Good day, and welcome to American Water's Third Quarter 2023 Earnings Conference Call. As a reminder, this call is being recorded and is also being webcast within an accompanying slide presentation through the company's Investor Relations website. The audio webcast archive will be available for one year on American Water's Investor Relations website. I'd now like to introduce you to your host for today's call, Aaron Musgrave, Vice President of Investor Relations. Mr. Musgrave, you may begin.

Thank you, Chris. Good morning, everyone, and thank you for joining us for today's call. At the end of our prepared remarks, we will open the call for your questions. Let me first go over some safe harbor language. Today, we will be making forward-looking statements that represent our expectations regarding our future performance or other future events. These statements are predictions based on our current expectations, estimates and assumptions. However, since these statements deal with future events, they are subject to numerous known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from the results indicated or implied by such statements. Additional information regarding these risks, uncertainties and factors as well as a more detailed analysis of our financials and other important information is provided in the third quarter earnings release and in our September 30 Form 10-Q, each filed yesterday with the SEC. And finally, all statements during this presentation related to earnings and earnings per share refer to diluted earnings and diluted earnings per share. Susan Hardwick, our President and CEO, will share highlights of third quarter and year-to-date results and will comment on our 2024 EPS guidance and longer-term targets. Cheryl Norton, our Executive Vice President and COO, will then discuss our new capital investment plan, including the expected impact of PFAS-related investments, and will conclude with a regulatory update, including our views on customer affordability. John Griffith, our Executive Vice President and CFO, will then discuss our year-to-date financial results in more detail, discuss our acquisition outlook, and will close with details behind our 2024 outlook and longer-term goals and our 2024 to 2028 financing plan. After a few final remarks, we'll then close by answering your questions. With that, I'll turn the call over to American Waters' President and CEO, Susan Hardwick.

Thanks, Aaron, and good morning, everyone. Let's turn to Slide five, and I'll start by covering some highlights from the third quarter and year-to-date periods. As we announced yesterday, we delivered strong financial results in the third quarter of 2023, and we're pleased to again reaffirm our 2023 guidance on a weather-normalized basis. Earnings were $1.66 per share for the quarter compared to $1.63 for the same period last year. In the first nine months of 2023, earnings were $4.03 per share compared to $3.70 per share in the same period of '22. The estimated net favorable weather impact year-to-date in '23 is about $0.11 per share compared to $0.06 per share favorable in '22. These weather-normalized results so far in 2023 continue to reflect our strong execution in line with our growth expectations for the year. John will elaborate further on results later. Moving on to some of our other key accomplishments to date in 2023, we have invested $1.8 billion in capital projects year-to-date, reflecting great work by our teams responsible for planning and completing these investments. As you will recall, the total capital investment planned for 2023 includes approximately $400 million of acquisitions, including one sizable transaction in Pennsylvania we expect to close in December and another in Illinois around the end of the year. As you know, we completed an equity issuance of $1.7 billion in March and a $1 billion convertible debt issuance in June. These were the two key priorities of our 2023 financing plan. We were focused on completing these issuances in the first half of the year to reduce market-related pricing risk and overall execution risk, which has served our investors, customers -- and our customers well, considering the current market conditions. Turning to Slide six, as we roll out our new…

Thanks, Susan, and good morning, everyone. Before I jump into a discussion of our current long-term capital plan, starting on Slide eight, I want to first acknowledge that our teams have done a great job executing on our accelerated capital investment plans these last few years. We have consistently met our capital deployment goal and we're on pace to do it again by meeting our overall capital plan of $2.9 billion this year, which includes acquisition investments. Looking ahead to 2024, we expect a modest increase in our investment spending level to roughly $3.1 billion. Over the next five years, we expect to invest approximately $16 billion to $17 billion, an increase of about $2 billion over our previous plan. We expect constructive outcomes for this important water quality initiative, and we will continue to advocate that the ultimate responsibility for the clean-up of these contaminants should fall to the polluters. We will also continue to advocate that all water and wastewater utility providers, regardless of ownership, have equal access to any federal and or state funding related to treating PFAS. In addition, we'll continue our efforts to request permanent federal funding for a water and wastewater low-income customer assistance program. The other two drivers of increased CapEx in the 2024 to 2028 plan are a higher level of spend related to prioritized renewal projects across our footprint, such as for hydrant, pipe and meter replacement, as well as a higher level of expected follow-on capital related to future acquisitions. Following recent acquisitions, we have continued to experience a higher level of investment need in order to bring water and wastewater systems into regulatory compliance and up to our operating standards, which is driving the higher estimated capital need of $600 million. You can also see that we have deferred…

Thank you, Cheryl, and good morning, everyone. Turning to Slide 13, let me provide a few more details on year-to-date results. The appendix also has details of third quarter EPS, which has many of the same drivers as year-to-date results. Consolidated earnings were $4.03 per share year-to-date, up $0.33 per share compared to the same period in 2022, and up $0.28 per share on a weather normalized basis. Increased revenues were driven by general rate cases we completed in late 2022 and early 2023 in our larger states. These additional revenues are driven by the significant investments we have made and continue to make in our systems. As noted, earnings were higher year-to-date by an estimated net $0.11 per share as a result of weather in the second and third quarters due to warm and dry conditions, primarily in Missouri, New Jersey and Pennsylvania. This compares to net favorable weather in the third quarter of 2022 of $0.06 per share, which related mostly to warm and dry conditions in New Jersey. In looking at operating costs, higher pension expense of about $0.10 per share and increased chemical costs of about $0.09 per share, including inflationary pressures, are being recovered in large part through higher revenues we proactively sought through the use of forward test years and traditional updates to base cost of service and general rate cases we completed in the last 12 months to 18 months. This strategy has limited the bottom line impact of those higher costs in 2023 and is a strategy we are continuing to use in our recently filed and upcoming cases. Supporting our investment growth, depreciation expense increased $0.17 per share, and the cost of additional long-term financing increased $0.28 per share, primarily related to share count dilution. As I mentioned last quarter, the…

Thanks, John. To close on Slide 20, you've heard our latest strategic thinking today, and it should sound very familiar. It's all about execution at every level. As we continue to demonstrate our ability to consistently execute, we believe our industry leading EPS and dividend growth, combined with our focus on affordability and ESG leadership will continue to be highly valued and rewarded by investors. We believe these aspects of our business and strategy separate us from all utilities. They are underpinned by our significant low-risk capital investment plan, which includes our best-in-class execution on acquisitions and our excellent regulatory execution, all while maintaining a strong balance sheet with a well-planned debt maturity profile and a differentiated affordability proposition. Through our consistent achievement of high operating standards, including our leading safety culture and water quality accolades, our team at American Water has raised the bar for success in the water and wastewater industry and that includes the outstanding efforts by our Military Services Group team to proudly serve the 18 military installations in our footprint. Our history of executing on our strategies has delivered a very competitive, sustainable shareholder return. With this long-term plan, we have full confidence in our ability to achieve the goals we talked about today and continue our track record of delivering superior shareholder value. And with that, let me turn the call back over to Chris to begin Q&A and take any questions you may have.

[Operator instructions] Today's first question comes from Richard Sunderland with JP Morgan. Please proceed.

Hi, good morning. Am I coming through clearly?

You are, Rich. Good morning.

Great, thank you. Appreciate the details around the update here. I wanted to start with the CapEx revision and the bill outlook. Looking back to 2021, when you first outlined the Accelerated Investment Plan, you gave some details on the customer affordability angle, but I'm curious, kind of bridging, not back to last year, but back to '21, is there anything different in that outlook now? Obviously, CapEx is up significantly. Also curious if the 2% customer additions target in the language around there for M&A has factored into how you've crafted this new capital plan around the customer affordability angle as well.

Okay, Rich, yeah, there's a lot in there. Let me start and then Cheryl and John can add to it. I would say our focus has sharpened over the last number of years related to customer affordability. And that sharpened focus, I think, has really been around this sort of wallet share concept that Cheryl talked about. I think it's important for us to understand the communities that we operate in and the demographics of those communities and what are the challenges of customers in those communities and we've been able to do a lot of analysis at a very detailed level around affordability, around household income, around just economic impacts in the various communities that we serve and our focus has been, I think, very clearly defined around our wallet share as a percentage of that household income and we've been developing this concept here now for a number of years and I think that our ability to confidently say this plan as we've continued to grow it, we'll continue to maintain our position of roughly 1% or less of a customer's bill in the communities that we serve specifically and I think that focus has allowed us to really think about how to build this plan, how to continue to grow it, how to continue to grow rate base while not overburdening customers with our growth expectations. I think this plan fits very nicely in that concept. Cheryl, you want to add anything?

Yeah, I would just add, Rich, that as Susan said, we look at all the communities that we serve. We look at the demographics, and yet the capital investments are not that different from community to community. And we need to make sure that we are investing at the right level in all of those communities. New regulations like PFAS, but also the lead and copper rule, that is driving a lot of capital investment across the board and so we have to continue to do that and we need to do that in all the communities. So these affordability calculations, the risk priority model that we use, we think it's really the best balance to getting the right amount of infrastructure investment in all of the communities that we serve and as we grow the number of communities that we're serving, that will continue to increase, but we think we're getting the right balance there because we have to treat all of our customers in a fair way. They all deserve clean, safe drinking water.

And Cheryl, I might just add one additional comment. From a regulatory perspective, this is also a concept that we've been sharing very transparently with regulators. This affordability analysis that we've done, and as we lay out in every jurisdiction, the plan and the investments that we have made, we're right alongside it talking about impacts to customers and how we've thought about the plan and how it affects affordability for the customers in the service territory. So again, it's a concept and a view that we've taken that we think is differentiating here and I think regulators, just as one party, are certainly recognizing that.

And Rich, I'll pick up on the 2% part of your question. As Susan mentioned in her commentary, 2% is a metric that we think is good to think about as a long-term metric given just the short-term variability around acquisitions, but you're right to point it out in this context. As you know, the 8% to 9% rate-based growth is what drives the 7% to 9% earnings growth, but being able to spread that 8% to 9% rate-based growth over a larger customer base is a healthy element of our growth.

Great. That was very helpful, color there. Thanks for laying all of that out. And then separately, turning to the financing plan here, you were clear on the drivers around the equity relative to the CapEx. I'm curious on the operating cash flow side. It looks like a significant step up, '24 to '20 versus '23 to '27, is that just normal course kind of rate recovery, any discrete items in there, just how to think about prior versus new?

Yeah, it's a good question, Rich. Really, there is a big step up. If you think about the increase in our capital plan as we go back from 2021, 2022, 2023 and forward, it's such a significant step up that when you drop 2023 out of the plan and you bring 2028 into the plan, the accumulation of the capital spend through that period, it accounts for a very significant portion of that operating cash flow step up and then as you would also intuitively think, there is increased cash flow in the interim years as well, just given the increase in capital plan.

Got it. Well, thank you for the time today.

Our next question is from Paul Zimbardo with Bank of America. Please proceed.

Hi, good morning, team. Just to clarify on that last line, confirm my understanding, so there's effectively no change in the growth triangle, as you call it, it's just kind of a representation.

Yeah, I think that's fair. We want to continue to emphasize that rate-based growth is the driver. Rate-based investment, which includes acquisitions, is the driver. What we're trying to do here, I think, is just give some clarity around or maybe a better view as to how you can measure our progress toward growth through acquisition by giving you that sort of metric around customer additions. The investment that we'll continue to make in acquisitions just rolls into rate-based, which it always has. So no real change in that. I just think it's a better view potentially for investors to be able to see progress we're making around the acquisition strategy.

Okay. Understood. That's what I thought. And then shifting to the financing plan, so if I understand it right and correct me if I'm wrong, it doesn't assume any litigation proceeds, state funding, federal funding for PFAS. Is there any sense of what that kind of offset could be to help out on customer bills?

Yeah, it's a good question. Obviously, the numbers that we have laid out here, as Cheryl outlined, continue to be our best estimates of the cost necessary to meet the current proposed rule. Obviously, we don't have a rule yet. So finalizing those numbers will occur once we have a final rule and we do participate in the ongoing litigation around this whole issue. We've laid all that out in the Q. So you can look at that there and probably won't talk much more about it than that since it is ongoing litigation. I think it is fair to say that our estimates today are the costs we would expect to incur. We have to see how the litigation ultimately works out to see what impact that may have. And I think Cheryl covered this well. We do believe, by virtue of our participation in the litigation, that polluters should be our first line here of responsibility. So we are quite involved in that to make sure that that is properly executed.

Okay. To make sure, it does have an assumption around getting external funding or it does not?

It does not at this point, no. It is just the cost estimates that we have developed so far.

Okay, that is what I thought. Okay, great. Thank you very much.

The next question comes from Will Granger [ph] with Mizuho. Please proceed.

Thanks for taking my question. Just wanted to ask, on the PFAS billion dollars that you have outlined today, how should we be thinking about the makeup of that over your service territories? Is it pretty radical? Yeah, if you could unpack the underlying assumptions there, that would be helpful.

Yeah, I will ask Cheryl to comment on that. We hit on, I think, a pretty high level, but Cheryl, you might want to just reemphasize that.

Yeah, as we have looked at this, as I mentioned in my comments earlier, we expect the bulk of the spend to be in our states where we have a larger footprint of customers, New Jersey, for example and the reason for that driver of that being the largest amount of spend is that there is more contamination there in general, but also these are large surface water plants that are very costly to add treatment to. We have Pennsylvania as a larger state, numerous locations there, but we really haven't outlined everywhere that we're going to add treatment, but anywhere that it's a surface water plant as opposed to a groundwater source is going to be a lot more costly to add that treatment and so New Jersey is our biggest dollar state for sure.

Got it. That's helpful and then maybe just on the equity for your plan, is that the incremental equity is just $700 million, if I've got my math right? The $300 million that you're planning to issue now and then an incremental $700 million, or is it an incremental billion?

You've got it right, Will. It's an incremental $700 million.

Okay. And we should expect the timing of that to come in towards the back half of your plan, or would that be issued like as an ATM and just kind of pretty radical?

What we've said is we'll issue it in the middle of our new 2024 to 2028 plan, subject to market conditions, obviously.

Got it. I'll leave it there. Thank you very much for the time.

Our next question is from Jonathan Reeder with Wells Fargo. Please proceed.

Hey, good morning, team. Just kind of following up a little bit on that last question, despite the higher operating cash flows, it looks like the external capital needs increased more than the $2 billion CapEx increase. You've got the $700 million of equity, and then I think its $1.7 billion of debt. Anything unique going on there?

No, Jonathan. We really lead this analysis by looking at our credit metrics, and so a lot of it just goes back to what we've said in the past, where incremental CapEx will fund at 50-50 debt and equity. As we think about equity there, it's internally generated funds as well as new issuance. So we think of it as lining up in that regard.

Okay. No, I was just thinking the debt portion was a little higher than I would have thought.

Yeah, that's just a function of the capital spend as well as the maturity schedule.

Okay, yeah, maybe the maturity schedule. Okay. So, Cheryl, I know you said that California filed on 10-16 to increase the '24 allowed ROE. Has there been any opposition filed to this request? I think there's like a 30-day comment period, which probably ended maybe yesterday.

Yeah, there is that 30-day period, and Jonathan, I am unaware of any kind of intervention or any kind of concern over that.

Okay. It's pretty formulaic, Jonathan. Yeah, we don't expect there to be any issue with that. It really just follows a formula.

Yeah, no, I think investor concern is more on the electric side, whether you see some intervention than the water, but we monitor both. I think the 10-year CapEx plan, you bumped up the M&A placeholder by a billion. Is there anything specific driving that, or is that just kind of passage of time more than anything?

Yeah, I'd say, Jonathan, it's certainly passage of time as part of it. We are investing in our capability across the system, starting with originations as well as due diligence and integrations. As we look at what happens when we make acquisitions and just our standards as a best-in-class operator relative to the systems that we acquire, we just continue to think that there's a lot of momentum there and a lot of strength in us as continuing this program. So it is a capability that we're investing significantly in and, yes, as you pointed out, as we move forward in time, we expect those numbers to become bigger to maintain that relative level of contribution.

Okay. And then last, you mentioned the pension costs for '24 and figuring that out, but do you have much exposure on that, or do most of your key states now have tracking mechanisms for pension?

We have trackers and deferral accounts in certain states, Jonathan, and we can go through that with you in detail. So there's a mix there of what we pick up already and what would need to be picked up in the future.

Okay. Thanks for taking my questions this morning.

[Operator instructions] The next question comes from Gregg Orrill with UBS. Please proceed.

Good morning. I think you mentioned you're working on an acquisition in Pennsylvania of $104 million to close in late 2024-2025. How do you think about, when you go into acquisitions, sort of the reasonable timeline for getting approvals? How do you think about that?

John, you want to comment on that? I think the one you're referring to in particular is a little more complicated. I wouldn't say it's sort of a traditional process, the Towamencin acquisition. I recall we stepped into that arrangement when NextEra decided to exit the opportunity. So that one's just a little more complicated, but, John, you want to talk sort of typically how we think about the process around acquisitions?

Yeah. And, Greg, it varies state to state, but since you mentioned Pennsylvania, there's a process you go through to file an application. The application has to be deemed complete, and then that starts a statutory clock and so in the case of Pennsylvania, there's a six-month statutory clock that runs through and then either you're settling your approval or you're litigating your approval, but all within that six-month statutory timetable and so what's different about this situation?

Well, Towamencin is one where there's opportunity based on precedent in Pennsylvania. We'll see how the post-PUC approval plays out, but we're just allowing a little bit of latitude in the event that there's any follow-up to the PUC approval from interveners.

The next question comes from Aditya Gandhi with Wolfe Research. Please proceed.

Good morning, Susan, Cheryl and John. Can you hear me?

We can. Good morning.

Thanks for taking my questions. I just wanted to start on PFAS. I'm curious to hear your latest thoughts around two specific topics. How are you thinking about the protection of water systems from any PFAS-related financial liability under CERCLA? Do you see risk if a final rule is released and it doesn't contain any protections and then the second topic is, can you maybe give some color on what portion of the $50 million additional annual O&M qualifies for [indiscernible] or expense mechanisms?

I can take those questions. This is Cheryl. As far as protections around the SOCLA, we have been really engaged in that process, and we have been pushing really hard to ensure that water and wastewater utilities are protected in that space. And so we're going to continue to fight that battle. Right now, you're right, there is a little bit of vulnerability out there, but we feel pretty confident that we're going to be able to manage through that and that we're going to be able to impact how we're treated in that space. So more to come on that, but rest assured, we're going to fight like crazy to make sure that we are protected there. And as far as the $50 million, I don't have an exact breakdown, and we haven't talked about an exact breakdown from state to state. But whether or not that would be recovered through mechanisms just depends on the type of mechanisms that a state would have. So if they have a mechanism that would allow them to recover their production costs, any kind of tracker in that space would be really helpful in those costs. In some cases, we have environmental riders that include capital improvements. Some of them include capital and operating improvements, so that would allow them to recover those costs as well. So there's going to be a portion that we're going to be able to recover right up front, but the rest of them will just recover through a general rate case with very little lag, I would anticipate, as far as those costs are concerned.

Yeah, and the only thing I would add to that is where we don't have an existing mechanism or an approach to ensure timely recovery, we're going to work to design one. Our view here is that these are federally mandated costs, and we are taking care of a problem created by someone else and because of that federal mandate and the federal rule behind it, we think we'll have a great argument to make around recovery and timely recovery. So we'll be looking for where we don't have existing solutions, we'll be looking to create a new opportunity to do that. So there'll be a lot on the regulatory front here to do once we have a final rule and know how this plays out.

Yeah, Susan, I would just add that that three-year implementation period that we have to put treatment in place gives us time to do those kinds of things and make those regulatory improvements.

Right. Got it. That's super helpful color. Thank you. And just one question for John, on the equity needs, you mentioned it's in the middle of your new '24 through '28 plans. So sort of in the '26 time frame. You're also going to have proceeds from the HOS note come in. I believe they're due at the end of 2026. Just can you add a little bit more color on timing and the form of equity? Is this just going to be like a straight block, or is this going to be some sort of forward where you'll maybe draw down on the forward over a couple of years? How should we think about that?

Yeah, I would say that we're not close enough yet in terms of time to have made the decision on the exact form of equity. You're right on the timing of the HOS note proceeds, but as we approach the more immediate timing, then we'll develop our thinking closer to that point, but certainly, we'll look and do what's best for shareholders there. I'd say that you've seen us issue the straight equity as we did this year with the $1.7 billion. We issued the convert this year for $1 billion, and so we're willing to look at everything, but I'd say that's a decision we'll make as that time approaches.

Okay, got it and just one follow-up. Can you just clarify the point you made on your cash taxpayer status? I just wanted to confirm, is there a base for your 7% to 9% EPS CAGR at all, I can find that in the slides or the earnings release.

Yeah, and let me just clarify, Aditya, on the equity that we've talked about, to be clear, it will be equity, not another instrument to replace the equity. With regards to our cash taxpayer status, with the Inflation Reduction Act, we do expect that we'll become subject to the corporate alternative minimum tax in the coming years. Those regulations are not finalized at this point, and there are certain elements that are in play that will dictate the precise timing for when we would become subject to the AMT, but we are expecting that to be the case for us. With regards to the 7% to 9% in a base year, I'd say on that, this is a target that we think of as a long-term target. You're aware that over the last few years, we reset the capital plan with the sale of HOS and the sale of New York, and we needed time to redeploy those proceeds, which was the case in '22 and '23 and as Susan pointed out, our '24 guidance reflects an 8% EPS CAGR at the midpoint. So we really think of 7% to 9% as a long-term target driven by the long-term 8% to 9% rate-based growth CAGR.

Got it. That's super helpful. Thanks for taking all my questions.

At this time, we are showing no further questioners in the queue, and this does conclude our question-and-answer session as well as our conference. Thank you for attending today's presentation and you may now disconnect.