American States Water Co (AWR) 2007 Q3 法說會逐字稿

Welcome to the American States Water Company conference call discussing third quarter 2007 results. If you have not received a copy of this morning's news release announcing earnings for the quarter, please call 909-394-3600, extension 710, and one will be faxed or e-mailed to you. If you would like to listen to the replay of this call, it will begin this afternoon at approximately 7:00 p.m. Pacific time and run through Thursday, November 15, 2007. The toll free number for the replay is 800-642-1687 and the conference ID number is 20300962. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder, this call will be recorded and will be limited to no more than one hour. Thank you.

I would like to turn the call over to Robert Sprowls. Please go ahead.

Okay. Thank you. Good morning or afternoon, ladies and gentlemen, and welcome to the presentation on American States Water Company's third quarter 2007 results. I'm Bob Sprowls, Chief Financial Officer of American States Water Company, and Floyd Wicks, President and CEO of the Company is also with me today.

As usual, following the conclusion of our prepared remarks, the call will be opened up for questions. I would like to remind you that certain matters discussed during this conference call are forward-looking statements intended to qualify for the Safe Harbor from liability established by the Private Securities Litigation Reform Act of 1995. I ask that you review the forward-looking information disclosure in our Form 10-K and Form 10-Qs on file with the Securities and Exchange Commission. Factors underlying the Company's forward-looking statements are dynamic and subject to change. Therefore, these forward-looking statements speak only as of the date they are given. The Company is under no obligation to update them. However, we may choose from time to time to update them, and if we do so, we will disseminate the updates to the investing public.

During our presentation today, Floyd and I may refer to American States Water Company as AWR, our flagship subsidiary, Golden State Water Company, as GSWC, and American States Utility Services as ASUS. Having said that, let's begin with the results for the quarter. Basic and fully diluted earnings for the quarter ended September 30, 2007, were $0.44 per share as compared to basic and fully diluted earnings of $0.32 per share for the same period ended September 30, 2006.

Significant items that impacted the earnings for the third quarter of 2007 in comparison to the same period of 2006 were first, an increase in the margin for the water segment's pretax operations of $1.7 million, or $0.06 per share as compared to the same period of 2006 due to increased water rates approved by the California Public Utilities Commission, or CPUC that were effective January 1, 2007, and a favorable change in the supply mix caused by an increased volume of ground water supply pumped in 2007 as compared to the prior year.

Second, an unrealized loss on purchase power contracts, also known as a derivative, which decreased pretax income by $896,000, or approximately $0.03 per share for the three months ended September 30, 2007, as compared to a $2.8 million unrealized loss or $0.10 per share for the three months ended September 30, 2006. I would like to remind everyone again that although the unrealized gains and losses result in significant fluctuations to our income statement, they have no affect on our cash flows. When analyzing the financial performance of the Company, we exclude the effect of derivative gains or losses, as they are not reflective of our day-to-day operations. Finally, higher operating expenses and other items, which I will describe shortly, were partially offset by a decrease in the effective income tax rate.

Let's discuss these items further. Total operating revenues increased by $602,000 to $75.8 million for the third quarter of 2007 compared to revenues of $75.2 million, recorded in the third quarter of 2006, an increase of 0.8%. We break down operating revenues into water revenues, electric revenues, and revenues from ASUS. Water revenues for the quarter remained flat, increasing by only 0.2%. Rate increases approved by the California Public Utility Commission, effective January 1, 2007, were offset by the expiration in October 2006 of a positive surcharge that was in rates to recover previously incurred supply costs, in region 3 service areas of Golden State Water Company. Consumption remained relatively unchanged when compared to the same period in 2006.

Also impacting water revenues for the quarter were delays by the CPUC in receiving final approval of a region 2 rate case and rate increases to cover general office expenses at the Corporate headquarters. The rate increases for the headquarter's expenses, when approved, would also increase region 3 rates for 2007. A final proposed decision on the new rates is expected to be approved by the California Public Utility Commission on November 16, 2007. Floyd will discuss the impact of these rate increases in more detail later in this call.

Electric revenues from Golden State Water Company's Bear Valley Electric division decreased by 2.4%, mainly due to the recording of a regulatory liability of approximately $442,000 and a corresponding reduction in revenues for probable refunds to customers related to the 8.4 megawatt natural gas fueled generation plant. The rate increase for the generation plant which became affective in April 2005 has resulted in an increase of approximately $2.3 million in annual revenues based on an estimated total capital related cost of $13 million. The rate increase is subject to refund pending the CPUC's final cost review. In addition, if actual recorded costs are less than the costs authorized by the CPUC of $13 million, the difference in revenue requirements is to be refunded to rate payers.

During the third quarter of 2007, Golden State Water Company received vendor credits, which reduced the actual recorded costs of the generation plant below the $13 million and resulted in the recording of this regulatory liability and reduction in electric revenues. This decrease in electric revenues was partially offset by an increase in kilowatt hour usage by customers. Contracted services operating revenues are comprised of construction revenues and management fees for operating and maintaining the water and waste water systems at military bases. The services being conducted by AWR's subsidiary, American States Utility Services, or ASUS. Such revenues increased by $604,000 during the third quarter of 2007, primarily due to an increase in construction revenues for a special waste water infrastructure expansion project performed by ASUS's Fort Bliss Water Service's Company subsidiary.

This project was an amendment and supplemental to the 50-year contract with the U.S. government to manage the entire water and waste water systems at Fort Bliss. The project was completed in August 2007 and there will be no further construction revenues associated with this amendment. Earnings and cash flows from these military special projects have been intermittent to date and may or may not continue in future periods.

Total operating expenses for the quarter ended September 30, 2007, decreased to $58.3 million as compared to the $60.0 million recorded for the same period in 2006, reflecting an overall decrease in water supply costs, resulting from more pumping from Golden State Water Company's own wells, a decrease of $1.9 million in the pretax unrealized loss on purchase power contracts in 2007 compared to the same period in 2006, and a decrease in administrative and general expenses due to lower outside services, such as legal, consulting, and accounting incurred during the period. These decreases were partially offset by increases in other operating expenses due to higher chemical and water treatment costs, an increase in required and emergency maintenance activities on Golden State Water Company's wells, increased depreciation and amortization expense reflecting, among other things, the affects of closing approximately $73 million of additions to utility plant during 2006, higher property taxes and payroll taxes, and an increase in construction expenses, reflecting primarily the costs incurred for the special waste water expansion project at Fort Bliss.

Interest expense remains unchanged at $5.3 million for the quarter. Average bank loan balances outstanding under AWR's credit facility remained constant for the third quarter of 2007 and 2006, at approximately $27 million. The third quarter 2007 income tax expense increased by 9.0% to $5.2 million, compared to $4.8 million for the same period of 2006, due primarily to a 24.0% increase in pretax income. Partially offsetting the increase is a reduction in the effective income tax rate, primarily as a result of differences between book and taxable income, better treated as flowthrough adjustments in accordance with regulatory requirements. This decrease in the effective tax rate for the three months ended September 30, 2007, is principally due to a net reduction in compensatory and employee benefit-related flowthrough adjustments.

Now on to the year-to-date 2007 results. Basic and fully diluted earnings were $1.26 per share for the nine months ended September 30, 2007, is principally due to a net reduction in compensatory and employee benefit related flowthrough adjustments.

Now on to the year to date 2007 results. Basic and fully diluted earnings were $1.26 per share for the nine months ended September 30, 2007 as compared to basic and fully diluted earnings of $1.03 per share for the nine months ended September 30, 2006. The $0.23 per share increase in fully diluted earnings for the nine months ended September 30, 2007, reflects primarily, first, an unrealized gain on purchased power contracts, which increase pretax income by approximately $1.6 million, or $0.05 per share for the nine months ended September 30, 2007, as compared to a $5.9 million unrealized loss or $0.21 per share for the nine months ended September 30, 2006.

Second, a decision issued by the California Public Utility Commission on April 13, 2006, regarding the accounting treatment of Golden State Water Company's water rights lease revenues, which increased pretax operating income by about $2.3 million in March 2006, or approximately $0.08 per share when compared to the same period in 2007.

Third, excluding the effects of the $2.3 million of water rights lease revenues just discussed, an increase in the 2007 margin for the water segment of $10.1 million or $0.35 per share as compared to the same period of 2006 due to increased water rates, an increase in water consumption, and a favorable supply mix change.

Fourth, an increase in American States Utility Services pretax operating income of $3.5 million or $0.12 per share as compared to the same period of 2006 for operating, maintaining, and improving the water and waste water systems at military bases for the U.S. government. The increase in pretax operating income is primarily due to the special waste water expansion project at Fort Bliss, which is undergoing significant development. The project was completed in August, 2007, and there will be no further construction revenues associated with this special project after that date.

Other higher operating expenses, a change in the effective income tax rate, as well as other items that I'll discuss shortly contributed to an overall decrease of $0.42 per share to the results of operations. Total operating revenues of $227.4 million for the first nine months of 2007 increased by 12.2% compared to revenues of $202.7 million recorded in the same period in 2006. While the total increase in revenues, water revenues increased by 4.2% due to rate increases in higher consumption caused by warmer and drinker weather. Electric revenues decreased by 1.8% to $21.4 million, reflecting the recording of probable refunds to customers, which I discussed in the quarterly results.

Contracted service revenues comprised of construction revenues and management fees for operating and maintaining the water and waste water systems at military bases increased to $29.3 million, an $18.0 million increase for the nine months ended September 30, 2007, due primarily to the waste water systems expansion project at Fort Bliss in 2007.

Total operating expenses for the first nine months of 2007 increased to $175.5 million as compared to the $159.1 million recorded for the same period in 2006. Primarily impacting the comparability of the two periods were, an overall decrease in water supply costs reflecting a favorable change in the supply mix, partially offset by higher consumption, an increase of $7.5 million in the unrealized gain on purchase power contracts, due to a rise in forward energy prices, increased other operating expenses due to higher chemical and water treatment costs, as well as the operation of the water and waste water systems at the Maryland and Virgin military bases for a full nine months in 2007, increased administrative and general expenses, resulting primarily from higher labor costs and outside services; higher maintenance expenses reflecting emergency and scheduled maintenance on wells; increased depreciation and amortization, increased property and other taxes due to increased assessed property values and payroll taxes, higher construction costs and expenses of $13.4 million at Fort Bliss and other military bases; and a net gain of $470,000 on the sales of property.

Interest expense for the nine months ended September 30, 2007, reflected an increase in short-term interest rates and an increase in the average level of borrowing. Interest income decreased for the nine months ended September 30, 2007, due primarily to the initial recording in the first quarter of 2006 of interest accrued on the uncollected balance of the Aerojet Litigation Memorandum account, authorized by the California Public Utility Commission, and the receipt of interest amounting to $381,000, related to a $3.0 million Internal Revenue Service refund in May 2006. There was no such interest income or refund in the same period of 2007. Income tax expense for the nine months ended September 30, 2007, increased, due primarily to an increase in pretax income. Now I'll turn the call over to Floyd.

Thank you, Bob, and good morning, ladies and gentlemen. I'll now discuss the status of key regulatory filings and important actions in the last quarter and those still pending. Even though the PUC in California took an action on October 18, of this year to approve rate increases for region 2 in Golden State Water Company and to recover -- I'm sorry, to cover Corporate headquarters' expenses, the written version of that decision, as approved, contained a number of inaccuracies. The proposed decision issued by the PUC on October 26, that corrects the inaccuracies will be placed on the November 16, agenda for final approval by the PUC.

Because of nearly 11 month delay in issuing a final decision on this application, the CPUC had previously approved an interim rate increase totaling $1.2 million that became effective January 1, 2007. Based on the proposed decision issued by the CPUC on October 26, 2007, the revenue increase for 2007 would total approximately $6.7 million, which is retroactive to January 1, of this year. The proposed decision authorizes Golden Stater Water Company to track the differences between the interim rates and the final rates approved by the PUC and to recover the difference by way of a temporary surcharge. The unbilled revenue represented by this amount covers the period from Jan 1, of 2007 through the implementation of the new final rates to be approved on November 16, 2007.

Based on the proposed decision, the estimated rate increases for region 2 are $4.6 million and $4.3 million for 2008 and 2009, respectively, subject to an earnings test. The proposed CPUC decision also changes the revenue requirement related to previously adopted rates for recovering supply costs, which are also retroactive to January 1, 2007. Accordingly, GSWC will recalculate, among other items the amount recorded in region 2's supply cost memorandum account based on these new rates. As of September 30, of this year an amount of $2.2 million was recorded in this supply cost memorandum amount, which positively impacted earnings in 2007 year-to-date, and increased regulatory assets for the period. Most of of the $2.2 million is to be reversed in the fourth quarter, based on the new rates for supply costs. The retroactive revenues, as previously discussed, will also be recorded in the fourth quarter of 2007, more than offsetting the reversal of the supply cost memorandum account.

Additionally, the proposed decision also reflects rate increases of approximately $3.0 million, for 2007, to recover general office expenses allocated to region 3. Similar to region 2, the CPUC had previously approved an interim rate increase for region 3, totaling $135,000, which became effective, January 1, 2007. GSWC will implement a temporary surcharge to recover the revenue difference between the interim rates implemented on January 1, and the final rates authorized by the CPUC for the period from January 1, to the implementation of the final rates to be approved on November 16. Had we received these decisions prior to the end of September 30, 2007, the net impact to our pre-tax income for the nine months ended September 30, 2007, would be an increase of approximately $3.3 million or $0.11 per share.

The final decision will also impose an increased allocation of corporate headquarters expenses to ASUS. This allocation is also retroactive to January 1, of '07, and will be made in the fourth quarter, thus negatively impacting ASUS pretax's income ranging from $450,000 to $600,000 for the nine months ended September 30, 2007, and positively impacting Golden State Water Company's pretax income by that same amount. While this additional allocation to ASUS has no impact on the consolidated earnings based on the new rates authorized by the CPUC, it should be noted that revenue requirements would be higher for Golden State Water Company's region 2 and region 3, had the allocation of corporate headquarters costs to ASUS been lower.

In January 2007, GSWC filed an application with the CPUC for rate increases in region 1. In the filing, GSWC requested rate increases, which are expected to generate approximately $10.6 million in annual revenues, starting in 2008, with additional increases of $0.5 million in '09, and $1.0 million in 2010. A decision on this application is expected in late 2007.

Chaparral City Water Company in Arizona also filed its general rate case with the Arizona Corporation Commission during the fourth quarter of 2007 for its water system in Fountain Hills, Arizona. The processing of this case is expected to take approximately 18 months. In the filing, CCWC requested an overall increase in annual revenues of $3.0 million. We are planning to issue equity in mid-2008 to fund our ongoing operational and capital needs. The proposed equity offering was included in the previous rate case filings and the positive earnings impact from the rate increases I have discussed is expected to absorb the dilutive effect of the new shares to be issued in 2008.

Let's now turn our attention to a review of water supply issues. Both California and Arizona have been experiencing lower than normal precipitation. Severe drought conditions continue in California and Arizona and from October of '06 to September of this year, Los Angeles experienced the driest year on record since 1877. It was also the fifth driest year for the State of California as a whole. Typically, our third quarter financial performance benefits from higher water sales due to the warmer weather. However, with supply variability and the general scarcity and value of water supplies available in the Western United States, American States Water Company has been promoting active conservation by all customer classes, and as a result we are experiencing less than expected increases in demand by existing customers.

Somewhat mitigating the drought conditions are reservoir levels. California reservoirs, at the end of September of this year, were at 71% of average levels for this time of year, resulting from the above-average precipitation in 2005 and 2006. The Colorado River storage was at 64% of average. Inflow into Lake Powell, which is on the Colorado River system for the water year has been 68% of normal for this time of year. For the two reservoirs nearest Chaparral City Water Company in Arizona, the Salt river and the Verde river, their storage levels are 103% and 65% of normal, respectively.

Over the next three months, the National Weather Service's climate prediction center, CPC, expects the drought conditions to lessen for Northern California and there will also be some improvement for Central California. The CPC predicts that drought conditions for Southern California and Southwest Arizona will persist. GSWC obtains approximately 55% of its water supply from its portfolio of reliable ground water supplies. To augment local ground water Golden State Water Company relies on supplemental supplies imported from distant watersheds, either naturally through river systems or artificially through integrated systems of reservoirs and conveyance facilities.

Golden State Water Company contracts either directly or through intermediate wholesalers for important supplemental water supplies with a variety of governmental agencies which manage water projects, including the California Department of Water Resources state water project. GSWC contracts for supplemental water supplies from the state water project through several member agencies of the metropolitan water district of Southern California, MWD, which act as subwholesalers. To receive such supplies, Golden State Water Company maintains physical connections through the MWD imported water distribution system throughout the six-county area, encompassing most of metropolitan Southern California.

In addition to the more generalized challenges facing all western water projects the state water project faces particular challenges to the operation of its pumping plant, located at the southern end of the San Joaquin Sacramento river delta, in Northern California, which naturally drains to the Pacific Ocean through the San Francisco Bay. Because of its diversion of water for export to Central, Coastal, and Southern California through the pumping plant, the state water project is subject to a variety of operating limitations and permitting processes designed collectively to balance the need for water exports with the need to restore and protect the Bay delta environment.

In the first quarter of this year the state water project received a Federal Court order to comply with certain endangered species permitting requirements, including protection of the delta smelt, a small fish, or cease pumping operations. The state water project complied with the temporary court order, which resulted in suspension of most SWP delta diversions for a nine-day period in the second quarter of this year. On August 31, a judge issued a decision orally, among other things, that the biological opinion, BIOP, or BIOP issued by the U.S. fish and wildlife service was legally insufficient and failed to consider recent declines in delta smelt abundance.

A new biop, responsive to recent scientific findings and to the judge's order is expected to be completed by September of '08. The judge also issued interim restrictions to be imposed on pumping until the new biop is completed. The interim remedy includes significant reductions in deliveries to contractual customers of the state water project, including Metropolitan Water District, of up to 37% of baseline deliveries. Actual curtailments will depend on weather conditions, fish and flow patterns in the delta.

Generally, imported supplies represent 60% of all the water used in Southern California and 40% represents local supplies. Approximately 15% of the total water supplies consumed by Southern Californians comes from the state water project. It is this volume that is being temporarily interrupted by the Federal Court order. Adequate levels of stored water south of the delta, as well as locally available ground water have prevented immediate mandatory curtailments of water per distribution to Golden State Water Company customers. However, Golden State Water along with MWD and other water purveyors across the state are aggressively pursuing voluntary conservation measures among their customers to address the water supply challenge.

Partially in response to delta diversion restrictions, which are expected in 2008, MWD has announced expected rate hikes for 2008 in excess of those previously announced. Increases in prices from wholesalers, such as MWD, flow through the water supply balancing accounts for Golden State Water Company. We are monitoring developments and working with MWD and its member agencies to safeguard the supply and evaluate potential emergency responses to prolonged reduction in state water project deliveries.

While we continue our efforts to be good stewards of the resource and to send active conservation messages to our customers, customer conservation can result in lower water sales than would otherwise occur and lower volumes of water sold can have a negative impact on our earnings. In order to remedy the financial disincentive associated with water conservation, we have worked collaboratively with the CPUC and the Arizona Cooperation Commission to address rate structure issues, which promote conservation of the resource. On October 19, 2007, Golden State Water Company and the Division of Rate Payer Advocates at the CPUC filed a settlement agreement regarding the conservation rate design and a water revenue adjustment mechanism. If the settlement is approved by the CPUC, Golden State Water Company would implement an increasing block rate design as a means to encourage water conservation.

As part of the Company's growth expansion strategy, ASUS recently reached an agreement to operate and maintain the water and waste water systems at Fort Bragg North Carolina and Fort Jackson, South Carolina. The value of the Fort Bragg contract is estimated at more than $570 million over the 50-year contract period, while the Fort Jackson contract has an estimated value of more than $143 million over the same 50-year period. These agreements are also subject to periodic price redetermination adjustments and modifications for changes in circumstances. ASUS, through wholly owned subsidiaries, is expected to commence operations under these two agreements during the first quarter of 2008 following the expiration of a transition period.

I am also very pleased to report to you that during the first nine months of 2007, ASUS efforts on military privatization have resulted in a $3.5 million increase in pretax operating income, or a $0.12 per share increase as compared to the same period of 2006. The increase in 2007 operating income -- the increases are primarily due to a $20.6 million special contract with the U.S. government for the construction of certain improvements to the existing waste water system located at Fort Bliss in El Paso, Texas. This construction project is supplemental to the Company's 50-year contract with the U.S. government to manage the entire water and waste water systems at Fort Bliss.

As a result of this new construction project, operating income increased by $4.9 million during the first nine months of '07, the majority of which occurred in the first two quarters of this year. The project was completed in August of '07 and there will be no further construction revenues associated with this amendment. Again, it should be noted that earnings and cash flows from these military special projects are intermittent and may or may not continue in future periods. Since 95% of the waste water expansion project was completed with associated earnings recognized in the first two quarters of this year, ASUS had a pretax operating loss of $60,000 for the third quarter. The additional allocation of expenses from the Company's Corporate headquarters in San Dimas, if approved by the PUC will have a negative impact on ASUS fourth quarter earnings as previously discussed.

We continue to thank you for your attention and for your support and ask that you remember that our total return prospects are reflected in our financials, our growth opportunities are coming to fruition, and our management team is meeting today's challenges and is prepared to meet tomorrow's. Three outstanding reasons we ask for your continued support in spreading the word to your clients as to why American States Water Company belongs in their investment portfolio.

As reported in our recent news release, the Board of Directors of American States Water Company approved a 0.015, $0.015 per share increase in its quarterly dividend to a total of $0.25 per share in the quarter, a 6.4% increase on the common shares of the Company. This increase is the largest per share quarterly dividend increase in more than 10 years and reflects the Board of Directors' continued confidence in the Company and its progress by rewarding our shareholders. This action also represents the 286th consecutive dividend payment by the Company. For more than 53 consecutive years, American States Water Company's shareholders have received an aggregate increase -- annual increase in dividends.

American States shareholders should know that using the SEC guidelines for reporting financial performance, $10,000 invested in the shares of American States at December 31, of '02, would be worth $19,554 at September 30, 2007. This amounts to an annual compound growth in value of 15.2%.

Thank you again. I will now turn the conference over to the operator to entertain any questions you may have. Please recall that you will need to press the one key followed by the four key on your telephone keypad. Thank you.

(OPERATOR INSTRUCTIONS) Your first question comes from Ajay Jain with UBS.

Hi. Good morning.

Good morning.

Hi.

Hi, there. Just first on the military contract in Fort Bragg, can you talk at all about the timing on that in terms of revenue recognition? And also based on your experience in Fort Bliss and the other military bases, I guess in the D.C. area, when would you think that this latest award gets better than break-even in terms of the P&L impact?

Well, just as we had in some of some of other bases, there is a transition period where we, essentially when that transition period is completed, we'll have the full operating responsibility at the base. We're expecting that transition period to be completed during the first quarter of '08 and we would take over completely at that time. In the past, we've received some transition revenues for the work effort involved. I don't recall what the amounts are in this particular case, but we'll have more to report on that by year end, certainly.

Regarding your other question, we're not -- we don't really want to get into details on a base-by-base comparison, but I would like to remind everyone that the amounts that we have in our current bid for both bases, those dollar amounts are subject to review on an incremental basis at I believe two-year intervals. Bob, am I right on that?

Right. The way it works is, after you take over a base, after the first two years of managing the base, there's a price redetermination and then every three years thereafter. So it's two years and then every three years.

And in some ways, and I've said this in prior calls like this, these price redeterminations in many respects are akin to what we go through in California and Arizona with the Utility Commissions on rate increases. Costs are reviewed and increased where appropriately, or where appropriate, and those kinds of things.

Okay. So the ramp-up to profitability isn't necessarily straight forward?

Yes. It's also Ajay, it's also a function of your capital expenditures at the base to the degree those are more front end loaded, you may see more profits at the front end, because it's -- you basically are getting a return on the dollars that you put in the ground. There's two sets of revenue streams, one for O&M and one for capital. So the capital, at one base, it's very much dependent upon how quickly you start to put capital on the ground.

We'll have more to report on this on a quarter by quarter basis, but Fort Bragg is clearly an older base. It was named after a confederate general, as I understand it, so it's been around a long time and infrastructure, of course, needs to be replaced. It's safe to say that there's going to be some definite need early on in the 50-year contract from what we have seen so far. It's a great contract, it's long-term and also just by means of size or at least relevant size, the local population of the base is between 70,000 and 80,000 people. So it's a fairly significant water and waste water system.

Okay, great. Thank you. And I know you covered this in your prepared comments, but I just wanted to see if I could get some clarification on the announcement from last week. In terms of the differences between E & ARM rate relief and the final rates that were approved and are retroactive for region 2, when does that incremental revenue get accrued based on the surcharge? If you don't want to go through that level of granularity, maybe we can talk about it offline, but is that all reflected in the $4.6 million that kicks in beginning in '08? Is that right?

Well, the rate increases actually would go effect immediately following the November 16, approval. Of course, assuming that the PUC follows through and approves it on that date, we believe they will. The retroactivity will actually have to implement a surcharge on the customer's bills immediately following that November 16, date to collect the revenue that we lost going back to January 1, of this year. That's why we're going to reflect -- even though we won't actually collect the cash immediately, it will be in a surcharge on bills on a go-forward basis. I don't know if it's going to be a 12-month surcharge or 24 months. It may be 24 months, but even though the cash flow comes in over subsequent months, we'll book the revenue as though we collected it in the fourth quarter. That's my understanding of the accounting. Bob, am I correct on that?

That's exactly right.

Okay. You are talking to an engineer, so bear with me.

Okay, fair enough. And then if region 3, based on the $3.3 million decision I think, if that's the right number, when does that get recognized? Is that also November 16?

Yes, same exact issue. We believe the combined effect in the fourth quarter -- I'm going to ask Bob to confirm, but I believe it's an $0.11 increase in EPS that we'll book in the fourth quarter.

That's right. Ajay, we believe the amount there is $3.0 million.

For region 3.

Okay.

Yes, for region 3.

Okay. Thanks for the clarification.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from Heike Doerr with Janney Montgomery Scott.

I was hoping you could explain a little better how we're going to see the revenue recognized associated with Region 2? I understand that you're going to be able to go back all the way back to January, so you'll get the surcharge between January and November, I'm wondering how we account for that. Is that a one-time gain in the fourth quarter, does it slowly get phased in over the next nine months, 12 months, is that something you can walk us through?

Let me give it a go here. What typically happens, if you can envision -- for example, when we have a supply cost that we incur a higher cost than what's in rates, that difference is booked into a memorandum account, and then the commission gives us approval to collect that on a go-forward basis. What we'll do in addition to the tariff that's in place for all customers, we'll add a surcharge, maybe $0.02 or $0.03 per 100 cubic feet to collect those supply costs. That is little bit different in the revenue increase.

The tariff that will be put into effect on say, November 17, depending on what the timing is following the PUC's approval that tariff will include the increase that should have been in effect in January of this year. So that revenue loss, if you will, really isn't lost. We've captured it through new legislation that was in effect for the last two or three-year period. A lot of effort by our Company people as well as the California Water Association, got legislation passed because the PUC was typically delaying rate cases and we would lose that revenue forever. Right now we're capturing it and on a go-forward basis, the tariff that we'll put into place, we'll continue to collect that revenue ongoing until it gets changed in the next rate case, or subsequent increases for the second year -- second test year and so on. So that the surcharge we put into affect to capture that revenue that we lost from January through November 16, will be put into place. It may be a $0.03 or $0.04 or $0.05 per 100 cubit feet surcharge, we'll collect that cash over either a 12-month or 24-months. I don't know which, how that's going to come out yet. Once that surcharge is done, that just takes care of the dollar amount we lost between January 1, and November 16, but the ongoing tariff allows us to continue to collect that revenue requirement on an annual basis.

Okay. So we wouldn't see a one-time gain to recoup the lost revenue in the fourth quarter. This is something that over a longer time frame, we would see these $0.11 slowly made up. Is that how we should be looking at it?

No, we'll recognize the accounting recognition of this in the fourth quarter.

Okay, you will?

You'll see the additional $0.11 in the fourth quarter, as well as you'll see the higher rates, of course, being in effect during the fourth quarter.

That's correct. And what happens, when the surcharge goes away, it just -- all the surcharge does is allows us to collect the cash, the accounting impact of the $0.11 per share must be realized at the time the actual decision is rendered, namely the fourth quarter of this year. So the accounting requirements are such that we have to recognize it in the quarter that the decision was rendered, even though it takes us 24 months, perhaps, to collect the cash. Hopefully that--.

That helps, that helps. Thank you. That was all I had. I appreciate your extra clarification.

Okay, thank you.

And the $0.11 represents up through September 30.

Okay.

So the $0.11 doesn't represent beyond September 30.

Oh, good point. Yes.

Okay. Good to know. Thank you.

Thank you.

And your next question comes from [Allan Seymore] with Columbia Management.

Yes. Hi. I'd kind of like to see if I could size the opportunity that you -- the services business through the military? Would it be correct for me to think that maybe by the end of '08 that as much as 10% of your revenues might be from the military on this basis? Presumably, without any of the ancillary construction-related things that you might flow through on an additional basis, but just on the straight kind of services that you provide for the military side?

Bob, do you want to take a first crack at that?

Sure.

And can I tell you how I get there. I get there from angelizing the $4 million in the quarter. That would be 16, plus if you have 5 million from one of your -- I guess it's Fort Bliss and maybe a couple million from the other contract, which is smaller, and then it might be 20 million, 25 million.

Currently, we're kind of in that 3 or 4% range, if you like for the quarter, if you were to back out the revenues associated with the special project. So that would mean we'd have to get another 6% to get to 10%. We really haven't put out any sort of forecast on that, so I'm really hesitant to sort of give guidance there.

Okay. But we know you have at least three contracts now. What would be the services run rate at the end of '08 ex any of the construction-related stuff that gets passed through?

Bob, I think one thing we have announced in the past would be the total revenue over the life of the contract.

That's right.

And all of those numbers that are out there, we have eight military bases now throughout the country. If you added all of those announced revenues over the 50-year contract life, they combined to a total of $1.3 billion. So if you divided that by 50 years, you can get a rough idea in today's dollars, at least, or close to today's dollars, what the annualized revenue is on the contract itself. That does not include any of these special projects that were referenced earlier. I hope that helps.

Okay.

And just so you know how the accounting works, on the military base activities, we do recognize revenue from the O&M piece on a quarterly basis. The revenue on the renewal and replacement piece is a function of, to the degree we are putting capital in the ground.

Right.

So if we don't put any capital in the ground at a base, we don't get to recognize the revenue there. So it is somewhat a function of the capital -- the timing of the capital at each of the bases.

Yes, that's a good--.

Okay, but the O&M side is a recurring thing whereas the capital is something that is periodic?

That's right. It bounces around. At some bases, we are collecting cash from the government ahead of when we're spending it on capital. At other bases, we're -- the exact opposite is happening.

Right. Okay. Can you get a -- I'll have to be careful how I -- you have eight bases now. Are there RFPs for another 15 bases out there that you might be interested in, or do you not talk about that?

Well, yes. My understanding at this point, Floyd, you can correct me if I'm wrong, is we at this point -- there are 25 to 30 other bases out there that need to be privatized. Initially we had bid on a lot of those bases, but at this point the bids have become somewhat stale and in some cases the government are rebidding some of those bases. We of course, are in a position to take our original bid and just update it. So it's not very costly, but that's my understanding of what's going on out in the military forefront. Floyd, if you would like to add to that, I'll let you.

I think you're right. I think, of course, one of the main reasons for delaying -- the government's delaying the processing has been the war effort. So presumably, when that lessens, we'll see some more activity, but we're still getting some bases, as we announced here with Fort Bragg and Fort Jackson in the Carolinas. So it's not as fast as we otherwise would have expected, but it's still steady.

Great. Thank you.

Thank you.

There are no further questions at this time. I would now like to turn it back over to management for any closing remarks.

Yes. Thank you very much. I would really like to thank all of those who participated today for your continued support and investment in American States Water Company and a good day to all of you.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.