Essential Utilities, Inc. (WTRG) Q2 2008 Earnings Report, Transcript and Summary

Welcome to the Aqua America Second Quarter 2008 Earnings Conference Call. Today's conference is being recorded. Now at this time, I would like to turn the conference over to Brian Dingerdissen, Director of Investor Relations. Please go ahead.

Thank you, Dwayne. Good morning everyone. Thank you for joining us for Aqua America's second quarter 2008 earnings conference call. If you did not receive a copy of the press release, you can find it by visiting the Investor Relations section of our website at aquaamerica.com or you can call Will Meade at 610-520-6309. There will also be a webcast of this event available at our site. At this time, I would also like to clarify the issue with the press release this morning. The first press release that went out had an incorrect date for the December 1 dividend for the record date. It should have said November 17th. A corrected release has since gone out. Yesterday's dividend release was correct that the record date for the dividend for December 1st was November 17th. Presenting today is Nick DeBenedictis, Chairman and President of Aqua America along with Dave Smeltzer, the company's Chief Financial Officer. As a reminder, some of the matters discussed during this call may include forward-looking statements that involve risks, uncertainties and other factors that may cause the actual results to be materially different from any future results expressed or implied by such forward-looking statements. Please refer to our most recent 10-K, 10-Q and other SEC filings for a description of such risks and uncertainties. During the course of this call, reference may be made to certain non-GAAP financial measures. Reconciliation of these non-GAAP to GAAP financial measures are posted in the Investor Relations section of the company's website. At this time, I would like to turn the call over to Nick for his formal remarks, after which we will open up the call for questions. Nick?

Thank you, Brian, and god morning everyone. This morning Aqua announced its earnings of $22.6 million for the quarter or $0.17, meeting First Call, but down a penny from last year. Also, yesterday, we released, after our Board meeting, the Board reviews in our strategic session in August. Reviews our annual business plan and future potentials and yesterday voted... a vote of confidence in our long-term growth business model by raising the dividend from $0.50 to $0.54 with the increase to go into effect in our December payment. And that's what Brian was just referring to, the record date to November 17th. That's an 8% increase, and I think it rewards our shareholders from a standpoint of this is the 10th consecutive year where we have been able to raise our dividend above our stated 5% target. That's our 18th increase in dividend in 17 years. That's a track record that very few companies have been able to achieve, and we're very proud of that. The biggest factor in our quarter is really flat revenues. Revenues were only up one-tenth of 1%. Obviously, it's hard to grow earnings if you can't grow revenues. And I want to address that, what happened and what we're doing and what we see as the future potential over the next two quarters. We were negatively affected by consumption generally, which basically was because of some wet weather in the Midwest and the drought declaration in North Carolina, which limited sales. And there was moderate weather good... one good month, one bad month in the Mid-Atlantic, which of course is our largest area. That was offset, however, almost equally by the increases in surcharges and rates and pricing. So the consumption and the rates really offset each other. And then the other offsetting factors, usually, we have growth that helps us increase revenues and we did have growth this quarter of between three quarters and a percent. On the other hand, we disposed of two properties and Rancho [ph] in the fourth quarter of last year and Fort Wayne in the first quarter of this year, and that entailed a loss of revenues about the same as our new growth. So reason for it being flat. So obviously, what's the solution going forward? We are praying a lot for warm weather this summer and no rain. But that's something out of our control. That will improve the consumption part. On the other hand, two things we can't control, at least partially. One is to try and achieve a fair return for all the investments we've made over the past couple of years, fixing up the system and improving the infrastructure in our 13 states, what we call regulatory lag. And that is you get through rate case litigation and then the final rate decisions. And I'll go into a lot more detail later in the call as to the status of the $70 million in rates that are in progress. The other part is growth, which obviously the national economy has a lot to do with. But our pace in the first half year year-over-year is still growing and that's good news. There is about 1% to 1.5%. So even with the much publicized national economic slowdown in housing and so on, it hasn't affected our states at least as much as you would tend to think when you hear the news reports. And recently, we announced a couple of acquisitions of reasonable size that we're very happy with. We are going to be working with the Borough of Sharpsville in Pennsylvania, 7000 people in the borough, to supply their water needs. And we just announced, I think it was yesterday or the day before, a community in Indiana, Northwestern Indiana, South Haven serving 12,000 people wastewater services. And I'll go into much more of our growth pipeline later in the call. So we're holding up reasonably well, not the pace that we're used to, but still considerable add to our top line growth potential as to this [ph] growth. We are maintaining our strong capital program, which I think is very important. We are not slowing down because of the economy or anything of sort. We are still looking at about $1.3 billion spend over the next five years, $250 so million a year. And the subtle shift as we have been putting a lot of money in our Southern operations, and we had to, mainly because we inherited a lot of problems that needed major fix ups. We are down to a handful to complete there and the run rate in the South will be lower, mainly because we're still going to spend more than depreciation and maintain the system excellently and do everything that has to be done, but not at the pace of 2.5 to 3 times depreciation that we inherited to get the system in shape in '04, '05 and '06. So '07 was down slightly, '08 will be down slightly, again then '09 and '10 will be more into a compliance mode at a little more than depreciation. Meanwhile, infrastructure replacement in the older areas will continue, mainly in the Mid-Atlantic and Northern states. And that's the states that have the surcharges that allow you to do infrastructure and not build up regulatory lag. So I think we have a nice predictable capital program gong forward and this year we should spend probably in the $280 million range, mainly because we've added about $30 million mostly in pipe work, because of the bonus depreciation of the new Economic Stimulus Act, which allows that we'll not build rates [ph] because it's, in the rate structure, it's really to help the rate payers, but also to put a lot of needed pipe in the ground. And that's about worth $30 million both in cash coming in from the bonus depreciation and then we're going to spend that in capital to improve our systems. Now the good news I think looking forward in the capital program. As we ramped up over the past couple of years, especially with the major expenditures in the South, the depreciation factors and the interest factors year-over-year really tax the P&L. Example, in '07, we were up about 19% first six months, 17% for the year in depreciation year-over-year and interest at about 14%. Huge hits to the P&L, but needed because we were... had the fund and do the work that was needed. A stark comparison in '08, first three months, which you're... first six months... excuse me, which is usually lower because of the fact that you would ramp up your spending in the summer and that [indiscernible] 3 and 4Q. Deprecation and amortization were only up 3% and we anticipate in the 7% to 8% range for the year, because of the increase in the next two quarters. But overall, less than half of what it was last year. And going forward, I think you can anticipate 9%, 10%, high single digits. In the interest category, last year we borrowed a lot of money and we also had to use a lot of short-term debt at LIBOR rates that were interestingly enough about 200 basis points higher than they are today. To give you an idea, last year we borrowed over $200 million. This year we're looking at maybe 60 to 70 and the same for next year. So much lower borrow rate because we're generating more cash to support this $0.25 million program... I'm sorry, $0.25 billion program to improve the environmental and infrastructure of our assets. And our use of the revolver has been lessened from probably in the last year at its peak. In the third quarter of '07, we've had $150 million in our revolver. This year it looks like we'll be between... right now, we're about 80, so about half of that pace. It doesn't look like we'll get much more that between $80 million and $100 million run rate for the rest of the year and probably can be able to hold that range... tight range over the next two. So as long as interest rates stay down, that obviously helps us because we are borrowing the revolver at LIBOR. But even if interest rates start rising, the impact going forward, because we are going to have less at risk, will be minimized. And I think that's what people look at in a secure, safe investment that they see a water utility being. Of course, part of this is helped by excellent S&P rating. Our Pennsylvania subsidiary was just reaffirmed at an A+ rating, which is... and a number two in the range of 1 to10; 1 being the most safe investment to 10 being the least, most risky. We're number 2, which puts us as one of the highest utility ratings I believe in the country. And the 8, the Aqua Pennsylvania rating does consider Aqua America's credit quality. So it sort of blends both the parent and the major subsidiary of the company. This quarter we also closed out the forward equity, which I tried to explain many times to many people is a very unique transaction. But it's now closed down, so it won't be in our Qs any more after this quarter. But it turned out to be very good for our rate payers and our shareholders. It closed out in the second quarter. We actually issued 1 million shares in the second quarter. So you will see a little dilution this year. On the other hand, we were able to, because of the closing of the other shares, we were able to bring in $33 million in cash that will be used to pay down short-term debt and used for capital projects, it's new equity. So if you want to look at it in a very simplistic non-accountant term, we ended up with $33 a share for those 1 million shares, which is obviously... was a good transaction for the company. It allowed our book value to jump about 3% this quarter and we anticipate, and that's with two quarters that we are flat with the hope for better quarters coming in the future, we'd look at 5% to 6% growth in the book value this year, which gets us back on track there. The dilution factor because of this million shares, we don't anticipate any new offerings in the near future. So if you want to look at another long-term factor, we were... because we had to issue a lot of equity to keep our standards up, our S&P rating up and the fact that our expansion plans were requiring that and we weren't generating as much internal cash to support it... we were growing at a 3 plus dilution factor over the last five year CAGR. In '08, you can anticipate well below 2% to 1.5% and 2% and then '09 and on forward, we look at our long-term plan possibly being less than one and going further down. With only... the only stock we need begin the DRIP, the dividend reinvestment program, which many of our shareholders participate in. Rather than taking cash dividends, they take stock. I'd like to also address the... so the capital program of basically pretty stable intact, addressing all the needs of the regulators and without the previous years' heavy increases in depreciation and interest that affected... affects the P&L. Much more stable look and with the S&P rating, solid and our need for new equity, it really is a good situation to be in from a capital risk standpoint, meaning dollar capital risk. The other big issue is we've gotten our O&M, which was growing at 10%, 15% in past years, mainly because of acquisitions stabilized. You will see this quarter, it's about 3% growth. And we think we can hold that 3% to 4% range going forward. Now why is it... what's happened? First of all, I told you in the first quarter, we were very negatively affected by bad debt and fuel costs. Those are both trending better. As we mentioned in the release, we've cut a lot of mileage driven down, changing out trucks as we speak to smaller trucks, which just like everybody in America is doing today. And fuel prices actually are starting to come down a little bit, which is good news. Diesel has not yet, so that's one of our big... we drive big tricks, so that hasn't hit yet. Hopefully, that will be coming down too. The other is bad debt. We had a better quarter in the second quarter than we had in the first. We expect that trend to continue as all our... we're working out all the kinks in the new customer service system, which prevented us from mailing out bills early on last year. This would be six months ago. Timely now. They're back on track, meters are being read on track and the collection, which is the last issue to hit, because you can't be asking people to pay back bills if the bill isn't in their hands. So now everything is working out and it's coming down. And even in its worst case, it was just slightly above 1% of revenue, which most utilities think is good; we don't. We like to get it well below 1%, which is our goal. We're approaching that level now in the second quarter and expect to get there in the third quarter. So the two variables I threw out in the first quarter conference call seem to be coming back in line. The biggest driver of O&M of course is labor and benefits, and that is well under control as you can see from the O&M both complement [ph] control and in benefits and labor. And all our union contracts in the north have been signed now, all done this year. We have two more contracts next year. But all of those were in the 3% range total package. So I think you can see there is no cost plus issue in our O&M coming up. Looking forward, there were... and because although they affect the O&M column, want to make sure that these were clear. In our fourth quarter of this year in '07, in comparison, you'll see that there were a couple of one-time items that I wanted to remind you of because that could affect the O&M column. And one was the sale of the Henrico system, which occurred in the fourth quarter. And the way the accounting standards are, you have to use a deduction in O&M versus gain on sale or whatever. And the other was... Bob, you have to help me... what was... excuse me?

The investment basin.

Sure. That one did show up on the gain on other sale. We had an investment in a start-up company that we undertook a couple of years ago and we decided to exit that investment last year or sometime in November I think it was. And we booked a petty sizable gain as a result of that investment that was called Basin Water. And between the add on the gain on the sale, which we don't have any more Basin Water this year and the idea that Henrico was sold and we booked a gain on that, but really is a reduction in O&M. And that's why I bring it up at this point in the call. That was about $0.02 in the fourth quarter. So if you're predicting on your forecasting, you have to look at that fourth quarter's earnings last year being $0.02 of non-recurring. Now, going back to where we think we can be growing revenues; therefore, growing earnings, first is of course in the acquisition area and in the customer growth area. The two ways you grow is unit growth or price growth. In the unit growth area, as I mentioned earlier, we are still seeing about a 1% to 1.5% organic growth that was in the 1.5% to 2% range not long ago. It starts falling rapidly in the third and fourth quarter of last year. So the comparisons going forward won't be... it wont' be as tough as they were in the first two quarters. But organic growth held up pretty well. I mean we were down, but not excessively in new units being put on our systems. And that includes the South and the North. So we're hopeful that things have stabilized now and hopefully start moving up again sometime at 9. Regarding acquisitions, we just announced the two acquisitions recently, and they'll add maybe 1% to the system. And we have another dozen or so, some small, some medium-sized in the pipeline that we have letters of intent or letters of agreement on that we're working to close. They may all close by the end of the year, they may not. And as you've realized, new ones are coming in. We're starting to see a lot of activity of smaller systems maybe looking at exiting the system. So we've made a management change in our corporate development group. Christopher Luning who has been with us five years in our legal department has now taken over. A former real estate lawyer. He is enjoying it he's doing a nice job and we're starting to see... he told me the other day, we're starting to see a lot more interest in people wanting our stock versus just cash. So I take that as a positive, I take that as a compliment, but we'll see. So I am modestly optimistic about growth even in today's national economic times and your guess is as good as mine is when the housing terms goes to the better. Regarding rate, which is more under our control, at least filing the rates are under our control, is we have... last call, I told you we had about $70 million of cases in various processes of the litigated process of filing rate. I can happily report that 49 of those... $49 million of that $70 million has already been decided, and the bulk being New Jersey and Pennsylvania, which in the last three weeks made final orders. We have another 11 million or so in very close to final stages where we are in final negotiations. And I would anticipate the rest of this quarter and early in the fourth quarter, we should be able to see those recognized. And therefore for the annualized basis, they would start and help 8, but also 9. So looking at about $60 million completed by the end of the year. If you want to put that on a trailing 12-month revenue basis, that's almost 9% to 10%. So you can see a lot of the lag in regulatory action is now coming home and some of this should have been probably over the last year, but now it's all coming in over this year and next year and actually the next two quarters and the first two quarters and third quarter of next year. We also are looking... we already have filed $21 million in cases, which I don't anticipate will be final this year. And we expect another $50 million probably to be filed during 9. So you can see the regulatory lag is being addressed very aggressively by the company. I think that really gives you a full rundown on the financials of the company and what our plans are. And maybe I'd open it up for questions now. We're very pleased with the dividend, because I think it shows where we think the company is going and we also have optimism with our national economy, although I can't say it's growing right now, but I think we're seeing stabilization. Open it up for questions. Question And Answer

[Operator Instructions]. Our first question will come from Tim Winter with Jesup & Lamont. Timothy M. Winter - Jesup & Lamont: Good morning, Nick. I've got a number of questions, one just house cleaning real quick. What was the actual number of shares that you issued and what was the price issued at?

New shares 1 million. Timothy M. Winter - Jesup & Lamont: Exactly 1 million?

Exactly 1 million. So that's what will show on the outstanding shares. But because of the cover of the shares that were... they were... I don't know what you call them... basically cover and shorts [ph] is really what it was. I don't know if that's the correct term, Tim. We issued 1 million and we covered about 1.7 million in shorts. And when you combine the full revenue we got, 33 million and instead you only issued 1 million shares, I very simplistically said we got 33 of share. And the 1 million that we have closed, I guess you could call it, we got 22 something. The rest was the transaction that we didn't actually need the shares since our cash generation [ph] was more than we had anticipated three years ago when we did this, or two years ago when we did it. And remember, we did it because we felt American was going to be coming out with their offering back in late '06 and we wanted to get into the market and get the number of shares we needed over the next two years out of the way. And that's why we did it and it turned out we didn't need all those shares. Timothy M. Winter - Jesup & Lamont: Worked out pretty well. As far as Pennsylvania, the rate case, I know that was a significant case. Can you give me a little detail... more details? I understand the allowed ROE was 11%, which I think is the highest it's been in some time.

Yes, I think... two things. First of all, it was fully litigated. Usually, we settle in Pennsylvania. So it's hard to tell what the ROE is when you settle. Pennsylvania, as you know, from a standpoint of water companies, is very progressive. They want infrastructure. As a matter of fact, the legislature just passed a bill, the biggest bill in the country as far as I know of 1 billion... I think it was 1.2 billion of new money going into infrastructure. They really feel that the water and wastewater systems have to be repaired in the state. So it's a trend I think more than just the Commission, and the entire legislature and Governor feel that way too. It's positive obviously. We won most of the cases... the litigated issues that the Consumer Advocate had bought up very fairly. Basically, they had an opinion, we had an opinion and judge sided with us on most of those, which helped us in the final award. And the ROE, we did get what we call bonus points for doing... buying small companies, fixing them up. The legislation allows if you'll take that risk and you're successful that the Commission can award you bonus points, which is apparently what happened in this proceeding. So, obviously, we think we were treated fairly by the Pennsylvania Commissions. Timothy M. Winter - Jesup & Lamont: So is there an official allowed ROE authorized?

Yes, 11. Timothy M. Winter - Jesup & Lamont: Okay.

But that included the bonus points, Tim. That's what I want to make sure you understood that. Timothy M. Winter - Jesup & Lamont: Okay, great. And then the --

Standpoint on an analysis, you can assume a 11% ROE on the rate base in Pennsylvania. Timothy M. Winter - Jesup & Lamont: Okay. And then the Florida cases, is that... how will that proceed here? Is there going to be a number of different districts decided at different times, or is it going to be somewhat of a uniform case with one decision? And when would you expect that? How much did you file and when would you expect a decision for this?

That's what we are hopeful for, but obviously that's up to the Commission. Florida has a process that it calls interim rates while you wait for the final rates. There's only 2 states that... I think there's only 2 of our 13 states to do it that way, but many states do it, New England and so on. So it's not unique to Florida. So there was an interim... as you know, there have been hearings held and our state President and our South President has been to every hearing and they are working on any issues that come up to transfer at some of those hearings. It's a very constructive process. And the commissioner actually attend all the hearings, which is very rare for commissioners to go to the public hearings. So we're hopeful that shows the interest of Florida in trying to get a good company to fix up some of the problems. And these were problem cases that we inherited that hadn't been in for rates since early 90s. A lot of them needed fix ups and meters were old and we're changing all the meters and all that type of thing. The process, the way I understand it, is that the interim rates are subject to bond and the case isn't decided until it's decided. And that's probably...is it 11 months? I don't know what the litigated range is in Florida, but they hold to a set range on when they agree on the case. The way we've asked for the decision is to look at it as we look at it in most of our other states, which is as one unit. But right now, they're all individual units that have to be merged into the one unit. Does that answer your question? Timothy M. Winter - Jesup & Lamont: Yes. Well, do you have a number of what the total number of revenues, annualized revenues you filed for for all of the --

Bob can give you that. I'll tell you what, if you don't mind after the call, I'll get you the exact number. Timothy M. Winter - Jesup & Lamont: Okay. That'll be fine. Thanks Nick.

And we will tell you what we got in the interim. I just don't know. Timothy M. Winter - Jesup & Lamont: Okay. Thank you.

[Operator Instructions]. We'll next go to Heike Doerr with Janney Montgomery Scott.

Good morning Nick.

Good morning.

I'm hoping we can do a little more big picture topics. So as we look at what the company's strategy had been, historically, we had used these four numbers 4, 7, 10, 5. I know we're shying away from the 4% customer growth and the dividend has been higher that 5% now for ten years. Can you maybe reframe how we should be looking at long-term growth strategies for the company. And as you try to fund more of your CapEx internally, does it make sense to be growing the dividend higher that this 5% level?

You sound like my Board members.

I'd be happy to take a seat.

Right. That's annually reviewed and it's always debated. You are exactly right. With the fact that we really don't have to sell stock, the fact that our yield is now very high compared to what it's been traditionally, but not overly excessive compared with most utilities. I think the yield of all the water companies now are in the 3% to 3.5% range, and I think electrics are probably in that range or maybe even a little higher, so. But we used to all be in the 2 range. So the stock price driving down and our continuing to raise dividends, it's given us a fair yield. I think those are realistic things to look at. But the bottom line is we want to build shareholder value. One way of building shareholder value is returning the profits in some reasonable way through either buy back some stock, which doesn't make sense if you're issuing stock at the time, or through dividends. So that's why we've relayed [ph] the dividend policy. We also have a number of long-term individual shareholders, and sometimes the demographic is the people who have already retired and are looking at dividends for their income. So we want to be careful not to abandon long-term shareholders who bought the stock with a intent in mind. So we wouldn't do anything drastic. But clearly, gets reviewed every year. Now I'll be glad to talk to you more in depth.

And we talked a little bit. I know you mentioned in the press release about the fuel costs coming down and the growth strategy of the company. When you look at sates that you acquired from AquaSource where you don't have a large presence, has divesting more systems... I'm thinking South Carolina and Missouri in particular, is that Is that something that's up for consideration to consider to kind of slim down states where it doesn't make sense?

The answer is everything in a portfolio is always under review, it's almost like a mutual fund. On the other hand, there's no way we would want to do anything in this position, so we make sure it's operating properly in fix, as our reputation is at stake, and that's why we put so much money. We've not been making money in this war [ph] as you know, but we're still doing all the fix ups at the... I think it's called the DCQ or something, but the EPA there one, and we've got into customer service billings are all up to the standards of the commission, so I think our reputation as a company nationally is at stake if we don't fix things before we decide if we're going to keep them or not.

Okay, that's helpful. And one last housekeeping item, perhaps this is a question for Dave. I know you guys had mentioned some of the charges that you took in the fourth quarter. The charges that were associated with the Florida case being tabled, that was a third quarter event. Can you refresh us what kind of charges there were as you refunded customers and I think wrote down some charges?

It was about a penny, but let me check. Yes, you're absolutely right. The third quarter is when Florida... just for other people on the call, last year [ph] we'd entered a case, had received interim rate relief, and I think it was like in an April timeframe, had been collecting the interim rates and then decided to withdraw the case in August so that we could refile it in a way that we thought had a more in line with what the Commission and their staff in the OPC expected from a company of our stature, which we have done. That caused us to write off legal expenses, rate case expenses and refund all the interim rates, which had been booked because when we got them, we thought they were good dollars. So Dave, I don't know what the total was, or whether if we can give them... Heike that later.

About $2.5 million.

Okay.

So there was a one penny charge in the third quarter and there were $0.02 of gains that you don't think will be repeated in the fourth quarter?

I think that's fair, right, Bob?

Okay, that's helpful. Thank you.

[Operator Instructions]. There are no further questions at this time. I'd like to turn the conference back to the speakers for closing comments.

No,that's it. Thank you everyone for listening.

Again, this does conclude today's conference call and we'd like to thank everyone gain for participating.