Essential Utilities Inc (WTRG) 2003 Q2 法說會逐字稿

At this time, all participants have been placed on a listen-only mode and will be opened for questions and comments following the presentation.

I would now like to turn the call over it your host.

Michelle Hanson, ma'am, you may begin.

Thank you, good morning, everyone, and welcome to Philadelphia Suburban Corporation 2003 earnings conference call.

We are pleased you are all able to join us today.

If you did not receive a copy of the press release this morning, please contact Tracy [McGonagle] at area code 610-645-1090, and she will fax you a copy immediately.

Presenting today is Nicholas DeBenedictis president and chairman of Philadelphia Suburban Corporation.

Also joining us is David Smeltzer, the company Chief Financial Officer.

As a reminder, some of the matters discussed in this call may include forward-looking statements involving risks and uncertainties that may cause the results to be materially different from any future results expressed and implied by such forward-looking statements.

Please refer to our most recent 10-q, 10-k for a description of such risks and uncertainties.

During the course of this call, reference may be made to the company's EBITDA, a reconciliation of EBITDA to net income is contained in the investor relation of the company's website at www.suburbanwater.com.

At this time, to turn the call over to Nick for his formal remarks, after which we will open the call to questions.

Thank you, [Cheryl] and good morning, everyone, thank you for joining us for today's earnings call.

Which earnings are 22 cents for the quarter.

Up a penny from last year's reported 21 cents which also included last year net gain a penny from other asset sale.

This has been a very exciting week, and I think rather than dive right into the numbers I would like at least recap some of the bigger picture items that have occurred over the last week.

Last Thursday, we closed on our second largest acquisition in the company's history.

The AquaSource utility company we bought from DQE.

The cost is at the bottom of range that we had predicted to in the conference call in May.

We projected when we announced the purchase of the system about a year ago July of '02, we thought it would close in the latter half of '03.

And it ends up we were targeting then, closer to in the end of the summer and ended up closing on July 31st.

We are very pleased to close ahead of schedule and for at lower end of range which I will get into and I can let you know we are hitting the ground running and I will answer some of your questions of what we are doing immediately once we are now running the company.

We also last week, secured over $200 million in debt, $90 million of it being a short-term line of libor plus 100 and $135 million of 4.87% debt which we are very pleased with that rate.

That'll be the long-term financing, and then of course the $90 million short-term debt will be replaced with equity.

At our board meeting just yesterday, a number of major events.

Had is our strategic meeting with the board we have once a year.

We present our five-year plan.

And take a look at where we think the company's going.

And as a result of that meeting, three things occurred.

First, the decision to change our name, as of October 10th, we'll be ringing hopefully the closing bell the at New York Stock Exchange.

The new name will be Aqua America, and that was announced late yesterday.

And -- will be Aqua America.

December one payment from 14 cents to 15 cents a share or 7.1% increase.

And the board also approved another stock split.

This is our fifth in seven years 25%, 5-4.

So it was an exciting day, exciting week, actually.

And I wanted to put today's earnings call in the context of what's happening.

As I've preferred the earnings last, I guess it was last May, when I got on.

I said we had not our best winter because of the cold weather and increased maintenance expense because of increased pipe breaks which carried a little over into the second quarter, but are now behind us.

The restoration occurs after you fix the pipe, you have to go back and repave some of the streets.

That happened in the second quarter.

It had been a wet early May, and I made the comment at the last conference call that the real make or break for us as to whether it's an average or a good or less than average summer is May 15th to August 15th.

Unfortunately, we are now into one week to go.

And we have yet to stop raining anywhere in our area.

As a matter of fact I just read in "the USA today," the three most rained on cities are areas that we serve.

Akron, Ohio, we served Madeleine and Youngstown, Ohio, we served [Boardman] and Asheville, North Carolina, which is one our faster growing states in North Carolina.

So a very wet spring and summer.

And that does not bode well per earnings.

On the other hand, earnings are holding up because of acquisition growth and increases from rates that are carrying through this year.

We are still maintaining upper earnings for the quarter.

As I always look at the brighter side I could be in the painting business or installing pools this summer and that would have been much worse.

The performance I think represents -- I have often said weather is a 5 to 10% impact.

For the quarter, the actual sales even with increased customer base was down about a percent.

So you're looking at probably same-store sales down 3% to 4%.

And translate that almost all into revenue that would fall to the bottom line to the bulk of it.

Probably cost us a couple pennies at least just due to weather in the second quarter.

The AquaSource investment -- well, let me take one more point and that is how we are holding expenses.

Very pleased in that in the sense they have stopped going up and moderating and actually going down now.

If we take the year to date, the efficiency ratios is 37-6.

And that's versus 37-9.

So you can see the insurance costs, the pension costs, are all starting to now moderate.

As we get to the fourth quarter of this year, you will start seeing hopefully even more moderation if not down.

Because that's when the insurance, pension, and health care really start hitting in 4Q '02 work the comparisons we will get back into 4Q '03 and then the following year.

We have taken some actions in those areas which are the surprised area.

Obviously, take no credit for the first action, which is the stock market's gone up and interest rates have gone up a bit so the discount rate and the actual base on the pension investments have gone up.

So that's some good news.

It's good news throughout the country, because corporate America was all facing that issue.

Health care, we did redo some health plan, higher deductible, moderate cost, and just had three of our five union contracts renegotiated in and in all of those, we received the union endorsement on co-pay of benefits up to 15% on all over single coverage.

Also, we are on the pension side we have basically limited the legacy liability by all new employees including union employees in those three contracts are being hired with strictly the -- without a defined pension plan is strictly enhanced 401(K), which means the employee takes -- it's all the upside but also takes all of the risk involving the investments that we make and we donate a defined amount each year that we predict.

So we think that's a very positive way of taking that risk factor out of our ongoing expenses.

On the AquaSource, the final number came in at 195 -- I shouldn't say final.

That's the number that DQE said they think we owe them and we closed on that number.

All of the regulatory approvals of course were completed and there were no appeals, so that's why we were able to close.

And we're now in the process of notifying regulators, visiting states, and really diving in as this is now part of our company.

And the idea of Aqua America is that we will present ourselves in a more of a national light to these new states versus a company that had somewhat of a regional name, Philadelphia Suburban, although well-known in the water business.

The 195 that we paid includes $5 million in working capital.

So apples to apples, the range of 180 to 205 that we had given prior, you it look at 190 being the amount that Duquesne feels that we should have paid.

And we think there's a challenge of probably up to $15 million, $16 million that we have an arbitration process setup and all of that will be decided in the next six months.

So I'm hopeful we may even look at a lower base than the $190 less the working capital.

Again, another $5 million of that $195, in addition to the working capital, was a tax deferral that gained from tax deferral cash that we will -- that we will gain from Duquesne, and therefore, we pay Duquesne $5 million for it.

Dave can comment on the present value of that.

Obviously it depends on the discount rates and so on.

Dave, maybe you can talk about that now.

Sure, Nick, thank you.

Essentially the tax basis of property that we have acquired is substantially in excess of the book basis or our costs, and the present value of those excess deductions is in excess of $7 million so having paid $5 for it, we feel pretty good about our opportunity to make a little bit on this aspect of the transaction.

So if you take $195 and take -- let's take, be conservative, and just take off $10 off, $5 for the taxes and $5 for the working capital, you are look at $185.

We think there is a challenge for another $15, $20 million of which I think the max out of the contract is 16 so if you take 15, you are look at probably 175 base, which would be best case, 174 would be best case.

And the asset value that Duquesne has given to us, and in understanding, we now have the books.

We will dive into the book, chew everything up, is closer to 230.

So you can see the rate base value of these assets.

These are only the IOU assets.

We theoretically paid in for the con-ops and that'll be the base that we start with.

So we are very pleased with it.

And also acknowledge Duquesne effort.

It's very difficult to run a company when you told the world you are leaving a year earlier and they managed well.

Came very close of their parameters.

Most of the reason for the downside is they did not get the rate cases in time that they thought they would get therefore we did not have to pay for those, although they are still in process and we are hoping to get some of those.

Just because of timing, may be giving us some advantage.

Most of the capital was invested and they kept the company together, and actually improved its profitability over the last year.

So we're very grateful for the ethical and professional behavior of the Duquesne people, who are now in their press release said last Friday, they are back to being an electric company and back to the basics which is a focus that we have always promoted at Philadelphia Suburban and now calling it Aqua America basically saying we are staying with our roots in the water business.

So we are very pleased and hitting the ground on AquaSource.

Our future story, and the first thing we've done is to try to take the A & G down as much as possible and if we compare run rates of what the run rate of Duquesne needed to run the business, -- Dave, help me with this $11 to $12 million?

Right, nick.

Okay.

And we are -- the run rate of people we've hired and on an annual basis, the PR, the legal, all of the numbers that we think it is going to take is in the 7 to 8 range.

So you can see we are look at probably a $4 million delta just in cost element in the overhead in the business.

And we are now starting to look at Fleet, more cars than there are people, so obviously we think we have some things to look at there.

Leases, rentals, things of that sort.

We're going to start look at right away, P.R., legal retainers, things of that sort, where we think we will find some dollars very quickly and that's our challenge over the next couple of months.

The other major issue we are dealing -- first of all, the good news is to report is all of the IS systems and all of the compact accounts systems were transferred over the weekend and Dave, I will let you comment on that.

Any hiccups?

No, in fact everything is right on schedule.

We allowed them a couple of days to do their final processing for July.

That concluded on schedule Tuesday.

And we're in the final stages of transferring the systems today.

So we are hopeful we'll be up and running early next week and ready to go.

The deal we made with Duquesne, is they would keep the accounting department on in Pittsburgh, what, for a month or so, Dave?

Yeah, at least.

At least a month.

And we pay them under a transition charge until everything is perfect at which we close down their operation completely and bring it here.

So you can see a lot of thought went into it, and I guess the bad news about utility mergers is it takes so long to get them done because of regulatory approvals and things of that sort.

The good news is it gives it the back offices a chance to really get to know each other, merge their numbers, and it's usually very clean when you make the transition.

So that's good news.

Rick Hugus was named president of AquaSource companies in the south.

Where we will have a different style of management.

I want to get into that, and the major company in the north will be run by Bob [Liptak], our present president of consumers, and Indiana will be under our Illinois president, we're going to merge the call centers and things of that sort overhead between Illinois, Indiana, and Missouri.

And also we have named one of our rising stars of Illinois operation to be assigned to Fort Wayne, which is the biggest customer center in Indiana, and where AquaSource was having some problems with governmental relations, things of that sort and hoping to turn that around very quickly.

As you can see, we have hit the ground from a management standpoint also.

We're starting what I will call a pruning exercise.

Which started in May, when we agreed to sell the Connecticut and New York operations.

We're looking at any of the smaller states where there's not economies scale already built in or growth patterns are not where we'd like them to be and we're taking those and then moving to a point of where we would get assets, if we sell assets move them into the faster growing states where we want to be.

Having said that, all of the states are under review at this point, but to give you a comparison, the Connecticut and New York properties were selling for $5 million, plus ASSUMPTION, with $700,000 in debt.

The company in Birmingham has already hit the ground running.

We have a transition agreement, somewhat, if we get our approval in the month or two, they would have already started running the company.

We have taken all of the risk out of it from our standpoint.

They're running it.

We are paying them a flat fee.

But the revenues and expenses of theirs.

In the meantime, and they are paying the franchise fee which is I think a fairway to do it.

We can basically put all of our management attention in the states where we know we'll be for a long-term basis.

And just an interesting statistic the four states where we are maintaining which are Indiana, Texas, Florida, and Virginia the four big states.

The North Carolina is a nice profit center too but that'll merge with our operation which is bigger there.

Dave, those four states represent how much of the revenues and how much of the EBITDA?

The I.O.U.s represent about 90% of the revenue and 95% of the EBITDA.

You can see, when we first did the AquaSource deal and we were negotiating, we said we really only wanted to do the I.O.U.s.

We didn't want all of the other businesses.

And we were able to buy the I.O.U.s about I would say about a third to 40% of the revenues, we did not buy.

They were the construction company and many of the contract operations.

They had about $30 million I believe in contract ops at one point and sold to other people.

We did end up, as we closed on Friday, buying some of the con-ops.

Give you an example, I think about $8 million worth of revenue coming in from the con-ops.

By the time at the end of year, we'll be closer to $4 million, and we think some time the follow year we may be as close as $1.5 million.

You can see we are pruning the con-ops very quickly.

We are looking at every state.

If they are not making a hurdle rate of at least 10%, we don't think worth our management time.

There were some that were not making any money, obviously the first, all of the contracts are either month to month or in most cases, the year contract in the year now to get rid of it.

And Connecticut has about 2.5 million of those con-ops.

That would be the quickest sale for all.

As soon as Birmingham buys the con-ops of I.O.U.s.

So you can see, we're trying to stay focused.

We want to stay a regulated water company.

If we can find an unregulated business that makes a reasonable return, we will keep it obviously, but it will be in the water business, but I wanted to make sure the people who follow us understand we're not going to start expanding in the con-op business.

As a matter of fact, immediately we are contracting down and I think probably at year end, Dave help me again, 2% of revenues may be, 3% under revenues?

Yeah, we'll certainly be under 5%, Nick.

Probably 2-3, right.

Good.

That gives you a very quick update.

We are very pleased with the debt offering last week.

Obviously we [pro-form it] in a higher amount.

So we can only get -- last summer this time we were hiring rain dancers to make it rain because we had the drought.

And this year, we just can't get rid of rain.

So sales are being hurt by that.

But shorter weather, very, very happy with the performance of the company and the way we were able to merge the AquaSource and now the way we're implementing it very quickly.

By year end, I think the questions will be basically on the whole company and how you are doing in this state versus that state versus trying to spend out the AquaSource.

Can I answer any questions that you may have.

[Caller Instructions]

q-and-a

Thank you, our first question comes from Tim Winter from A.G. Edwards.

Good morning, guys.

Now that AquaSource transaction is closed, can you talk a little bit more of what revenues and net income were from that business, say on a trailing 12-month basis?

Sure.

I can give I think revenues stream but I'm concerned about -- because they're going to report in their own qued I guess of how much they think they have made.

We have already [pro forma'ed] in with our $7 million rate versus their $11 and $12, and that didn't include the Duquesne overhead on top of that.

So I think an I.O.U. number, and Dave, I will give this without Connecticut and New York.

Probably on an annualized basis, for the rest of the company, would be between $62, $65 million.

And I think you figure the con-ops which also carry expenses with, it we would knock that down from probably the $9 $8 million.

Knock that down to initially $4.5, $5.

Although I would venture to say that $4.5, $5 is a wash.

I am not sure they are making much money on their con-ops.

So that gives you an idea.

Dave, do you want to comment on expenses.

I think we acknowledged earlier that the O&M ratio at AquaSource is substantially higher than ours.

Probably north of 60%, perhaps as much as 70.

And obviously our first target will be to take down toes expenses so we can show a declining OEM much like it shown declining in the last of our subsidiaries in the last five years.

However we don't see it matching the balance of the system as it is really a different structure and a different style of operation.

So it will initially elevate our O and M ratios as the AquaSource numbers are incorporated into ours over the next 12 months but after we have reached a combined number, we do expect to be in a position of continuing to bring it down into the future.

Tim on the base numbers I have given you and obviously hopefully to grow it and get credit for the asset we are buying and doesn't include our current rates.

Using the lower overhead A & G, the $7 million over the $11 million.

So you can see how I am not sure if they are making money or not.

But using that and using our expense base which is fewer people and so on, now that doesn't take out - vehicles and the other trims that we are going to do but probably over 70 even with the 4 million taken out.

And so, therefore, I don't know, you asked the original question, are they making money?

I can't comment.

We will, I can say that.

That 70 is the key to get down and I think you can look at our company, as two companies now.

Look at that this way 80% of company with revenue in customer base will be in the traditional mode that you've been following.

O and M ratios in the 36, 37 range hoping to get it down to 5000 basis points to get it down mainly increases revenues through growth and through rates by EBITDA through capitalization and investment versus expense growth.

On the other hand, 20% of the company now has a very high O&M ratio which raises that whole mix but I think you have to start with the 70 ratio and hope we can get that down 200 current basis point a year as we start trimming down basis and building revenues and get more economy of scale in these states as we grow them.

That'll be the exciting and challenging part for us but there's a lot to take out when you are starting at 70%.

And then the third part would be where you will grow faster.

We are looking at growing at 20%, much more rapidly than growing the 80%.

The 80% will grow mainly through the same reason we have been growing, 1% from normal growth, organic growth, whatever you want to call it.

The rest would be through acquisitions.

In the south, we think we're going to get 4-5% growth by getting developers hooked up because we'll number the faster growing areas in the faster growing states.

If you look at the AquaSource numbers.

I will give you these.

This is their year ending 630.

Rick Hugus gave me these -- Texas grew 8%, North Carolina 12%, Virginia 6%.

You can see a lot more rapid growth.

Florida only 2%.

Which surprised me.

I don't know if it was the [hustle] factor or not.

But we think we'll get the 4% in the south just normally without acquisitions and if we can get some acquisitions in there, we could expedite that 20% base more rapidly and bring that O&M revenue ratio down quicker.

You can see give us a break.

We are starting to get into this but we see a lot of potential.

And the first goal, hit the ground running, get the system turned over and make sure our O&M, the A & G overhead is as low as we could get it.

And now getting into this stuff that you can't get into the company, leases, who has what car, travel expenses and things of that nature.

Okay, thanks, one other question for you can.

Can you talk about the $15 to $20 million charge with regards to DQE?

Sure.

It'll be decided by some accountant some day.

I guess that's the way it is set up, right, Dave.

An arbitrator would make the decision?

Yes, sir.

Unless we can negotiate it until we get into the final arbitration.

It is almost exclusively over how much is in rate base and accountable and rate base.

We think if you go by the rules of the regulatory agencies it's going to be -- we think we have a good case to say that we can bring it down slightly.

The other two factors, there are four factors.

Customer growth, where they actually exceeded their limit, which is good news.

We want to monitor that.

We want to check the meters versus the number of customers they said.

There's no reason to believe that's going to move greatly, Dave, and I guess in a month you will have that chewed up, right?

Yes.

The second parameter is they couldn't drop below their run rate a year ago and con-ops.

Because we wanted to make sure there was at least some dollar flows in their revenue flows that would support expenses that we would get when we took the company over and an area that grew over a bit, it actually grew that 15-20%.

We are now going to prune the ones that are not making any money and keep the ones that are.

The third item was rates, and in the rate area, it was very clear they had to get so much of a rate case in what state by a certain time.

And basically they did not meet that.

But everything in there we made up because there are actual orders from a commission.

So that one's pretty clear and probably some that are going to come in now over the next couple of months that will get and didn't have to actually pay the parameter for, because they just didn't come in time and we will start filing quickly and moving in on those about the rates department.

The fourth area is rate -- base and the argument, the challenge is based on what is the formal definition of rate base?

And we believe that we're, by going by going right by the back, things they could nut rate base that we think shouldn't be there.

But I think it could be argued either way.

I would probably be arguing it a different way if I was on Duquesne's side.

I think that's the biggest part of the challenge.

Dave, do you want to fill in on that?

Well, Nick, I think you summarized it very well.

I don't know that it would be appropriate to get into the specifics right now.

The challenge lies in the definition of rate base, and either way, the margin between the ultimate rate base and the ultimate purchase price will remain fairly consistent because both would move together.

That's really the only major item left on the table and hopefully that'll be decided within the next six months or so.

That margin right now is almost 20%.

Okay, thank you, guys.

Thank you.

Our next question comes from David of Janney.

Good morning.

Good morning, David.

Congratulations on the name change and all of the other good things in the quarter.

I'm in New York right now.

The other people are not mad?

No, I'm in New York as well.

All right.

A couple of questions.

First of all, if this weather continues in the quarter as it has been, what's kind of a ballpark number that we might expect for weather affected in the third quarter?

I think you are right.

I think look at second quarter it was 2 cents and that was affected by a same-store sales.

Assuming 3%, 4% growth rate plus we were actually down 1% overall in sales.

You look at that being in the range of 4%, let's say, and take that off your revenue stream and bring it down to the bottom line and you come up with two ] penny.

Third quarter, let me give you some numbers through July, at our biggest subsidiary which is Philadelphia Suburban and tell you, Ohio and Illinois have actually had floods.

I am sure they are just as bad.

Philadelphia Suburban for July was 6% below last year.

And remember last year was not a great year, although they lifted the drought in early July and we did see a lot of water in the end of July, but it would have been an average year if you take the drought and the rate month and split it.

This case we were down 6% from that average year.

And in August so far, we haven't seen the sun yet in August, through whatever, the first six days.

Down almost 10%.

And last August was a fairly good August, up because the drought came back on in late August, early September.

You probably could not have had a worst year for water utility.

Cold winter with a lot of main breaks and a lot more expenses.

And followed up by a wet summer.

On the other hand, we are going to survive and as you can see from our numbers, we are still in there.

Based on the capital investment we have been making in the customer growth, but we haven't had any break from the weathers.

Dave Smeltzer, are you comfortable with 3 cents, if the weather is bad?

Yeah, any given quarter could be as much as 3 cents, right.

I think unless August turns around for us, we already know what July looks like for us.

July was a penny below or maybe more.

Right.

You mentioned the rate cases that hadn't been yet reached a natural conclusion for AquaSource.

Could you give us kind of an interim schedule of when you see those rate cases coming to conclusion?

Okay.

Dave, I don't know if Kathy is with us but not, I will take a shot.

Kathy is not here.

Okay.

We'll file right away with Missouri.

They had an informal discussion in Missouri, you have to help me Dave, 25% rate increase, maybe?

Yeah.

And basically got nowhere.

We'll start in file formally, go in with a normalized rate of return, the whole works and not try to do it informally but actually do it formally.

In Indiana, the rate case that was approved which was at a very low level of what they asked for.

I think they asked for 30-some percent.

Got 11 or something like that or less.

There was a challenge by AquaSource.

That challenge did prove that the commiswas willing to give them an extra half a million dollars.

On the other hand, the city of Fort Wayne, my comment about getting better governmental [relation], and that challenge helped the time order that would have been amended it by half a million dollars.

So that's still in a court proceeding and we're optimistic the court of will rule on that in the next couple of months and we think AquaSource had a good argument in trying to get that half a million extra.

In Virginia, there's indexing of rates, and they were slightly behind.

We're going to move very quickly on those indexes.

Same in New York, where you get inflation every year in New York.

And I think in Sarasota, they did get their rate relief, but they didn't get it formalized by the end.

Now, we will pay them for that, because that was part of the contract, but the rate case has to go to the formal county commissioner's and get approved some time in November, but the staff has recommended what we think is a reasonable rate increase, which we would get the payback for all the investments they did in Sarasota.

So that was in good shape.

Texas is the big one, we're going to be filing very quickly.

Dave, do you have any idea when we'll be filing Texas?

Well, Texas overall start with their recent results.

They have some pass-through opportunities in Texas, which have actually exceeded their expectations.

In the last year.

So Texas is in pretty good shape.

In terms of the overall returns in Texas, that's a state without tremendous returns and with tremendous capital expenditures in the last couple years.

So we do envision a significant rate case sometime in 2004 to be effective in 2005.

Probably in a 20%, 30% range.

Okay.

One other quick question about dealing with some of these new states.

Are the states that don't have the DSIC, any that you are targeting for targeting early interact to try to get a DSIC put in?

Two important one are Ohio and Virginia, nothing to do with AquaSource, but part of our portfolio and don't have disks.

We anticipate disk passing in Ohio very similar to the Pennsylvania one probably sometime this fall, which will get Ohio and Pennsylvania.

In Indiana they already have a disk.

And they have filed for a disk and were not satisfied with the amount they got.

And it was over the way they filed I believe.

So we're going to work on that right away.

By the way, we have hired a woman who used to be the rate's person for IWC, [karlette], she'll be our rate's person out in Indiana.

Getting someone on the ground.

If it's local and understands the commission.

In New Jersey, we're going to file our next rate case which will be later this year for all of the capital we've been investing and we're going to initiate in the rate proceedings a process to do disc work and we're hopeful in that and then in the southern states there has been no mention of the disc yet but in fairness, the pipes aren't old and most of the work we are doing there is sewer plants and water plant.

The traditional stuff we did in the northeast probably ten years ago, which really built rate base over the last ten years before we got into the pipe work.

I should mention, I mentioned [karlet], we hired two people.

On the ground now and Rick Hugus is down there with them, meeting all of our new employees.

We hired a gentleman named Bob Laughlin, he'll be the president in Texas and he's a former executive with United Water, who ran their Southwest operations in the O&M area and the I.O.U. area and Bob is a professional and understands our business and I think went to the right school, Texas A&M you have to go through, where you have to go if you want to get anything done and he hit the ground running and hit the former head of the EPA for the water division.

They call it Quality TQE something, but it's basically - Steve Blackhurst [ph].

And he's on board and he's already working with the EPA.

And so we are hiring local people to understand the specifics.

I think that's going to help us move very quickly.

One last quick question, Nick.

I was fascinated by the growth rates in some of these states that you just mentioned before in your formal remarks.

They were not the gross rate in the states they were in the gross rate serviced by AquaSource.

Right.

That's what I was referring to.

And I know it's still early on, and I was wondering if you had any sense -- and being really conservative, if you took the AquaSource of the package as a whole, what would you sign as a generic growth rate?

Somewhere in the vicinity of 5%.

Dave, did -- what did you pro forma in your five year?

The prior 12 months, Nick, that you were mentioning in terms of growth rates was over 6%.

And as you noted, Nick, that was primarily new system connections and really not acquisition oriented.

That's what I was referring to.

What kind of organic growth?

I think, Dave, did we pro forma in the 5 year 5% or 4%?

Me it varies by state.

Overall it was certainly less than historic 6% growth rate.

And I am thinking it averaged in the 4% to 5% range.

Great!

Thanks for that information.

That's all of questions I have.

Thank you.

Our next question comes from Ketch Monroe of Thomas, Weisel and Partners.

Good morning.

Good morning.

In terms of the payment to DQE, when do you have to actually cut them a check?

They have the 195.

They have it.

on Thursday.

I tried them to give meet properties without the money but --

I wanted to clarify that.

Okay.

Rate increases for Philadelphia Suburban, what did you get in the third quarter?

We beat our number by a think about 30 basis points.

The surcharge for the disc that started July 1 is at 3.32.

And I think our budget was 287, Dave?

Yeah, in the 28 range?

We put more pipe in than we had anticipated and that'll help on forward to ameliorate some of the lack of sales through the weather.

Okay, do you have any rate increases coming up?

Yeah.

In the next couple of months?

The third quarter, which will be October 1, we probably, Dave, help me, what are we budgeting rather than 387 then or more?

Are you talking about disc?

Disc on October 1.

The disc in October should be high threes.

And if we know to trend maybe we beat that by 20 basis points and the rate case that we'll file for all the other capital we have invested in Pennsylvania and this time around for expenses that we had not anticipated.

I.E., pension, the health care rises and the [DNO] insurance and all of that kind of stuff, security, safety.

That rate case which would get those expenses blocked plus a fair return on the investment capital would be filed some time this fall in Pennsylvania and a similar one in New Jersey.

And we have the case ongoing in Illinois, which was a 22% rate increase in [ inaudible ]

Okay, thank you.

Thank you, our next question comes from Brad Coltman of Deutsche Bank.

Yeah, thank you.

Good morning, guys.

Good morning, Brad.

I realize it is very early because you just closed the transaction.

But you mentioned there were some structural differences that would cause the overall efficiency ratio to go up for the company.

I wondered if you could give us a sense of what you were actually budgeting?

Say may get down to over say the next 12 months.

The combined company?

The combined company, you mean?

what do you might end up, say, in 12 months now?

Dave, you have to help me.

I assume it pops up 40% when you merge 65 and 36.

Yeah, it should be very close to that Nick.

And I hope we take it down that 100, 150 basis points.

Probably take it down 2 to 250 on this 20% that's in the high 60s, Brad.

And then on the other side, we are hopeful now, hopefully the pensions and health care moderate and go quarter to quarter with a pretty fair comparison, we should get back in that trend of 50 to 100 basis points out of the company, the 80% that's traditional rate base company.

The other thing that really hurt us this quarter, if you look at your trailing 12, is the fact we didn't get the normal boost we get from an average weather send out.

It could have been two more pennies.

You can see how that would have taken that OEM ratYOU down right there.

And that'll help us too and even when the weather we were able to hold the line I think it was 36 or something.

I guess for our purposes for miling it, is it fair to assume that the expenses of going to obviously step up to the third quarter but maybe you would have a quick step down in the fourth quarter, and then more gradual reduction getting into that targeted level?

Well, what are seeing is insurance -- last year this time, we always renew in the July-October time period.

And I think last year insurance was up 30%, 40%.

Dave, do you have any idea what Roy is looking at now at insurance?

Well, I think insurance will continue to go up.

The other thing that will take another step up next year is pension.

Yeah.

Because it's a five-year rolling average, Brad.

Right.

But next year we will have it in rates.

You will have on the revenue sides and the expense side.

Okay.

And tax rates?

Still keep it at the same one?

Any changes in the second half of this year?

Now, we are comfortable with the tax rate.

Okay, and lastly, any acquisitions in the last quarter than the one you announced just recently, the small one?

Now, we have a number in Ohio and Pennsylvania in the pipeline but none ready it announce.

I think we announced one club Jefferson Heights.

Which is up in the northeast in Pennsylvania and we should have announced one grant park, which is out in Illinois.

And there was one other small one.

But the number of a small ones we are still working on.

I am confident we will hit the 15 to 20 of the normalized one.

Yeah, okay.

Thank you.

Once again, for any questions, that's one followed by four.

On your Touch-Tone phone.

Our next question comes from Jim Lykins [ph] of Hillard Lyons [ph].

Good morning, everyone.

Wonder if you could give us a feel on the potential feels on the regulate or boards in the new states that you'll be operating in now?

Well, what the AquaSource, did and this is what really caused them some of the problems when they were starting to grow so rapidly and realized they were not fixing the ones they bought before they bought the new ones.

The new management took over and they really started spending money and fixing things and they have done a nice job and that's where most the capital additions are driving these rate cases came from.

They have what they call consent decrees in these states which is very important because the environmental regulator says we know you are trying.

If you do this, this, and this, you will not be in violations and subject to the daily fine.

If you don't do it, then you're responsible.

In most cases, those compliance agreements have been either renewed or ended because they got the work done.

In any case, however, in the agreement we signed with AquaSource, Duquesne has accepted the liability of those ongoing environmental liabilities.

If they didn't do the right thing in the dissent decrees and we can't get release from that.

Having that said that there, is only one that I have any concern with and that popped up in the last month and that's an operation in Virginia, where again the Duquesne's credit, AquaSource's credit they let us have the engineers at the table with the Virginia environmental people, and as we speak, we are doing a designed plant.

That's an operation called lake monticello.

Home to Jefferson, well, not that property but the development named after it, it's a fast-growing area and it's a wastewater issue.

We are having to redesign pipes and design a plant.

And also do you think you'll be sell your assets in Kentucky and South Carolina?

I would say they fall into that category.

I mentioned generically, any place we don't have 5,000 customers and is not a growth area and we don't see it as good as some of the other areas They would all be under the microscope early on.

Okay thank you.

Thank you.

We have a follow-up question coming from Tim Winter of A.G. Edwards.

Yeah, Nick, can you talk about how you have treated merger costs?

Certainly there was some fees associated with due diligence and closing, and merger.

And maybe what the dollar payment was.

sure, Dave, do you want to take that one?

Sure, Tim.

Recognizing the ultimate purchase price will be below the asset value, the costs are being counted for as additional purchase price.

And there aren't -- there weren't investment banking fees and so forth.

So the costs are not tremendous but we did have legal fees and transition costs and so forth amounting to several million dollars, but in the end, they will simply represent additional purchase price in the final accounting.

Okay.

So how have they been treated over, say, the last six, nine months?

Have you been just amortizing them?

no, most of costs have been deferred on the books.

Okay thank you.

Thank you, our final question comes from Debra Coy of Schwab Capital Markets*.

Good morning, guys.

Good morning.

Nick, to take a look back.

You just had your five-year strategic plan meeting.

You just closed the AquaSource deal.

And you have gone much more national.

Thinking back to the way the stock acted after the consumer's merger and some of these issues that you have to do to improve your cost structure, get returns on the capital expense at AquaSource.

Can you give us just sort of your view again on how you see the pattern of returns and earnings growth, earnings dilution, related to this acquisition and growth going forward say in the next, call it two to three years?

Sure.

Sure.

Unlike the consumer merger, where we actually had to have a write-off the first quarter, even though we clearly said that from day one and we took the acquisition costs and merger costs and wrote them down and so on.

That first quarter that we announced, I don't know, a penny versus 17 cents, the stock took a hit because most of our investors retail-wise -- basically you look at the number and you get nervous and whether it was the time of day and the market or whatever, our stock did talk a hit.

This time around we don't have that, because there will be no write-offers.

As a matter of fact, if we can get -- no write-offs.

If we can get the fleet, the number of bills that we still think are on the table at AquaSource, we may pick up a few dollars between now and the end of the year and get in place next year that most of the kick from AquaSource will come from rate cases without adding expenses.

Getting that 20% margin between the capital and the purchase price.

Right.

So that's really the story on AquaSource.

We did lower ores in our five-year plan.

We wanted to be conservative because interest rates are still down lower but we are still comfortable with the kind of model that we have been saying, our goals, models, that the probably the customers -- the customer account means less because if it's organic growth how to you judge it versus acquisition growth which costs you money.

But I think we are very comfortable with, let's take the range of 7% on revenue going forward.

We are comfortable with that.

Some of it from natural growth.

Some of it from acquisitions and some of it from rates.

Especially with the discs really kicking in now and in two, three four states should make that more predictable and we're still comfortable that we can continue to cut costs.

There was a quo many of your minds, how many year in, year out, can you take 5000 basis points out of your costs when you are in bigger, stable states?

That's true, we have been able to do it.

But now we probably have a chance to grow a economy to scale in the are states and get that higher O & M down quicker.

I think that brought that down into play.

I feel pretty comfortable, you can augment the 7% revenue growth goal to stay with that 10% expense goal.

Okay.

And the payout ratio on the dividend, I am surprised Dave didn't ask me this question.

Our goal was 4-7-10-5 has always been our goals we have always been able to Cager [ph] the revenue has exceeded that and the Cager on the earnings per shares exceeded that.

The dividend, we've averaged just between 5 and 6.

A little higher than the 5 goal.

But we decided to up the dividend a little bit more this time, mainly because of the fact the dividend tax goes down and I think our shareholders are going to expect it.

And most of our retail shareholders are buy and hold, which we appreciate it and we think giving them a higher dividend is important.

So bottom line, we're not in it anyway back off -- you guys have typically had an 11ish% ore, maybe that comes off with interest rates?

That's right.

The earnings growth stays and the average 10, 11% range --

And what you will see different if you take five-year bench marks and look forward in the next couple of years.

The earnings to ratio will go up.

It has to.

The customer's growth should hang in there, although I don't think it is as relevant as we are pruning.

How do you count one that you had and then you sold?

Give us credit for that or negative for that?

If you sold an undervalued asset you are losing customers but probably picking up profits.

But the revenue's side I feel very comfortable with because this is -- a lot of this is going to be rate driven and regulatory process driven even with lower ROEs, so you may see our ROE drop a couple of basis points but when you look at fact we are getting that on the assets now that are earningng -- Dave, what would be the average ROE in Texas!

Very low.

Even if you got 10-2 versus 10-6, it's better than 5.

Some of the quick will come in the next three, four years as a series of rate cases in those states.

And the real story is the growth in the south.

If we can maintain that, become we don't have competition I -- I don't say any competition.

There is always competition.

Woe we don't have four, five companies like in New Jersey where every developer wants to talk to a water company they have a choice.

Here it is a very few.

In fact in most cases one.

Okay.

That helps.

I mean what I am getting it is it does -- clearly the -- strategically it is the long--term growth decision take mass a lot of sense for you in terms of those opportunities continue your old pattern of growing well above other utilities.

However in the meantime, it does appear that we're looking probably at an '04 that's going to be below trend line in terms of -- in terms of earnings growth and returns?

Well, --

Or you hope not?

I hope not.

Weather being --

Yeah --

: -- normal?

That's always the case but see, last year, our earnings really were [gap of] 97, and that was what it was. 5 cents of that was the sale of a one time of a utility in Ohio, which was under earning and we got condemned and took the money and redeployed it elsewhere and it was the best thing for shareholders and we are still holding it now.

So we didn't lose the expense side.

That theoretically adding a nickel.

Five cents, Nick.

So I think for us to say we can take last year's fourth quarter and go up 10%, that's really a stretch.

Unless we sell something for a nickel, it's really core -- if you want to say operating earnings for 22 last quarter.

But if you look at 92 as last year, still comfortable even with the weather, if you extrapolate for the weather and you added for the AquaSource for the year.

I'm comfortable we are -- in that same range that you have all been predicting and do the same thing for '04 in that same range.

But if you start off on the high base that was augmented by a nickel to start with, that's going to be difficult for us.

Okay.

Fair enough.

Good color Thanks, Nick, congratulations.

Thank you.

Thank you.

I would now like to turn the call over to the speaker for further or closing comments.

Nick, do you have any closing comments?

No, I don't.

Thank you, everyone.

Thank you, this does conclude today's teleconference.

Please dismiss your lines, and have a wonderful day.