothy M. Winter - G. Research, Inc.

On the subject of the military bases and as this business grows, the price redeterminations, if I can try to understand those a little bit better. What prompts a filing? Who makes the decision? Are these becoming more standardized? Is each base different? Can you maybe just sort provide some color there how that works?

Robert J. Sprowls

Sure. Well, generally, under the way the contract works is you bid a levelized payment stream for, let's call it, operations and maintenance and renewal and replacement. And renewal and replacement is generally replacing the system over 50 years, if you will. So you bid a levelized payment stream. And then 2 years after you take over a base and every 3 years thereafter, you can get a price increase on both of those revenue streams. And so it's incumbent upon you then to make your price redetermination filings and then work through the Defense Logistics Agency Energy, which is DLA-E, that's the group of contracting officers -- that's where the contracting officers are housed that sort of handle all of the bases that we manage on the East Coast. Fort Bliss has a separate contracting officer, so that's not part of the DLA-E. So we make our filing with -- at each of the 6 contracts that we have. And then let's just say the DLA-E is handling it and they will review our filing. There'll be a lot of back and forth on what the cost increases are. But the point is the first price redetermination under each contract has been very difficult. It seems like the second redetermination goes more smoothly, and then -- so sort of getting that first redetermination done is really key. Now you're allowed to get retroactive adjustments back to the time when the price redetermination was supposed to be done. So for instance, the first price redetermination if you started your base on January 1, 2008, managed it '08 and '09, your redetermination would be effective January 1, 2010. And then you would do another one, 3 years later, and so that sort of how it works.

Eva G. Tang

And Tim, to Bob's point, fortunately, we have done all of the -- come through all of the first price redetermination approval, except for Fort Jackson, which we expect to receive the end of next quarter. So once the first redetermination is done, the second and third become routinely processed. So that's a positive side for those government process there.

Robert J. Sprowls

Yes. And then both our company and the government, the DLA-E, have been trying to work at an approach to try to streamline the process going forward, possibly considering putting an index or something like that into sort of help streamline the process.

Timothy M. Winter - G. Research, Inc.

Okay. And then if I could ask a more conceptual question on the same topic. If you were to take your bases that you operate and exclude construction projects, would you say that they're earning near the returns that you had forecast when you entered these? Or that you need further price redeterminations?

Robert J. Sprowls

Well, okay, so that's a bit of a difficult question because the -- I mean we're talking about 3 years of delays here in prices. So my view is, once we get the redeterminations done -- I mean, we're already very pleased with the business. Once we get the redeterminations done, we'll even be happier with it because it's a business that's sort of pulled our overall return up, return on capital up. And the retroactive revenues for price redeterminations will help. And so we like it, we like the business. I also think this whole redetermination process is a bit of a barrier to entry for other folks that come and want to be in this business because it is a different animal than the utility business, I can tell you that. And learning how to interface with the government on a variety of fronts -- I mean, it is a government contracting business, it is not a utility business. I mean, the management is utilities, but in terms of pricing and dealing with the government, I mean, we are a government contractor and we're required to abide all government contracting requirements.

Operator

The next question is a follow-up from Jonathan Reeder of Wells Fargo.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Bob, if I could just go back to the GRC. If depreciation rates weren't revised, if you just kept them at your normal level, how much of a difference would that have made? I mean, what's the absolute dollar impact from the extended depreciation life?

Robert J. Sprowls

Well, okay, so your gross plant is growing all the time because our CapEx is higher than our accumulated depreciation, our net utility plant is growing. So absent the depreciation change, we probably would be looking at what, Eva, $7 million or $8 million increase in depreciation expense?

Eva G. Tang

Yes.

Robert J. Sprowls

That's a fair statement. Because -- I mean depreciation expense, absent changing your composite rate, is going to grow over time because what you're depreciating is growing over time.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Right. So $7 million to $8 million increase over the depreciation that you filed for? Is that what you're implying?

Robert J. Sprowls

Yes. I think that's -- call it maybe $7 million to $8 million is too tight, maybe $5 million to $8 million.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Okay. But it's over the amount that you requested in the filing, I guess?

Robert J. Sprowls

Yes. Because we have reduced the composite rates, we have extended the lives because of the depreciation study.

Eva G. Tang

Yes. The depreciation expense, the decrease in that expense in our application for 2016 compared to the current depreciation expense level is about $1.4 million lower. So imagine we're having to change the composite rate or do the study, that rate, that dollar amount would be a much higher positive number, Jonathan.

Operator

[Operator Instructions] As there are no further questions, this concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Bob Sprowls for any closing remarks.

Robert J. Sprowls

Thank you, Gary. Again, I just want to thank everyone for your participation today and your continued interest in the company, and appreciate talking to everyone going forward. So thank you very much.

Operator

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, August 6, 2014, at 5:00 p.m. Eastern Time, 2:00 p.m. Pacific Time, and will run through Wednesday, August 13, 2014. Thank you for your participation. You may now disconnect.

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Source: American States Water's (AWR) CEO Robert Sprowls on Q2 2014 Results - Earnings Call Transcript

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