Essential Utilities, Inc. (WTRG) Q2 2012 Earnings Report, Transcript and Summary

Good day, welcome to the Aqua America Second Quarter 2012 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Brian Dingerdissen. Please go ahead, sir.

Thank you, Alicia. Good morning everyone. Thank you for joining us for Aqua America’s second quarter 2012 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 call Fred Martino at 610-645-1196. There will also be a webcast of this event available on our website. Presenting today is Nicholas DeBenedictis, Chairman and President of Aqua America, along with David Smeltzer, the company’s Chief Financial Officer. As a reminder, some of the matters discussed during this call may include forward-looking statements that involved risk, 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-Q, 10-K 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 the call up for questions.

Thank you, Brian, and good morning, everyone. Pleased to report another solid quarter with GAAP EPS up 11% at 30 versus 27 last year, we experienced strong revenue growth of 11% in this quarter broken down 5% of that’s from rates, 4% from acquisitions, the fact that the Ohio purchase and the Texas purchase last year were up against less the robust results from the other states that we used to have. And also seven new smaller acquisitions. And the remaining 2% from better than expected weather chiefly in the Mid West. But the main story of this solid financial performance in the quarter, I believe is execution, execution, execution. Thanks for just clicking. Our operating expenses from continuing ops and interest expenses were both flat, and that allowed the GAAP earnings on a continuing basis to actually go up even faster 30 versus 26 or 15% increase in EPS. On the interest front, financing we held onto our coveted A+ rating in Pennsylvania, which makes us one of the higher rank utilities by S&P. And that’s allowing us to borrow at unprecedented low rates, we did $50 million in May a 15 year note for 3.57. We have about 55% of our $300 million revolver used, so we still have quite a bit of space on it, and we’re averaging 1% a year on that borrowing. And we have – we already took out this year a $5 million issue at 9%, who can remember 9% money that was 30 years ago, I guess and $25 million that is 6%. And we have over $100 million in tax freeze ranging from 4.5 to 5.5 that we plan to call in the second half there after 10 year time period. And if we just stay with the same length of…

(Operator Instructions) We’ll go first to Michael Roomberg from Ladenburg Thalmann Investments. Michael Roomberg – Ladenburg Thalmann Investments: Hey, good morning.

Good morning, Michael. Michael Roomberg – Ladenburg Thalmann Investments: Can you just clarify the portion of revenue in O&M that was attributable to other operations in the quarter?

We’ve always been to try and get what the ratio is on the... Michael Roomberg – Ladenburg Thalmann Investments: The regulated versus non-regulated

Okay, sure. Okay, I’ll also look that up, can you get that really Bob or you want to, we get back to you after the call on that. Michael Roomberg – Ladenburg Thalmann Investments: Sure. Not a problem. Secondarily, there’s been some...

Probably just – it’s probably higher now and it’s all in that 37.3, but it’s probably higher now that because all our startup cost and the revenues aren’t coming in yet on the infrastructure, on the Aqua Resources, which is our other unit probably in the – I think that’s 50% margins, that’s probably in the 80% range O&M revenue. Michael Roomberg – Ladenburg Thalmann Investments: Gotcha.

But there’s no capital needs in that areas, it generates cash year-in and year-out. So it actually feeds the machine at the regulated side. Michael Roomberg – Ladenburg Thalmann Investments: Gotcha.

But nowhere near the margins, you get the regulated. Michael Roomberg – Ladenburg Thalmann Investments: Right. Okay, I’ve been – we’re coming across some news reports recently, Nick, about some developments of the turnpike in Allentown where they are toying with the idea of a long-term lease on their water system. And I’m just wondering what your thoughts are with respect to that is it a model that’s attractive potentially, it’s Aqua and kind of from a broader nationwide perspective. Do you view this type of arrangement as a way that kind of bridge the gap between economic justification for privatization versus kind of public apprehension towards private ownership of water assets?

Yeah, obviously our preference would be asset purchased because then you can merge it in, synergize it with everything else, it’s our basic business model. The one-off build, design, operate or O&M just operate, it’s not lower margins, but plenty of cash out all depending on how you rate the contract obviously. So we are interested, we’ve talked to them, we’ve been in discussions with them for over two years, what’s driving it as you could see from the news articles Michael is the welcoming how lot of these municipality is based on their pensions. And if you assume, you’re not going to earn 8% on your assets and the interest rate stay down for any period of time i.e. or discounted amounts if you need in your contribution to make up for inclusion 4% really has put a large contribution in the visibility of these budgets, which are usually two, three years out. And that’s really what’s happening in Allentown, it happens in Frampton where they actually – start working at minimum wage. Because it’s just – it’s consuming every possible discretionary dollar without major taxation in some of these middle size to smaller cities throughout the areas that have hot large pension – police and fire. So, it’s not gone away unless we start getting 10%, 12% returns on the S&P again steadily and until interest rates get it back up to the 5% to 6% range for discount then you’ll get more stabilization on these pensions. And I think that was driving it, now having said that that means the sole purpose of doing it is financial versus we really don’t want to be in the business, which makes it a tougher political convincing argument on why would we give up our water system. And that’s why you’re seeing more of these unique ideas like leasing now, whether if the lease makes sense or not, we haven’t been ready to owning RFP and RFQs yet and that we will be in the hunt for sure. But there is not enough information on the table to understand, we understand conceptually what that the Mayor wants, but don’t know how he thinks he’ll get there, in his messengers and whether that would work for private company. Michael Roomberg – Ladenburg Thalmann Investments: Got you, thank you, Nick.

We’ll go next to Ryan Connors from Janney Montgomery Scott.

Ryan, you might be on mute. (Inaudible).

We’ll go next to Spencer Joyce from Hilliard Lyons. Spencer Joyce – Hilliard Lyons: Hi, good morning, guys. Nice quarter.

Thank you. Spencer Joyce – Hilliard Lyons: All right. Just a quick question here, Nick I think you mention maybe in the share, it sort of a longer term target for the natural gas supplying initiative once all three phases are up and running and sort of in place. As far as the timeframe on that, within that $0.10 to be maybe like a year 2014, I’m assuming you wouldn’t quite get there in 2013, is that right?

Definitely not 2013. 2013 would be closer to a ramp-up to it, 2014 will be the third phase of that ramp up, because we wouldn’t be done until late 2013, so 14 would be on its way up. And what I said was, we’d reach maturity in 2015 and that’s when your steady state would be occurring for how long they drill. Spencer Joyce – Hilliard Lyons: Okay

Close to the 2015, but it would ramp-up over those three year period. Spencer Joyce – Hilliard Lyons: Okay.

Remember Spencer, that’s one pipeline, we’re not hopefully going to stop with one pipeline, but I want to give you that prototype. Spencer Joyce – Hilliard Lyons: Okay. And that kind of leads me into a fear, because you’re obviously still pretty far away from being sort of two completion on this first pipeline and what – do you want know any sort of timeframe that you would look to maybe make some set plans for a second or third major venter here or we still away from that?

Well, we’re talking to those periods of four or five major midstream people who are developing the gas side of it, trying to see if the where we will fit. We started this one a year ago. Talking about it and then got the first phase down within six months, so I’d say the gestation period could be as much as a year, year and a half on each one. Spencer Joyce – Hilliard Lyons: Okay. One follow-up question on the expenses; phenomenal quarter this quarter, I think we had to go back and have to go back to maybe 2002 to find a quarter this good, so congrats there.

Okay. Spencer Joyce – Hilliard Lyons: I know the trailing 12 months has continue to come down, I think we’re just over 37% now, do you’ll have any sort of target amount as far as that is concerned or some sort of an idea of how low maybe that can go on a longer-term or you just sort of making smaller picture decisions and then the overall expense hopefully will trend lower?

Great. Well the reason I gave you a five year trend was to show you that it’s constantly one of our key objectives than we have been able to achieve a reasonable sometimes more than 100%, 100 basis points, sometimes less. But generally that type of reduction if those get tougher as you get lower because there is only so low, you can go right. Spencer Joyce – Hilliard Lyons: Yeah exactly.

Take the limbo for, so now the number is 37.2, I think well its 37.3 so far for trailing 12, which is 50 basis points better than last year’s trailing 12. Last year’s full year was 38 and we’re comfortable that we think we can hopefully get closer to the 100 versus the 50 always give a range 50 to 100. But some things it affected is the revenue growth, which is all contingent on rate cases on the we’re also looking at different tax policies that could change some of that around that would be positive from cash flow, which is more important than the O&M revenue. The ratios only important if the results are better. Spencer Joyce – Hilliard Lyons: Yeah.

Bottom line results, so we wouldn’t sacrifice results or tax policy or cash generation just to look good in the comparison especially when we are the top in the industry. But I’m comfortable, we can continue to keep bringing it down. Spencer Joyce – Hilliard Lyons: Okay, sounds good. One more just kind of small follow-up, I believe we may have discussed some time ago that there was maybe some chatter about bringing back the bonus depreciation for this year...

Yeah. Spencer Joyce – Hilliard Lyons: Is that pretty much that at this point or is there plenty of possibility, we maybe get a bad rate there or going forward could see that?

Yeah, I’ve talked to our Senator who is on the super committee at Pennsylvania and he does not think it’s dead. But honestly no one thinks anything is going to happen until after the election. And the bonus depreciation is something that the members and the senators feel is an instant way to kick start manufacturing and production in the economy. And I would – I can say if it’s 50/50 or 25/75 or whatever, but there is a likelihood it will be enacted in the fourth quarter, if they do they will probably make it retroactive for the year or at least spread it over starting in the fourth quarter of this year all through 2013. And depending how Pennsylvania let’s just treat it, we might be able to generate again more cash and more net income. Spencer Joyce – Hilliard Lyons: Okay.

If not. Spencer Joyce – Hilliard Lyons: Okay, that’s all I had. Thanks for taking my questions.

Thank you.

(Operator Instructions) we’ll go next to Jonathan Reeder from Wells Fargo. Jonathan Reeder – Wells Fargo: Hey, good morning, Nick.

Good morning, Jonathan. Jonathan Reeder – Wells Fargo: How are you doing today?

Good. Jonathan Reeder – Wells Fargo: The Q2 2011, you indicated whether I guess versus that was about $0.015 benefit, how was the first...

Out of the $0.06 of continuing. Jonathan Reeder – Wells Fargo: Right.

So I mean in percentage wise it’s like 20%, 25% of the growth in our earnings. If you could clearly that’s in the $0.03, but it would be whatever that would be 75. Jonathan Reeder – Wells Fargo: Right, do you recall Q2 last year, was it kind of normal weather, was it above normal weather just wondering how you are running this past quarter?

Last June we had a bad spring and then it got to be a good June, it was wet spring and then as we we’re doing great since we we’re doing great in a 11 versus 10 for the first two months and then June and July were just fabulous months. So it picked up the whole quarter of the last year. So I would say ended up being normal versus normal. Jonathan Reeder – Wells Fargo: Okay.

The real difference here was Ohio, where we timing is everything; we picked up Ohio right on time for the hot spell, that was up 5% and Illinois and Indiana had great months. Texas had another good month, but nothing compared to last year’s drought weather. Jonathan Reeder – Wells Fargo: All right. And then you said Q3 last year, you ended up when all the certain down about the normal after the strong start to what?

We had a great July, terrible August and September. This year July Midwest is off to a good start, 3% to 4%; Pennsylvania, New Jersey are down over 5%, but I think that’s going to turnaround on a time in August and September because assuming we don’t have a lot of rain, because last year’s terrible August and September in New Jersey and Pennsylvania. Jonathan Reeder – Wells Fargo: All right, okay, just want a little clarity there and then on the Marcellus pipeline, I guess, what exactly is the timing them for Phase II and III and the costs associated with those?

Sure, Phase II has already started, should be done by November-December timeframe, its 18 miles plus river intake, total cost would be $40 million or so, I mean they are the estimates right now, they are coming... Jonathan Reeder – Wells Fargo: In that your care or is that the 50-50.

That’s the whole thing, ours should be half of that. Jonathan Reeder – Wells Fargo: Okay.

A Phase that will hook into Phase I which is already build, which is 15, 18 miles in the mountains. And Mike you flew over that, Mike actually pick a helicopter – those is in basically the (inaudible) we’re getting water off as a local water company that has their reservoir there now to feed that, that will be part of our solution going forward. And then Phase III, which we started, but the major phase that won’t be really started until 2013, that won’t be completed for sometime in 2014, is another 20 or so miles, another $50 million half of that is ours, it will take the line 20 some miles recently I have that number up to that. And that will take us up through Lycoming County and actually into Tyrone county that opens up a whole new area where shell oil is now drilling. I’ll get to that Phase III and distance and hopefully we break it after the call. Jonathan Reeder – Wells Fargo: Okay. So that’s where you’re saying I’ll reach maturity you’ll finish it up sometime in 2014, it will be full year and 15 and you think it’s around opportunities?

Yeah, that’s based on a very extrapolating what we’ve sold so far, I mean we know the prices, that’s good news. They won’t change, because we have contracts. It depends on are they’re going to drill as much as they’re drilling now or maybe even more in the future, it’s all those kind of questions. Jonathan Reeder – Wells Fargo: Okay, so the price that you guys received is locked in that perhaps...

But it’s 30 miles, Phase III is 30, Phase II is 18, Phase I was 18, the cost were Phase I is on 24, Phase II is projected to be 40, as that they have, Phase III 30 miles has projected to be 50 million, we pay that. Jonathan Reeder – Wells Fargo: Okay. And so you are saying, yeah, the price I guess (inaudible) in the contract but the volume is completely variable because it’s not a take or pay type thing.

Yeah, David, committed to buy from us, if they drill. Jonathan Reeder – Wells Fargo: Okay.

That’s the best, we’ll do, because the gas prices go to two bucks if they may stop drilling, now if gas coming back up a little bit this last couple of months, we’re seeing a little uptick in drilling. Jonathan Reeder – Wells Fargo: Okay, that’s fair enough. And then last question was a bigger picture, so you know that when I used to start following you guys you may have the 4.7, 10.5 kind of targets used to talk about. And the 10% was really, I guess you kind of backed off a little bit, when you’re digesting Aqua stores and what not. What’s kind of the long-term target now I mean is that 10% year-in and year-out and how does that breakdown between the regulated business and call it the unregulated Marcellus type?

Well, we’ll give you the numbers, but and I think we’ve to do it on a continuing basis because there’s so much noise with the gap regarding the tax policies or everything else and if you take out...

Yeah, going up in 93 or 94.

Okay, if you go back from 2007, which is after we digested most of the AquaSource it has been pretty steady, 10% of not even higher 7 to 8, 8 to 9, 9 to 10 or maybe was 8 to 9, 9 to 10, 10 to 11 and 11 to 12 is going to be even as excess of 10 based on the continuing less adjusted for the taxes, because we don’t have in this year. And we’re comfortable going forward, visibility being a couple of years that the model still holds. Now where we weakened is with the acquisitions just aren’t out there, and organic growth isn’t out there, so the four has the last couple of years, but we see a return to that as soon as the economy comes back. But what we’re trying to do is make up part of it with the unregulated, which is done nicely as a skeptic and they are making money and growing every year and not taking any cash from the company. So part of the new model, if you want to call it that was the Marcellus still using a lot of capital. But it’s getting paid back a lot quicker, it’s not 100 year most pipelines is 1% depreciation. This one Jonathan, we’re taking it over through the 10 or 7 years, 10 years, which is the max. So your expenses are heavy in that JV for 10 years. But we don’t want also in case they stop drilling in 9 years, we don’t want to take the right off either. So while it’s just a different model, but I don’t see it right now, it’s 2% of our revenue stream, I don’t see it growing much more than 15% to 20% at the max over the next five years. And it’s really predictable unregulated, if you can, we are looking at pipeline stuff, we do anyhow it’s just in different way rather than having a regulator and rates, we’re doing it with contracts with people who are going to be constant buyers of the water or wastewater. Jonathan Reeder – Wells Fargo: Right, you say in five years, you could envision the non-regulated business being about 15% to 20% of consolidated EPS?

Yeah, I think so, I mean that’s aggressive, but I mean we’re not going to do it, unless it makes more money than the regulator or comparables to the regulated, but if we start growing at 6%, 7% regulated on acquisitions again. Probably it won’t ever get to 15%. Jonathan Reeder – Wells Fargo: Okay.

But now we have something to keep that bottom-line growing, it has to be something to replace the regulated, if the regulated slows up. Jonathan Reeder – Wells Fargo: Right, and are you baking in any sort of assumptions around those other, pipelines that you are talking about with the four or five other people?

Okay, yeah, hopefully, there will be prototypes of the starting I think we are, starting things with the prototype we have now. I mean we now understand the business a little bit we know what the contract should look like with the JV partner. And we understand the permits that are needed core of engineers little bit for permitting that we’re use to was entire fresh or bigger range. And operationally, we take everything for granted, it works that’s a big deal again Michael has flown up there, he is in a terrain and you them terrain and the fresher and everything else. This was not a slammed article we started. That’s what I am saying, execution we take for granted in our company and I really do want to reinforce with the people who follow these all these years. It is something that’s accomplished because with the management. Jonathan Reeder – Wells Fargo: Okay, thanks. I appreciate the time, Nick.

Okay, good.

We’ll go now to Nick DeBenedictis just for any additional or closing comments.

Thank you very much and hopefully nice sunny summer for all of us. See you later.

That does conclude today’s conference. We thank you for your participation.