美國水務 (AWK) 2011 Q2 法說會逐字稿

Good morning, and welcome to the American Water's second quarter 2011 earnings conference call. 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 call an audio archive of the call will be available through August 11th of 2011 by dialing 303-590-3030 for U.S. and international callers. The access code for replay is 4456951. The online archive of the webcast will be available through September 6th of 2011 by accessing the Investor Relations page of the Company's website located at www.amwater.com. Following the presentation the conference will be open for questions. (Operator instructions.)

I would now like to introduce the host for today's call, Ed Vallejo, Vice President of Investor Relations. Please go ahead.

Thank you, good morning, everyone, and welcome to American Water's 2011 second quarter earnings conference call. As usual, we will keep our call to about an hour. At the end of our prepared statements we will have time for questions.

But before we begin I would like to remind everyone that during the course of the 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 estimates 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 would like to turn the call over to American Waters' President and CEO, Jeff Sterba.

Thanks, Ed. Good morning to all of you, and I appreciate you joining us this morning. In the room with Ed and I is Ellen Wolf, our Chief Financial Officer, who will join me in the presentation, Walter Lynch, the President of Regulated Operations, and Kellye Walker, our Chief Administrative Officer and General Counsel.

It's a pleasure to once again announce strong performance for the quarter from all of our lines of business, and this continues the trend of improving financial results that you've seen over the last year.

As you can see on slide five, total system revenues increased 6.2% quarter-over-quarter to just under $675 million. Adjusted net income and earnings per share increased by 11.8% and 9.5%, respectively, over the prior year to $81 million, a little over $81 million and $0.46 a share.

You will recall that we are showing these results with an adjustment to our GAAP earnings to exclude the benefit from the cessation of depreciation for assets under agreements for sale. And remember last quarter that included our Arizona and New Mexico properties. For the second quarter it also includes Ohio. This adjustment that we make enables there to be an apples-to-apples comparison to our earnings guidance.

You'll note that cash flow from operations is the only one of the indicators that's slightly down from 2010. This is driven by a onetime tax refund received last year and an increase in pension investment this year.

As you saw in our press release, we estimate that our earnings per share as adjusted will now be in the upper end of the guidance range of $1.65 to $1.75 per share based on our performance to date. And Ellen will go into more details on this and our financials, but let me first speak about our portfolio optimization efforts and some other highlights of the quarter.

Moving to slide six you'll see that upon completion of the transactions we've previously announced as part of our rationalization process our regulated footprint will be reduced from 20 to 16 states. Our scale and cost efficiency will be improved, as will our financial performance and each and every one of these transactions when you include the use of proceeds is additive to the value of the Company and will enable us to increase our earned ROE more rapidly.

Now these are all relatively small transactions when you compare them to our overall system size so they don't move the needle dramatically, but they will improve both our short and long-term performance.

Our most recent news on this front was the announced agreement to purchase Aqua Seven Regulated Water Systems in New York. This will about double our New York customer base, adding approximately 152,000 people in four counties, and it will make our operations in New York the largest investor owned water utility in that State. Not only does this agreement allow us to take advantage of economies of scale, it gives us a platform for growth in areas north of New York City.

And the sale of our Ohio properties doesn't diminish our opportunity to continue to participate in the important growth of the Marcellus Shale region, given our strategic positioning throughout many of the active drilling areas in Pennsylvania.

As to the pending sale of our Arizona and New Mexico properties, regulatory hearings will occur later this month. We really haven't run into any opposition to the transaction at this stage, and so closing by yearend remains feasible. And we've also closed on both the Missouri acquisition, which added approximately 10,000 people to our service, along with the sale of the small Texas properties.

Turning to slide seven, let me just touch on a few other quarterly highlights. Our earned return on equity increased to 7.1% over the last 12 months, which continues our drive to reach our allowed rates of return. We increased our dividends to shareholders by 5% to $0.23 per share, continuing the consistency of yearly increases to dividends since the IPO issue.

During the second quarter we filed general rate cases in six states requesting additional annualized revenues of just over $150 million, and then in July we have filed another two cases in Ohio and New Jersey for approximately $104 million.

So far year-to-date we've also continued our strong investment track record, and we've put in almost $392 million to improve infrastructure and service reliability, which reflects about a $65 million increase from the same period in 2010.

We also completed the industry's first report on environmental, social, and governance performance against GRI guidelines. And I think, for me, the important part of this is that we really have a strong Corporate commitment to sustainability and integrated water resource management, which I firmly believe will enable growth opportunities for us in the future, while also just being the right thing to do. And we'll talk more about particularly the integrated water resource management and how we see that fitting into growth opportunities in the future at a later meeting.

Now I've already discussed the transactions that have been driven by our rationalization review. In addition, we just completed the acquisition of the Roark water and sewer operation that operates in some counties near Branson, Missouri, and we I think also announced the receipt of two design build, operate wastewater contracts in Massachusetts.

We're continuing to expand service in the Marcellus Shale region where we now have 29 points of interconnection, serving 12 different drilling companies. These are mostly hard lined connections so that we are not adding to the movement of trucks and the environmental issues that are associated with that. We're adding pipe into the ground.

One thing I want to touch on that I think represents, on the one hand it doesn't -- you could say how does it add to shareholder value? In my mind, it adds dramatically because it demonstrates the commitment we have to our customers. As you may know and recall, that in June Joplin was hit by a devastating hurricane, killed over 130 people, and about 8,000 structures were either completely destroyed or significantly damaged. And this is in a town of only about 55,000 people.

I really couldn't be more proud about what our people did, coming from all over, parts of Missouri, to help ensure that we could get water pressure for fire and other reasons back from zero to full pressure within 24 hours. And to be able to do the things necessary to move off of a mandatory boil advisory because of all the entrant points that had occurred with the rupture of lines, the demolition of hydrants and the like, within six days. I really couldn't be prouder of our folks.

And along that line, as you know, having engaged employees obviously makes a business better, and with all the technology challenges businesses face having your IT Group named as one of the top 50 best places to work, we did score in the top 50 of the entities in the top 100. It gives me some comfort about our ability to meet our technology challenges.

And the value of our employee wellness program is really direct and fundamental. With what has and will continue to occur in healthcare costs, having a culture and programs that focus on employee wellness and disease management is the greatest tool to managing those costs in the future. The payoff is both in healthcare costs, but also employees who feel good and are more productive. These are the kinds of things that add-up to sustained value creation for our customers and shareholders.

With that, let me turn it over to Ellen to go into the detail of the financials.

Thank you, Jeff. And welcome to those of you are joining us for our second quarter 2011 earnings conference call.

Jeff has just reviewed with you some of the highlights of our strong second quarter. Now I'd like to review with you some of the key drivers of those results. For a more detailed discussion please feel free to access our 10-Q through our IR website. The Q was filed with the SEC yesterday after the market closed.

As Jeff just mentioned, overall we had solid financial results for the second quarter of 2011, with increases in revenue, net income, and earnings per share, as well as continued improvement in our regulated O&M efficiency ratio. These results are driven by our Team's commitment to strategies that focused around value to our customers that result in value for our shareholders.

For the quarter ended June 30, 2011 we reported operating revenues of approximately $674 million, a $39 million or approximately 6% increase over the $635 million reported for the second quarter of 2010.

GAAP net income and earnings per share increased over 14%, however they do include a benefit from the cessation of depreciation of our discontinued operations. Adjusted net income and adjusted earnings per share represent American Water's results as if we had continued to depreciate our discontinued operations.

Our second quarter 2011 adjusted net income was approximately $81 million compared with around $73 million for the second quarter of 2010, or $0.46 per share compared with $0.42 per share in 2010. Included in these numbers is approximately a $0.03 per share contribution after depreciation from these discontinued operations.

Now I'd like to turn the discussion to the various components of our net income, starting with revenues. As Jeff mentioned, operating revenues increased $35 to $39 million quarter-over-quarter, with approximately 80% of that increase being driven by our regulated operations. Operating revenues from our regulated business increased $28 million or around 5% driven by new rates and various surcharges granted by regulators relating to our continued investment in infrastructure.

For the quarter the impact of these rate increases, some of which were granted and became effective during 2010, was approximately $41 million. These increases were offset by decreased revenues of approximately $16 million attributable to decreased water sales in 2011 compared to 2010. I will be addressing shortly the water sales for the quarter.

In our market based operations revenue increased by approximately $12.5 million or 16.6% during the second quarter of 2011. The increase was primarily attributable to incremental revenues of around $11 million from our Contract Operations Group relating to water and wastewater services that we provide to several military bases.

Now, as has been previously mentioned, the ability to earn an appropriate rate of return on our investment is a key element of our creating value for our shareholder, customer, and employees. Our rate cases are one measure of the recognition of the value of our investments. This slide shows increases and infrastructure charges that have been recently granted. During 2010 and into 2011 we were granted approximately $251 million in annualized revenue increases and infrastructure charges, assuming normal usage patterns.

In the second quarter our Tennessee and West Virginia rate cases, both of which were filed in 2010, were approved, authorizing additional annualized revenues of $5.6 million and $5.1 million, respectively.

In July of 2011 additional annualized infrastructure revenue of $3.3 million was granted and became effective relating to infrastructure investments in both our Pennsylvania and New York subsidiaries.

And on July 29th of 2011, just last week, interim rates which provide for an additional $2.3 million of annualized revenues were put into effect under bond subject to refund for our Iowa subsidiary.

Just as a reminder for those of you viewing the chart, shown on this slide are the annualized increases which will be realized over a 12-month period from the date the new rates were effective. This may or may not match our calendar year for reporting purposes.

This next slide shows the rate cases that have been filed and are awaiting a final order. As of August 3rd, 2011 we have approximately $315 million in general rate cases filed in 11 states awaiting final order. During the second quarter of 2011 we filed general rate cases in six states -- Pennsylvania, Iowa, New York, Indiana, New Mexico and Missouri -- requesting additional annualized revenues of about $151 million. And within the past month we have filed general rate cases in Ohio, where we are requesting additional annualized revenues of around $8 million, and in New Jersey, where we are requesting additional annualized rate revenues of about $95 million.

In addition to these general rate cases we also have outstanding requests for annualized revenue increases for infrastructure surcharges, purchased water, and sewage treatment surcharges amounting to approximately $3 million. There is, of course, no assurance the filed amount or any portion thereof to any requested increases will be granted.

As a reminder, through these rate cases we'll be working with regulators to address some significant regulatory lag issues, including declining usage and the timing of infrastructure spend, as well as pass-through mechanisms for key expenses that are an essential part of the services we provide, such as chemicals and power costs.

Turning now to our water sales volumes for the quarter and year-to-date, overall the sales volumes decreased from the quarter ended June 30, 2010 to 2011 by approximately 3.7%. On a year-to-date basis overall water sales volumes have decreased 2.3% from the prior year's comparable period. The year-to-date and quarterly volumes saw continuation of the long-term decreasing usage trend that we have noticed and which has accelerated over the past few years.

We can never be completely sure of the reason for the decline in usage. While weather is certainly a factor, at this time it also appears that for residential the decline is related to conservation and more efficient water related appliances. For our industrial customers usage appears to have flattened out year-over-year. And for our public and other usage customers we did see a decline of about 4.4% year-to-date, which may be an indication we believe of the economic hardships that many municipalities are now facing. We will continue to monitor water consumption carefully and to address this decline with our state regulators, and have done so in our rate case filings for this year.

Now many of you on the East Coast may have noticed some very hot weather in June, continuing into July, which in some ways is similar to last year's weather pattern. However, the major difference between the two years, particularly in New Jersey, is that in 2010 there were significant periods of time without rainfall in the summer which triggered discussions of the need for drought mitigation.

In 2011 while we also have had a very hot weather, we also have more rain. Supplies are at or above normal levels in New Jersey, and there have been no drought discussions from either State or regional authorities. And then, also as a reminder, in the Midwest during the second quarter there was an unusual amount of rain leading to floods throughout many of these Midwestern States.

Turning our attention now to expenses. Total operating expenses for the second quarter of 2011 increased by approximately $27 million or 5.9% from the second quarter of 2010. Regulated O&M expenses increased $9.7 million or about 3.7% for the three months ended June 30, 2011, mainly from increases in employee related costs, which were driven by pension expense and also increases in operating services attributable to filling open positions with temporary labor as a result of our business transformation project, as a number of our employees are now working fulltime on that project.

As mentioned previously, our regulated O&M efficiency ratio improved from 43.6% for the quarter ended June 30, 2010 to 43.2% for the same quarter ended in 2011. And on a six-month basis our O&M efficiency ratio has improved to 45.5%, a 70 basis point improvement versus the comparable period last year. We continue to see improvement in this ratio as we remain committed to cost containment and long-term margin improvement.

Our market based operation expenses increased by about $9 million, mainly driven by expenses related to the Contract Operations Group's increased activities and our military construction projects.

And now, finally, as you heard from Jeff, we reaffirmed our overall earnings guidance for 2011 of $1.65 to $1.75 per share. While there are no changes to the earnings guidance, we anticipate being at the upper end of the guidance range based on our performance year-to-date and assuming no unusual events that would impact water sales, volume for the remainder of the year.

The guidance range based upon what we call adjusted earnings per share does not recognize the benefit of earnings per share of the cessation of depreciation for our discontinued operations in Arizona and New Mexico, Texas, and Ohio, and that impact is expected to be around $0.09 per share for 2011.

I would also like to note the Board's decision to increase the quarterly cash dividend reaffirms our commitment to providing to our shareholders a total return consisting of both stock price growth and dividends.

And, with that, I'd now like to turn the call back to Jeff.

Thanks, Ellen.

If you look at slide 16, this is the slide, the standard slide that we've talked about in the past on which you can track our progress. Most of these items we have not talked about, so I'm not going to go back over them in detail. Let me just highlight a couple.

First, one of the items that we've talked about before and Ellen also addressed was the issue of declining residential usage. In every rate case that we have filed this year it has been addressed, it is being addressed in different ways, really three different approaches that are being used, and which approach is used is really kind of dependent on where the negotiations and discussions are with that state and what the particular situation of that state may be.

So in one instance we filed what I'd call a more full decoupling mechanism that's like what we have in New York. In other states we have filed changes in rate design that move us to more emphasis on the fixed and less on the volume metric component of the rate. And in other states we have used regression analysis over a shorter period of time to do a forward-looking adjustment to residential consumption. So it depends on -- which approach we use depends on the state and their particular situation, but it is being addressed in all of the states and we will continue to push on that hard.

Ellen touched on both the improvements and operating efficiency and our earned ROE. Let me just touch on one other aspect of growth, let me use homeowner services this time to just highlight a few things that are going on. We are now moving warranty products into the commercial segment, which is something that we haven't in the past done, we've been focused on the homeowner side. And we're seeing a good opportunity into the commercial side. We're also exploring ways to expand home service warranty offerings into gas and electric line and appliance care areas to expand the portfolio of offerings that can be available to customers.

So those are just a few of the things that continue to help us feel that we'll be able to have reasonable growth out of our market based operations. And, as you can tell, in the second quarter, as Ellen highlighted, we've picked up revenue of over $12 million and cost increase of around $9 million, so adding to the bottom line.

With that, we will be happy to take any questions that you may have.

Thank you, sir. (Operator instructions.)

Our first question is from the line of Ryan Connors with Janney Montgomery Scott. Please go ahead.

Great. Thank you. A very detailed review of the quarter, so I've actually got a couple of bigger picture questions. And, first off, just actually on the market based side, I know, Jeff, you've talked since you've joined the Company about rolling out kind of an innovative approach to contract operations on the municipal side. And there was an interesting kind of beta test of that in California with Rialto that did not work out.

I wonder if you could just briefly summarize how that situation went down from your perspective, what the key drivers were behind that ultimately not making it across the goal line, and what the Company learned about how it approaches those types of opportunities going forward? How you might tweak that model? And then, finally, just what that says about the state of the appetite for contract operations on the municipal side?

Thanks, Ryan. Good question. A couple of things about the Rialto. A, it's not over, it's not been decided. What happened is we ended up with a 2, 2 vote out of the City Council, and that's not a definitive vote, it just meant that the deal could not go forward at this stage. So there's still ongoing discussions because they still face a fairly significant problem. In fact, in some respects it seems to be manifesting itself more significantly for them.

But I think there are -- there clearly are some learnings. One of the major challenges and this could occur in a lot of the situations, is that there's a significant rate increase. Now in this situation the significant rate increase is there regardless of the proposal we had in front of them. But I think one of the things that happened is that that rate increase got tied to our proposal because it was a specific proposal. And their own analysts, the old [R.W. Beck SAIC Firm], demonstrated that they would still be facing a significant rate increase.

But I think you get that label and it creates tension in a community, particularly during these economic times. The reality that a Rialto and other communities have to face is, okay, so if not this then what? And it's the then what that I think some communities will struggle with.

Our position and commitment is that we're interested in finding a different way to be able to provide value to those markets. We will not go back to doing it in the traditional short-term contracted O&M way. And if we can't find a way to do that, well, then we just won't do it. I do believe, though, that there is a market. It's not -- it's targeted, it's not a broad based desire of cities to sell-out their systems or to do something like this, but there are definitely multiple entities that do have an interest. And those conversations are starting to continue to move. And, as I said, Rialto is still on the table.

So I think the learnings for us, one, is that the rate impact that a city faces has got to be understood by the city independent of what we propose. And they really have to help their constituency understand the need to raise rates. And that this is a way, it may be the same rate increase but it will create greater longer term value. And if we can demonstrate that then I think that business model could be successful.

Okay, and then on the regulated side, I just wanted to get some view on this issue of portfolio optimization or the swaps or whatever people are calling it. I think there's a broad consensus that that game plan makes sense strategically, and obviously there's more -- there's further overlap with your listed peers, there are other deals taking place obviously outside of even your own Company. So it seems to be a very active period here in terms of assets management by you and your peers.

What are the limits to that process continuing at this pace or even accelerating? I mean are there limits to how quickly the industry can do these deals, whether they're personnel internally, whether they're regulatory in nature, or can we kind expect this period of accelerated activity to kind of sustain itself for a little while?

Well, any -- each of these transactions you have to look at on its own merits. And one of the things that you're -- at least we're sensitive to is also transaction cost. So there are times you may be able to do something but the transaction costs that can be associated with regulatory approvals, et cetera, can take those, whatever the benefits may be to something that just doesn't make it worthwhile.

That said, I think the good thing that has happened is that the dialogue has opened up, instead of people kind of hunkered down behind their own walls, to have the conversations about how can we benefit the overall industry and our customers. And if there are ways to do that that are sensible for owners and customers and pass regulatory muster then there will be a basis to pursue them.

I'm not sure that I would forecast that we're going to see a huge rash of this because transactions are still fairly labor intensive and there's a pace at which it can go. And I think we and others in the industry we're fundamentally based on being utilities that provide service to customers. Transactions are not our business, they can be a way in which we enhance our business.

Great. Well, thanks for your time this morning.

Thank you. The next question is from the line of Mike Roomberg with Ladenburg Thalmann & Company. Please go ahead.

Hey, good morning. How are you?

Great.

Morning.

Good. I just wanted to start-off with the New Jersey rate request that was just filed last week. It was a bit earlier than we had expected previously. I know that you guys have been about a 24-month filing schedule. And I guess given that you have a [10-3] ROE in the State right now and are from what I understand also in the midst of a proceeding with respect to [DISC], I just wanted to get your perspective on why now and kind of the rationale behind that?

Okay, this is Walter Lynch. I'll take that question. The New Jersey rate request is really tied to the significant capital that we've been putting into the system since our last rate increase. It's really about $300 million, and a big portion of that is the new plant that we're putting up in Short Hills, New Jersey, and that'll be completed the summer of 2012. So it was really tied to the capital and the necessary infrastructure investment that we're making in the systems in New Jersey.

Okay, understood. But is there any kind of read-through to, say, other states that you have filed on a more rapid filing? I think you last filed 16 months ago as opposed to again the 24-month historical precedent. Is there any read-through in terms of your filing timelines in other states that we can read from this?

Hi, this is Ellen. The way we file rate cases is really around our capital investment, and as we noted in New Jersey what we have is an accelerated capital investment because of the need to upgrade and update and put a more modern plant in, replacing something that's over 100 years old. You'll note we also filed in Pennsylvania because we have a major project that we had talked about going on there, as well, in Pittsburgh. So really the drive around our rate cases is the timing of any major capital investment.

Okay. Okay, understood. So I guess, you know, you mentioned Pennsylvania, we follow two other companies that have pretty significant presence in Pennsylvania, and both of them this year are recording a tax benefit related to -- a unique tax benefit in Pennsylvania for bonus depreciation. One has been reporting it as a onetime item, one has been reporting it as a lower overall general tax rate.

You guys, it seems that your tax rate this up a bit this year on a consolidated basis. Given that PA is about 25% of your Company is that something that you guys are not accruing? And I just, in terms of figuring out how that compares to next year's results or estimates, I'm just trying to get a handle on that, can you help me with it?

Sure. And let me do that in two parts. And not just Pennsylvania. Let me go back to 2008 where as a Company we were very -- took the position to apply for a repairs and maintenance deduction which was not required but was something we took the initiative on because it does provide a cash flow benefit to us and, therefore, our customers. We filed for that back in 2008 and have recorded the benefit of that back at that time and in 2009, and that is one of the main drivers of our tax loss carry forwards that we have that will -- are going to benefit us for a number of years.

In 2011 you might remember on our first quarter we did announce a benefit of a little under $5 million for Pennsylvania related to adopting bonus depreciation and, therefore, realizing a State benefit in the first quarter. And, again, we did announce that and took that benefit in the first quarter of 2011.

Okay, I see. Thank you. And then I guess, lastly, we were impressed to see the dividend grow at a 9% year-over-year rate and with this most recent increase. And I'm just wondering as you go forward and think about the payout ratio, et cetera, whether or not you see that as being a sustainable rate or something that even could grow, can you comment on that?

You said 9%, I mean I think it is a 5% growth rate, that's what we have sustained since the IPO. We've talked to an awful lot of our owners about the issue of dividends and the balance between being able to reinvest that capital at a strong regulated rate versus paying it out in dividends.

And what's really come out of those conversations and our belief is striking the right balance, and that's what's really important to people is consistency in its growth. And that's really where we're focused. We don't necessarily look at the payout ratio as driving the decision, but obviously we're in a situation where our earnings are growing a bit more rapidly than the dividend is increasing, which has been increasing at 5% a year.

Okay. Thank you very much.

Thank you.

Thank you. The next question is from the line of Heike Doerr with Robert W. Baird. Please go ahead.

Thank you. Good morning. Congrats on a solid quarter, and thanks for getting us the Q yesterday. It really helps on our end.

You're welcome.

I had a couple of questions. First, on your infrastructure surcharges. On slide 10, Ellen, can you tell us how much of this $41 million in revenue increase is attributable to base rates versus how much of that is from these infrastructure surcharges?

Yes, and, Heike, the majority of that is from rate increases. When you look at the total amount for the year while it again helps us close regulatory lag it is really around the rate cases that drive that increase.

But would you say it's a quarter of that $41 million, maybe only 10%? How should we think about it?

I would think about it as a small portion of that.

Okay. Okay, and on slide 11, where you list the infrastructure surcharges by state, is this as of the beginning of 2010, this $34 million, or is this just in 2011 you've had $34 million of infrastructure surcharges awarded?

This would be those infrastructure surcharges that have been awarded in 2010 or 2011 that have not been covered by the rate cases above. So to the extent if we had an Illinois decision, that Illinois decision, that 1.6 that's on the chart, that is since the rate case has been decided.

Okay, do you know year-to-date how many infrastructure surcharges have been awarded just in calendar 2011?

I will have to get you that number, Heike. Off hand I don't know. I mean we're looking -- we can get you that.

And on the consumption pattern, if we look at the differences between the first quarter and the second quarter what jumps out is that you had seen a modest increase in industrial consumption in the first quarter and in the second quarter we saw that going back to being a decline, as it had been with residential and commercial. Can you tell us what's going on there?

Well, Heike, it's difficult to tell what goes on in any one category, but generally we look at the first quarter as a cleaner quarter and that it's not impacted by weather.

Is industrial impacted by weather, though?

Just to the extent they're watering their lawns or their plant sites and things like that.

Well, and also remember that some of our industrial load is in that flood plain area that in the second quarter had real challenges relative to their operation. Think about the food processors, a number of the food processors actually got stranded, they couldn't even get to their plants for processing. And that's where we saw some of the [run].

Okay, that's helpful. And as a final question just to make sure that we're all talking apples-to-apples for how your guidance looks compared to what the earnings are, in the first quarter we had been talking about $0.24 from continuing operations and $0.03 of discontinued operations, but I don't recall us really talking about the cessation of depreciation. Can you reconcile that for me so that first quarter and second quarter we're looking at them the same way?

Yes, I think in the first quarter we did talk about cessation of depreciation. The number for that first quarter was about the same, $0.03. So when you look at the discontinued ops it has a $0.03 boost in it for the first quarter related to that depreciation.

And, Ellen, for the year we expect that will be a total of $0.09.

About $0.09.

Okay.

Which is a little higher than you heard at the end of the first quarter because we've now added Ohio to the discontinued operations.

Right. Okay, that's helpful. Thanks for the additional visibility on that.

Sure.

Thank you. The next question is from the line of Brian Chin with Citigroup. Please go ahead.

Hi, good morning.

Morning.

There's been quite a bit of activity from other high quality credit players about placing capital out there at very, very low cost. Is there any opportunity that you guys see about potentially refinancing some of your fixed rate debt just to take advantage of the little bit lower cost debt that's out there?

Okay, let me -- if you look at our interest rate, our interest expense year-over-year you will notice that we are about flat in our interest expense. And included in there is about a $3 million benefit that we got from doing some refinancing. So pulling that out year-over-year you'll see a decrease in our interest, and that is really driven by the fact that we did a number of refinancing back in 2010 and are seeing the benefits of them this year, as well as some, while we will always continue to look at refinancing opportunities throughout 2011.

Given the magnitude of where bond yields have fallen since you did that large set in 2010 are there sort of any items that come to mind as being readily available now?

Yes, and again we just look at it on an ongoing basis. We have nothing out there at the moment, but we will continue to look.

Appreciate that. Thank you.

Thank you. The next question is from the line of [Barry Klein] with Macquarie Research. Please go ahead.

Hey, there, good morning. I have two unrelated questions. Can you please expand on Jeff's comments with regard to your strategic positioning in Pennsylvania and the Marcellus Shale, and what your plans with regard to the Marcellus Shale are? Also, with regard to your NOLs, where do they stand and over what period do you expect to utilize them? Thanks.

Let me ask Walter to answer the first one?

Yes, particularly the Marcellus Shale, our service territories overlap many of the drilling sites in Pennsylvania, primarily in our northeast and western operations and that's where we've been selling a lot of water to the 12 different drilling companies we're working with. Year-to-date through six months we've sold approximately 120 million gallons to these 12 drillers through 29 connection points. So we've been working very closely with them. And, again, many of our service territories overlap the drilling sites in the Marcellus Shale areas.

One of the things that I'm just thinking we may want to -- we may post on our web would be the map that shows all of -- where the wells, the current wells are and the new wells are being drilled relative to our service territories. Because we're not heavily concentrated in the eastern part of the State, we're more concentrated in the western and up in the northeastern parts of the State which are, in fact, in that Marcellus region to a much greater degree.

And, again, Jeff mentioned that some of the drillers extended lines to reduce the traffic in the areas where we serve, so that's a big benefit, as well. And also prolonging the infrastructure of these roads that many of them are in rural areas, they're not designed for that kind of truck traffic.

Well, are you also looking at wastewater opportunities there, as well? Or is it purely selling the water?

We certainly are looking at wastewater opportunities. Frankly, what's happening today is the water is going through a reuse, so they dilute the liquids that come back up, about 40% of those liquids come back up fairly quickly to the surface through the well hole and are put into lined pits. Then that's being diluted and being used for the next fracing.

But there are certain situations where already we're starting to see the need for wastewater processing, and Pennsylvania has limited the ability of these high TDS water sources from being put through traditional wastewater treatment. We see wastewater treatment as an integral component of the integrated water cycle and, in fact, have a number of initiatives underway to expand that. So I won't comment any further on specific initiatives, but we are very definitely looking and working in the wastewater treatment area.

On your NOLs, we have significant NOLs, we have over a billion dollars of NOLs. These NOLs do not begin expiring until sometime after 2024, but we anticipate utilizing those NOLs in a much shorter timeframe somewhere in the next seven to 10 years. A much more detailed analysis, if you would like it, is available on our 10-K on footnote 14, so.

Okay. Thank you very much.

You're welcome.

Thank you. The next question is from the line of David Paz with Bank of America. Please go ahead.

Good morning.

Morning.

Morning.

I just wanted to confirm, have you incorporated the July weather into your current guidance?

Thanks for the question. What we have said is our guidance assumes normal, put that in quotes, normal weather patterns for the remaining six months of the year. You never know, as a matter of fact today it's actually raining, and that's as we go into August, so we don't go into sort of predicting the future and don't know what will happen for the rest of the quarter. So at this stage we assume a normal weather pattern.

Okay, and does the lack of drought conditions in New Jersey, Pennsylvania, at least in July, how should we think about that as affecting sales versus last year when there were drought conditions? In other words, when there are drought conditions you cannot sell as much, and now that there aren't maybe some more? However, whatever color you can add that would be helpful?

What you have is that, you know, I don't know if you want to call it a tipping point or what have you, but if you have hot and dry weather obviously that increases sales. You hit a point where drought conditions are imposed and people are first voluntarily and then maybe mandatorily restricted. So then you start to see a decline, but it's a decline from a pretty high level. So you've got to get there before you see the decline.

Okay, and just speaking of long-term usage declines, I think you or maybe others in the water industry have said that the long-term decline has been roughly about half a percent, maybe 0.6% per year, is that still valid or now that you've seen an acceleration in the declines should -- maybe is it a little higher?

Yes, we're looking at a half to 1.5%, and we've done a lot of analysis on this using regression trend analysis, particularly in the winter months where weather is not impacting the results. And we're looking at that range of a half to 1.5% typically.

That's probably a little on the higher.

Yes, it's a little on the higher recently.

Great. And one final question, just your -- I had noticed or maybe I missed it, but your long-term growth rate is that still applicable and does that apply to the upper end of the guidance which you guys expect to earn this year?

As a long-term growth rate, yes, it is still applicable. It is not an individual year-over-year, it's a trend, but, yes, it is still applicable.

So the base being the upper end of the guidance, it's fair.

Yes.

Okay. Thank you.

Thank you. (Operator instructions.)

The next question is from the line of Garik Shmois with Longbow Research. Please go ahead.

Thank you. Good morning. I just have one question just with respect to the recent debt deal in Congress and the potential cuts to the Department of Defense, does that change your view, at all, as far as the long-term growth of the military contract business and maybe the rate of contract awards going forward?

Yes, that's something we've really taken a pretty close look at, and you never really know. I don't think it is going to alter or slow-down the pace at which outsourcing and privatization is done. Over time it certainly may impact the overall number of bases because I think it's a reasonable expectation through this process you'll see another [break]. So over time it will certainly impose, the potential for base closings, but in fact it may accelerate some things.

So, for example, in the base privatization today there's a requirement that privatization bids must provide at least a 10% savings. When you really get into a budget crunch, if it's not 10% you go to zero or do you, does the government say, wait a minute, if we can say save 3% or 5% or help avoid some capital expenditures that we don't have the money for, then privatization still makes sense. So there's the counterbalance where it can, in fact, speed-up some of the opportunities to take over bases that are currently not in that state.

Okay, that's helpful. Thank you very much.

Thank you. The next question is a follow-up from the line of Mike Roomberg with Ladenburg Thalmann & Company. Please go ahead.

Yes, thanks, guys. I just had a follow-up for Ellen, if you will? On the NOL point, I just want to know are the NOLs held exclusively at the parent Company level or is some portion of those NOLs at the utility level only because I believe there's different regulatory treatment for those if they are, indeed, held at that level?

Yes, the NOLs I mentioned are the federal NOLs, but there are state specific NOLs, as well that are down at the different states. And then even as the federal NOLs are taken into account differently by each state in their rate setting process, not so much the future NOLs but the historic, anything we have in the way of deferred taxes.

Okay, all right. That's helpful. Thank you.

Sure. Thanks.

Thank you. The next question is from the line of Cleo Zagrean with Macquarie Capital. Please go ahead.

Hi, good morning.

Good morning.

Could you just help us understand the different factors that quarter-to-quarter affect the progress on the regulated O&M efficiency ratio? For example, Q1 of this year versus Q2? And then longer term what are the key drivers that will get you to the 40% level within five years? Thank you so much.

Well, Ellen, touch on the part on the quarter, and then I'll take the longer term.

Yes, let me -- one of the reasons we look at O&M over a 12-month period is because we do have fluctuations in the revenue that go up or down. And remember the calculation of that amount is O&M expenses less the impact of purchased water, divided by revenue. And so you will see fluctuations quarter-to-quarter, just based on weather or usage impacts in the quarter on the revenue side. But our expenses are -- we control, and you'll see that except for [parent] chemical they do not, are not impacted by quarter-over-quarter variations. So, again, you will see that difference from quarter-to-quarter, but the way to look at it is really over a 12-month cycle.

And for the long term year-over-year, some of the actions that we're taking obviously [increase] our labor expense to make sure our employees are as efficient as possible. And also leveraging our purchasing. And I mention this every quarter, but we continue to realize significant savings year-over-year in energy, doing reverse options in our big states, New Jersey and Pennsylvania, and then some of the other expense items, such as paving services, our fleet and chemicals, where we've been able to show significant reductions year-over-year.

Yes, just to add to what Walter said, our biggest expenditure other than labor is power, and so we've got a number of major energy efficiency elements going into place. Then after that it's chemicals. And, as Walter said, this is where our supply chain really gets exercise. At the end of the day, though, the major element for us will be efficiency in productivity and the ability to utilize systems we currently do not have around, relative to both our financial recordkeeping, our human resource recordkeeping, our asset management, and our customer care system. As you know, we're going through a replacement of those major systems as we speak.

Thank you very much.

Thank you. The next question is a follow-up from the line of Heike Doerr with Robert W. Baird. Please go ahead.

Thanks. Just to follow on this topic of efficiency ratio, I know over the longer term you're looking to get below 40% in I believe the next five years. Do you have a more shorter term goal on where we're expecting you to be by the end of this year?

Heike, as we said, our longer term goal is 40%. It's being driven, as was mentioned, a lot by putting in new systems because our infrastructure in terms of IT systems is very antiquated and old, can't do some basic things we need to drive our expenses down. And, again, we're looking to see continuous improvement with the majority of it coming towards the end as we put those systems in.

Heike, yes, I think it's fair to say that we'll -- it's probably a little backend loaded for the reason that Ellen mentioned, but with that said we're going to continue to drive it down every year.

Okay. Thank you.

Thank you. This concludes the question and answer portion of the call. I would like to turn it back over to Jeff Sterba for closing remarks.

Well, let me thank you for joining us this morning, and appreciate all the questions. Feel free to obviously get hold of Ed or any of us if you have questions in the meantime, and we will certainly be back on the line after the third quarter, which you know is important to us, and be able to report on what I believe will be continued great progress. Thanks.

Ladies and gentlemen, this does conclude the conference call. You may now disconnect, and thank you for your participation.