美國水務 (AWK) 2010 Q1 法說會逐字稿

Good morning and welcome to American Water's first quarter 2010 earnings conference call. On the call today are Donald L. Correll, our President and Chief Executive Officer, Ellen Wolf, our Senior Vice President and Chief Financial Officer, and Edward D. Vallejo, Vice President of Investor Relations.

As a reminder, this call is being recorded and also being webcast with an accompanying slide presentation through the Company's website, www.amwater.com. Following the earnings conference call, an audio archive of the call will be available through May 12th, 2010 by dialing 303-590-3030 for US and international callers. The access code for replay is 4282600. The online archive of the webcast will be available through June 2nd, 2010 by accessing the Investor Relations page of the Company's website located at www.amwater.com.

(Operator instructions.) I would now like to introduce your host for today's call, Ed Vellejo, Vice President of Investor Relations. Mr. Vallejo, you may begin.

Thank you. Good morning, everyone, and welcome to American Water's first quarter earnings conference call.

As usual, as the operator mentioned, we'll keep our call to about an hour. At the end of our prepared remarks, we will have time for questions. Before we begin, I'd like to remind everyone that during the course of this conference call, both in our prepared remarks and answers to your questions, we may make statements related to future performance.

Our statements represent our most reasonable estimates. However, since these statements deal with future events, they are subject to numerous risks, uncertainties, and other factors that may cause the actual performance of American Water to be materially different from the performance indicated or implied by such statements. Such risk factors are set forth in the Company's SEC filings.

Now I'd like to turn the call over to Don Correll.

Thank you, Ed, and good morning, everyone. And thanks for joining us today. Before we begin, I do want to mention that we did file our 10-Q prior to this call. We'd received feedback from several of you that you prefer we file before the call. And so, we're happy that we could accommodate that request starting with this, our first quarter of 2010. And since you now have more information on the quarter, we'll not go into as much detail during our earnings presentation and leave more time for Q&A.

With that, let me touch on the highlights of the quarter. We reported solid gains in revenues, operating income, and cash flow for the first quarter. Net income also increased modestly, and we're pleased with the improvement we're seeing in operations quarter-over-quarter. I think it's a reflection of our Companywide commitment to the execution of our core strategies.

And for the quarter, the Company reported operating revenues of $588.1 million, a 6.9% increase over the same period in 2009. And net income was $30.8 million, or $0.18 per basic and diluted common share.

Again, what drives this solid performance is our ability to execute on our strategies in order to ensure reliable service and provide water solutions. To do that, we must make needed investments in our infrastructure and seek appropriate returns. And during the first quarter, we invested almost $143 million in capital projects.

We also announced a fairly significant project in New Jersey. We're replacing a 1920s era water treatment plant in Millburn Township, New Jersey, and building a new state of the art facility on the same grounds. We estimate that the approximately $72 million project will create almost 200 construction jobs and once it is complete will deliver 14 million gallons of water per day to customers in our Short Hills service area. This is just one example of a long-term water solution we announced in the first quarter.

In Pennsylvania, our operations expanded into Clinton County, our 36th county in Pennsylvania, with the acquisition of Nittany Water Company. With this acquisition, Pennsylvania American Water takes over a troubled water system and nearly 1,500 people will now have the opportunity to receive reliable water service.

The acquisition serves as a further evidence of meaningful water system regionalization, and it represents our eighth acquisition in this section of north-central Pennsylvania in the last two decades. And again, it is a long-term solution.

In terms of seeking return on our investments, Ellen will give you further details on our pending cases and recent filings. But, subsequent to the quarter, rate cases authorizing additional annualized revenues of $73.4 million were approved. And as of May 3rd, the Company was awaiting final orders for general rate cases in multiple states requesting $295.4 million in total additional annual revenues. As you're aware, the extent to which requested rate increases will be granted by these applicable regulatory agencies will indeed vary.

And regarding the potential for freeing up other funding to address water sustainability issues, as I've mentioned in the past American Water has been actively communicating with external stakeholders speaking about the state of the nation's water and wastewater infrastructure, and putting it into the context of the budget crunch that many municipalities and government entities are experiencing. Not only are we able to talk about the variety of successful public-private partnerships American Water is proud to be part of, we've also been active in promoting legislation to remove impediments to private infrastructure investment.

During the first quarter, legislation removing water and wastewater from under the Private Activity Bonds' volume cap moved out of the House of Representatives in Washington and is now being considered by the US Senate. So, whether it is through conversations with the US Conference of Mayors, the US Chamber of Commerce, or a visit to the representatives in our service areas, we're seeing an increase in interest in solving the serious water challenges that exist across the county.

Moving to some other highlights of the Company, last week the Fillmore Water Recycling plant earned an Award of Distinction for Water Reuse Project of the Year at the Global Water Intelligence 2010 Global Water Awards. The facility is a state of the art wastewater treatment plant that was designed, built, and is now being operated by American Water in a public-private partnership with the city of Fillmore in California.

The plant, built ahead of schedule and under budget, currently produces one million gallons a day of high quality filtered and disinfected water. And approximately 200,000 gallons per day is used to irrigate the grounds around two public schools, a park, and a new greenbelt in downtown Fillmore.

American Water was also recently honored in the IR Global Rankings as one of the top five best-ranked companies in North America for financial disclosure procedures. The analysis conducted by IR Global Rankings is based on the quality of the information provided on each of the participant's latest financial material. We're honored to receive this acknowledgement and it clearly reflects our commitment to transparency.

Also in terms of reporting, I hope many of you had a chance to visit our website and see our virtual annual report this year, as well as our report on corporate responsibility that was just added the beginning of last week. We expect to enhance these reports even more next year.

American Water was also pleased to announce American Water Stock Direct, a dividend reinvestment and direct stock purchase plan which enables stockholders to reinvest cash dividends and purchase additional American Water common shares without any brokerage commissions or service charges.

As a result of all of the items we reported on this quarter, as well as our future outlook, our Board declared our eighth consecutive dividend on April 30th. And as it relates to this future outlook, we have announced that we are narrowing our earnings guidance for 2010 based on our first quarter results and management's current outlook for the remainder of the year.

We now estimate that our 2010 earnings will be in the range of $1.33 to $1.40 per share. We previously provided annual earnings guidance for the full year of 2010 in the range of $1.30 to $1.40 per share. In addition to tightening our earnings guidance, we are reiterating our previously stated long-term objectives, which include investing between $800 million to $1 billion annually in our ongoing capital program, a 50% to 70% dividend payout ratio, a 45% to 50% equity to total capitalization, and a long-term goal of 7% to 10% long-term earnings per share growth target.

Our 2010 actual performance will obviously depend on numerous factors such as weather conditions, current economic conditions, and no significant changes in prevailing regulatory policies.

And lastly, I know we've discussed in the past our earned versus allowed return on equity during our Analysts' Day last December. We're often asked where the Company stands in that regard, and I'd like to spend a brief moment updating you.

We've made substantial improvement since this management team came into place in 2006, but we do have more work to be done. We're taking steps to continue the progress we've made and to further tighten the difference between the earned and the allowed ROE. We're currently considering strategies to lower the impact of interest expense related to our previous owner, which represents about 1.25% of the difference between earned and allowed ROE. We're also taking measures to address regulatory lag, representing another 100 to 150 basis points of the difference.

Given the projected costs of water and wastewater infrastructure improvements, certain commissions, over the last decade, have put in place infrastructure surcharge programs which are mechanisms for providing timely returns on these investments in critical infrastructure. We're working hard to get these programs adopted in other states.

Surcharge rates, which tend to stimulate a utilities' infrastructure replacement program, are typically limited to a percentage cap between 5% and 7.5% of a utilities' annual revenue, but have been found to have a relatively small impact on customer water bills.

To address the rest of the difference, we believe our efforts to drive efficiency and execute on our core strategies, as well as an analysis of our current portfolio, will contribute to making up that difference. These measures are all steps that every good business should take on a regular basis to ensure potential efforts are considered to drive maximum performance.

As I said at the start of the call, we'll keep the details of the quarter more brief. So, with those highlights of the quarter as well as a snapshot of where we're going, I'll turn the call over Ellen to discuss our financial results.

Thank you very much, Don, and good morning, everyone.

As Don indicated, we filed our 10-Q last night. Therefore, my prepared comments will be limited so as to expand the time that's available for questions and answers.

From the first quarter of 2009 to the first quarter of 2010, excluding goodwill impairment charges in 2009, our revenue and operating income increased despite any impact due to the slow economic recovery. Net income modestly increased year-over-year due to increased operating income offset by increased interest expense. And earnings per share decreased slightly over the same period last year, given the higher share count from our primary equity offering in 2009.

For the quarter ended March 31st, 2010, American Water reported net income of $30.8 million, or $0.18 per share, compared to net income of $29.9 million, or $0.19 per share, excluding the goodwill impairment charge for the same quarter last year.

I continue to emphasize that our financial results are driven by a focus on our core strategies of prudently investing in our infrastructure, applying for and receiving appropriate rates of return on that investment, and focusing on cost containment while also making continuous improvements to the service provided to the customers and communities that we serve, as well as the processes and procedures utilized to provide these services.

While we continued to experience the positive financial impacts associated with the execution of our strategies, during the winter months we began to see some downward trends in residential usage that I'll discuss shortly.

For the quarter, American Water reported revenues of approximately $588 million, a $37.9 million increase, or 6.9%, over the $550 million reported for the first quarter of 2009. Revenues from our regulated business increased by $22.1 million, or 4.4%, from March 31st, 2009 to 2010. During the same period, our non-regulated businesses' revenues increased by $17 million, or 29.5%.

Regulated revenues increased primarily due to rate awards and various surcharges granted by regulators related to our continued investment in infrastructure since the prior comparable period. Offsetting these increases was a slight decline in water sales volume. Revenues in the non-regulated business increased primarily as a result of its entry into the industrial market through an acquisition that closed in December of 2009.

This next slide includes detailed information that we are routinely asked for. We provide this information not only during our earnings call, but you can also find it on our website as well. We have received almost $81 million in annualized rate authorizations, assuming normalized sales volumes, since the beginning of 2009 through the end of the March 31, 2010 quarter, the impact of which can be reflected -- can be seen and is reflected in our first quarter results. During the most recent quarter, we were authorized increases of $3.9 million related to infrastructure investments.

Subsequent to the quarter's end, we received final rate orders which granted increases of approximately $73.4 million in annual revenue. During the quarter, we made rate filings for additional annualized revenues of $25.8 million and $6.9 million in Kentucky and Virginia respectively. At the end of the first quarter of 2010, we were awaiting the final orders in 10 states.

Since the end of the first quarter, we received final orders in three of those states -- Illinois, New Mexico, and Indiana. Subsequent to the end of the first quarter, we also filed rate cases in three states requesting additional annualized revenues of $150 million. There is no assurance that the filed amount or any portion thereof of any requested increases will be granted.

Total company sales volume decreased from the quarter ended March 31, 2009 to 2010 by 1.1 billion gallons or 1.4%. The commercial and industrial customer classes experienced increased sales volume of 0.9% and 6.8% respectively as we see what we believe may be the effect of the beginning of the economic recovery. However, residential customer sales volume decreased by 4.1%.

It is difficult to determine whether the extent of this decrease is driven by the cyclical economy or associated with our customers' general conservation efforts and concern for the environment. We are actively engaged in assessing and analyzing this trend to determine its impact on our rate cases and rate case testimony as well as any other actions necessary to counter the impact of this decline on our results.

As a reminder, declines in water sales volumes generally only impact our results during the period of regulatory lag.

I'd like to take a few minutes to discuss our operating expenses. Total operating expenses increased by approximately $26.5 million, primarily due to our entry into the industrial market through an acquisition by our non-regulated businesses and increased depreciation costs due to our capital investments in our regulated operations, which included the investment of approximately $800 million last year.

The ratio of gross margin to revenue increased to 21.4% for the quarter ended March 31, 2010 from 20.8% for the quarter ended March 31, '09. We continue to see improvement in this margin quarter-over-quarter as we remain committed to cost containment and long-term margin improvements.

Operating expenses of our regulated businesses increased by $11.1 million, or 2.8%, for the first quarter of 2010 to $401.5 million. The increase was primarily driven by higher employee related expenses and depreciation expenses.

Our non-regulated businesses also experienced an increase in operating expenses of $16.8 million, primarily related to our entry into the industrial market through an acquisition completed in December '09.

It should be noted that the provisions of the new healthcare legislation had minimal impact on our first quarter results, and it is not anticipated to impact our results for the remainder of the year.

To meet our continued commitment to providing water resource solutions to communities we serve and deliver a reliable service to our customers, we incurred capital expenditures of $142.7 million during the first quarter of 2010. This is lower than the $196 million incurred during the same period last year. However, we are still on track to invest between $800 million to $1 billion this year.

To fund our ongoing capital program, we primarily use cash flow from operations. Cash flow from operations for the three months totaled approximately $176 million. This represents a $33.5 million or 23.5% increase over the three months ended March 31, 2009.

Our increases in cash flow and access to the commercial paper market enhanced our liquidity and increased our funds available under our credit facility. As of both March 31 and April 30, we had no borrowings outstanding under our $850 million credit facility. Commercial paper outstanding at March 31 and April 30 was $138.6 million and $143.1 million respectively.

Our interest expense for the quarter was $6.7 million higher than the similar quarter last year due to approximately $600 million of incremental debt, most of which relates to the refinancing of short term debt to long term debt during 2009.

Separately, during the first quarter of 2010, we filed applications totaling $22 million with state revolving loan fund agencies for either American Recovery and Reinvestment Act or other governmental subsidized funds. During the first quarter of '10, we received $1.1 million and were awarded an additional $9.9 million associated with applications that we did file in 2009.

And finally, our latest quarterly dividend was paid on March 1st. The just recently declared dividend will be paid on June 1st. As mentioned in our last call, our policy, subject to approval by our Board of Directors, is to declare and pay a dividend on a quarterly basis. And in the long run, we expect to maintain a payout ratio in the 50% to 70% range of net income.

That concludes our prepared statements on American Water's quarterly financial results. And with that, I'll turn the call back to Don.

Thank you, Ellen. And thank you, everyone, for joining us. We are truly pleased to relay another solid quarter of results to you, and I want to thank all of our employees for helping us achieve these results.

And we're now happy to take any questions that you may have. Thank you.

(Operator instructions.) Our first question comes from the line of Maria Karahalis with Goldman Sachs.

Thank you very much. Good morning.

Morning.

I have two questions, please. The first one is you've had a number of rate cases come in recently, and the two cases in Illinois and Indiana in particular came in nicely above 60% of what you had requested. These levels are higher than I think we've seen in some of the more recent rate cases prior to that. Is there a change in the trend that you're seeing in terms of, I'll call it, a success rate?

I guess, Maria, we don't necessarily look at it as a 50% or 60% or 70% of what we filed for. What we do look at in particular is what is the authorized return on equity that we've been granted. And in these cases, we continue to see that authorized return on equity to be within the 10 to 10.5 range that we've seen in prior cases.

But, we do continue to see from the commissions an acknowledgement and an appreciation of the investment that we have made and the necessary investment that we need to make in the infrastructure to provide our service.

So, Ellen, if I can -- and Don, if I can ask a follow up question related to the chart that you shared with us on the approach to catching up on ROE where you laid it out in terms of the ROE catch up. Can you help us think about when you're going in for rate cases now, how much of what you're asking for relates to catch up versus relates to new investment? And I don't know if the right way to ask that question is what part of your CapEx are you either under earning on or not earning on that you still need to go in to catch up on, so to speak.

Maria, this is Don. I would say we don't generally break it out that way in any of our filings. We've kind of described in the past the efforts going back to 2006 making up for the capital investment for which rates had not been filed for inflation for prior years, as well as some expenses that we needed to put back into the Company to restore some of our service to customers and the like in 2006 and 2007.

We've been filing for those in our cases and we have made substantial progress. So, we're -- we believe we're more than halfway through now in terms of our catch up. But, it's not really broken down in rate cases in this format. This is what we did to try to indicate to you as well as a lot of others who asked the question about where are we on this getting back to sort of a normal sustainable earning our authorized returns. And this is our attempt to try to capture where we are on this.

So, we are continuing to file the cases to earn the appropriate rate of return, include all of our CapEx that we can in any of those filings. We're looking to recover on all of the expenses that are prudently incurred. But, there's no real breakdown in any of our rate cases that shows a catch up piece.

Okay. Thank you.

Our next question comes from the line of Ryan Connors with Janney Montgomery Scott.

Thank you. Good morning and congratulations to you, Ed, in particular on the recognition of the IR program. It's well deserved.

Thank you.

I first wanted to talk about this issue you're talking about here with Maria on the actual versus the allowed ROE. Can you just update us on where you are using that -- in terms of that blended corporate target? Is that the 10% to 10.5% that you just quoted there to Maria's question?

Correct. The chart shows that that's the general kind of range today. And Ellen had that in her remarks and you can see that in the summary of rate decisions that we've got that are included in the appendix and on our website. That's the general range today that we're seeing for the vast majority of the states, so that's where we got that number.

Okay. And then, when you say that you're going to explore strategies to rectify the 125 basis point drag due to, I guess, the parent company's debt, can you kind of elaborate on exactly what you mean by that and what kind of timing you have in terms of taking some kind of concrete action there?

Sure, Ryan. One of the things we're looking at is the majority of that debt, actually all of that debt, none of it is allocated in any way or represents any investment that we've made in our regulated entity. It is pure parent company debt. And so, we will be looking to see if there are ways that we can minimize the interest on that by looking at other instruments that may lower the impact of the interest expense.

Okay. So, swaps and that sort of thing?

That's correct.

Okay. Okay, that's helpful. And then, a bigger picture kind of question I had. Now that we're facing the possibility of a potentially massive increase in the rate of taxation on equity dividends next year, we're hearing maybe from 15% to as high as 44% or 45%, can you just talk about how that impacts your thought process around capital deployment? I mean, if that kind of a punitive tax rate on dividends were to become a reality, would you consider lowering your payout ratio, and why or why not? And if so, would you have enough prudent projects to up the CapEx level, or would you maybe look at acquisitions a little more aggressively? Can you just talk about how that potential tax rate change and that huge double taxation on the dividend might impact your deployment priorities?

Well, Ryan, as you often do, I think you incorporated about eight to 10 questions in there. So, we'll try to touch on as many of them as we can as time allows.

I think it would be speculative and probably more of a philosophical discussion to really go too far down the road talking about what kind of tax changes might be coming. I think everybody understands what kind of shape the economy's in and what the level of federal debt and deficit is right now. And everyone knows what is set to expire come the end of the year in terms of prior tax cuts.

But, we would be speculating to say that we could predict what's going to happen come the start of next year. Lots of things can still happen between now and the end of the year. But, I don't disagree with your point that, if indeed there were an increase in the taxes of some amount, that it would be something that would require us to take a look at what our dividend policy is.

But, that's not different than what we do on a regular basis in any event. The only thing that we have said from the time that we have had -- that we prepared for the IPO is that we have a policy now because we felt it was important, in the floating of American Water once again and getting our shares out there, to have a dividend policy. And we felt very comfortable that the 50% to 70% payout ratio was appropriate and consistent with our long-term investment strategy.

But, our Board regularly discusses what our dividend policy is and should be in the context of everything that we're doing at American Water. And if circumstances change that occasion different taxes, it's something that we will clearly look at.

We are committed to continuing to invest the appropriate amount to sustain our investments and our water properties and providing the quality service that we think is necessary for the long-term. And we're certainly going to take a look at that as well.

So, I can't say that I see anything on the horizon that necessarily would suggest that we're going to be making a significant change to our capital program going forward. I think we've given an awful lot of thought to what the appropriate level of capital is that should be invested in our existing franchise areas, whether it's for water supply or for infrastructure or for the one we had mentioned today in new water treatment. We're going to continue to make those investments.

But, how it affects our dividend policy is something that there's an awful lot of potential moving parts on. And I think we've certainly -- other than having some internal discussions, we've not reached any kind of conclusions on any changes yet.

Okay. Well, that's helpful perspective. Thanks for your time this morning.

Thank you.

Our next question comes from the line of Barry Klein with Citi.

How's it going, guys?

Morning. Fine, thank you.

I'm just going to start the non-regulated operations. I think you mentioned that the operating expenses had increased about $16.8 million related to the entry into the -- some industrial markets. First, what should that recurring number be? Should it come down significantly? And also, what kind of upside do you see from entering this new market?

Let me just address the $16.8 million, because there's more than just the industrial increase in that. That is the larger piece of it, but there is also increases in there related to our military operations where we had some incremental contracts during the first quarter related to capital investment projects for the military, as well as increases in our homeowner services penetration rate in the first quarter. So, the whole 16 is not really just around the new market, industrial market.

In terms of the future that we see, we see this as an excellent market to be in. That was the basis behind our acquisition. And it's something that we're looking forward to in the future.

Okay. Thank you. And then, with regard to the Milburn project, the $72 million project, is that something that you received approval for from the commission prior to entering into that deal? Or, is that something that you have to go back to the commission and get approval to put into rates?

There's very few things that we will get advanced approval, to use that in the strictest sense, from a New Jersey commission or any commission. That's -- but, one of the things that we do do is have regular dialog with the commissioners, with the staff, and with local elected officials as well to make sure that everyone is aware of what we're doing and why we're doing it and what the potential impact will be on ultimately customer rates but also on the quality of service.

We will -- we do, in a number of states, file things in advance to make sure that, where it's necessary or appropriate, get some kind of acquiescence and understanding or certificates of need or whatever the appropriate term is in the various states. But, in this specific case, there was no specific filing or preapproval.

I don't want to sound cavalier about a $72 million project, but it is 8% of our total budget. It's about a third of our New Jersey spending. It's not really a significant part of our capital program in the total. So, this isn't the kind of thing that we do in advance with the regulators.

And I'd also note that the $72 million is over a two-year period. It's not something that's going to be just within a quarter, but it's over a certain period to rebuild a plant.

Okay. And that would just go through the regular ratemaking process?

That's correct.

All right. And with regard to -- I mean, you do have a pretty significant growth program, capital growth program. In addition to the DRIP, should we expect a small level of equity issuances each year to help fund that growth?

One of the things that we'll be doing this time is we're going to watch the DRIP. It's new, and our first dividend on it won't be paid until June 1st. So, we'll take a look at what our experience will be with that first dividend payment in June, and then we'll take a look at the equity offerings that we would do.

We have said we would do them every 12 to 18 or 24 months, depending upon our needs. And we will continue to watch that.

Okay.

Okay? I would add to that to also note that we do continue to see a nice increase in our cash flow, internally generated cash flow.

Okay. And just one more broader question. With a lot of the municipalities having trouble with their budgets, have you seen more interest from municipalities in sort of being tucked into your operations or has it been relatively stable?

As we reported last fall and again at year-end, that we had some 75 active opportunities that we were pursuing and that we had seen a continued increase. We've seen no abatement in that at all. We certainly see continued interest and an open mind from many municipalities to consider privatizing, public-private partnership, outsourcing, and a variety of things to deal with the financial situation they find themselves in.

Okay. And that level, the 75 active opportunities, is that above average, or is that pretty much in line with what it's been historically?

I can only speak to where we've been in the last four years. And it's the highest level that we've had since we relaunched and reemerged from underneath the RWE ownership. That has continued to accelerate and we're quite pleased with that pipeline.

All right, great. Thanks a lot for the time, guys.

You're welcome.

Thank you.

Our next question comes from the line of Steve Fleishman with Bank of America Merrill Lynch.

Yes, hi. Good morning.

Good morning.

Good morning.

Morning. Thanks for the incremental disclosures. A couple questions. First, just if I had to summarize the reason to increase the low end of your guidance, what would that have been?

I think the -- as both Ellen and I had acknowledged, at the beginning of the year we had a number of things that were pending, including a number of regulatory decisions. We always have a first quarter that is typically the lowest of the first quarter -- or the lowest of the quarters of the year. And we had solid performance. We were very pleased with the performance compared to prior years in our plans. And we got some regulatory decisions that Ellen alluded to that came in and they are no longer speculative.

They were at the beginning of the year when we gave our guidance of management's estimates of things that could happen. And we just wanted to make sure we kept a broader range with regard to the potential outcomes. We were satisfied with the outcomes. They are now certain. They are behind us. And based upon all of these things, we felt that it was appropriate to tighten it and use the current guidance.

Okay. Second question on the -- you mentioned one of your initiatives is the infrastructure surcharges. Is there any update on movement towards a DISC mechanism in New Jersey?

Nothing specific has moved yet. There have been more discussions. We have a new administration, as you're aware, in the state of New Jersey now. We have had a change in several of the -- in the leadership and in several of the commissioners as well.

There's lot of moving parts in regulation, so we've not necessarily sought any specific new treatment. We have filed another rate case, as you're aware, in New Jersey. But, there has been no specific action. We are continuing to follow it closely, though, and we continue to be hopeful that it will be something that New Jersey will add in the near future.

Okay. And then, last question on the residential sales weakness. Is that something that, in your first quarter, could it all be weather driven? Or, does it have to be basically some kind of economic or usage?

The first quarter is generally the least weather driven of our quarters. However, occasionally when it's been extremely, extremely cold, actually water usage will go up a little when people leave their faucets open for a drip so that there's no freezing of the pipes. So, there might be some weather related here.

It's very difficult for us, as I said, to break it out between weather, the economy, or just pure conservation, new appliances coming into the home. So, we are watching it very closely and are looking at how we can address the issue.

And one other question. Is it consistent across regions, or is it more one region versus others?

Where we're finding it is -- well, as you know, conservation, as an issue, has always been very big in the West. So, we don't find that as much now. They're also been very, very conscious of it. But, in our other regions, we are starting to see this decline.

Okay. Thank you.

Thank you.

(Operator instructions.) Our next question comes from the line of Angie Storozynski with Macquarie.

Thank you. I just wanted to talk more about slide seven and the way of increasing your realized ROE. At 526, I mean, this is a very, very low ROE. And it's actually, I think, down versus last year, at least according to our estimates, which I understand it coincides with you investing more money into your business and the regulatory lag. But, could you talk a little bit more about how are you actually trying to get to the 10% ROE, how long do you think it's going to take you? Is there maybe some curtailment of investments that you might consider, any of those?

Well, let me first say that the -- with the earnings improvement and the double-digits earnings per share growth that we've had for the last three years, we have shown continued improvement. And the 526 that was the mathematical -- the calculation we made as of the end of the first quarter was very close to where we were at the end of the year. And it was also decidedly higher than it was in '08 and '07.

So, that number is substantially improved, by our calculations, and that's the kind of progress that we were alluding to. It's up from 2006 where, by a comparable calculation, it was down in the 2% or less level. So, we're -- we have seen substantial improvement in the catch up, and that's what we were trying to show in this slide.

But, the way we're trying to do it is the way both Ellen and I have outlined a number of things. She's already alluded to the parent company debt and some of the different instruments and avenues that are available to us to look to deal with the interest associated with the $1.2 billion debt that was left as a legacy of RWE's time here and associated with the goodwill that's on our books. We have certain avenues that we can explore, and that's precisely what we plan to do.

Estimated regulatory lag, we've discussed a number of the options. DISC is --and infrastructure surcharges or whatever names they go by in multiple states, is probably the most significant of those because, this being a very capital-intensive business, reducing the lag associated with the capital that's invested is best dealt with through the surcharge mechanisms. And expanding that, expanding the percentage of it, or expanding it into other states is probably one of the largest ways we see to reduce that. And that's part of our plan.

In the catch up, a variety of things including continuing to file the necessary cases. That's part of our business. That's why we have the -- all of the cases listed that we regularly report on. But, continuing to focus on driving efficiency into the business, looking at the way we process things, looking at all of our operating ratios, looking at avenues to reduce expenses, those are all the things that are part of what our plans are going forward.

As I said, we're more than halfway there. The slide that we've shown in the past that shows the correlation between our earnings and the amount of investment, I think that this depicts in a better fashion how we're isolating some of those buckets to try to deal with it. But, we still have some more to go and that's what we're working on.

Is there any operating efficiency ratio that you're trying to achieve over the next, say, year or two?

When we look at operating efficiency ratios, we look at them, Angie, on a state-by-state basis. So, it's very difficult for us to say what that overall is. But, we do look at each state. We look at the type of expenses in that state.

For example, purchased water is a dollar for dollar pass-through. There's no margin on that. So, those with a higher purchased water percentage have a lower margin. And we do have goals to be the best in class within those states.

Okay. Thank you.

Thank you.

This concludes the question and answer portion of the call. I would now like to turn the call over to Don Correll for closing remarks.

Well, thank you. And before you go, I do want to remind everyone on the call that our annual meeting will take place this Friday.

And also starting next week, we'll have a brief video on our website giving a quick summary of the quarter. This is something new that we're introducing as another tool to communicate with our investors and we're planning to do this also on a quarterly basis. Please visit the Investor Relations section of our website to get more details on this.

This does conclude today's call. I want to thank you all again for joining us today and for your interest in American Water. And if you do have more questions, please contact our Investor Relations team directly. Thank you.

Thank you. This does conclude today's conference call and webcast.