Essential Utilities Inc (WTRG) 2003 Q3 法說會逐字稿

Good day and welcome to your Philadelphia Suburban Corporation sponsored third-quarter earnings conference call.

At this time all participants have been placed on a listen only mode and the floor will be open for questions following the presentation.

At this time, I will turn the floor over to your host for today's conference, Cheryl Hansen.

Ma'am, you may begin.

Good morning, everyone.

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

Presenting today is Nicholas DeBenedictis, Chairman and President of the Philadelphia Suburban Corporation as well as Dave Smeltzer, the Company's Chief Financial Officer.

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

Please refer to our most recent 10-K or 10-Q and other SEC filings for a description of such risks and uncertainties.

During the course of this call reference may be made to the Company's EBITDA.

A reconciliation of EBITDA [indiscernible] income is contained in the investor relations section of the Company's web site at www.suburbanwater.com.

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

Nick.

Good morning, everyone.

Hopefully, everyone got the press release.

Sorry for the length.

There's a lot going on and actually this is probably been one of the most of eventful and important three to four months in the Corporation's history.

And we've been around for over 100 years.

It was during this period that we completed our I'll call it a round-trip but basically finalized the last remnants of the Vivendi investment and this investment in our Company and that was completely finalized sometime in late or mid May and at this point in time after our second offering this year, we now have a shareholder basically 2 to 1 retail [indiscernible] about 65 percent retail and no one in the ownership line is more than 2 percent of the Company whereas we had always one large investor of up to 40 percent when we had the large French utility investment investor.

We completed our second largest acquisition ever which was the AquaSource acquisition.

About 130,000 customers.

And put this into a lot of new states which we're excited about and will talk more on the conference call about but the bottom line is that the pricing on that is working well, and that actually helped earnings for the quarter even though we were only in place for two -- in place for two months.

Now I'll talk much more about that.

The refinancing of the entire Company basically but also with after the Vivendi but also to pay for the AquaSource was done at very favorable rates.

We've bought $135 million at 4.87 percent which is therefore at least 30 years or 25 years.

That's a good solid base to work off of on the growth platform and we continue to lower our overall cost of debt which is very favorably received by regulators and also helps earnings to less than 6.5 percent on almost 800 million in debt.

So we're very pleased with that we've been able to take advantage of refinancing on our base company and then to finance the new acquisition at a very favorable rate.

We of course had to do another major offering in addition to the finalization of Vivendi which is about 1.5 million shares of 2306.

We went out with another 4 million shares at -- in August and we're very pleased with the offering.

It's the second-largest offering we ever did.

And there was good demand - both institutional and retail - and that was completed at 2340, so we kept intact stock trading today around 2375.

We kept intact our record of never having an offering where the price wasn't higher on the next offering and it remains that way as we see it today and from a shareholder standpoint, from an intrinsic value we increased book value based on all these acquisitions and issuance of stock by about 20 percent year-to-year.

And the stock has performed fairly well since we were up a little over 15 percent for the year not counting dividends.

We announced our stock split and stock dividend increase which was effective -- effective date is November -- December 1 but of record November 14.

And we also proposed a name change which was going to happen during the quarter but I guess I can announce we've settled the disagreement we had with another large water company - RWE, which is a German owner of American Water which challenged our using the word America.

Our name will still be Aqua America under the settlement but in each of our states we will call ourselves the state name with the Aqua symbolic trademark not -- example we will be Aqua America on the New York Stock Exchange we ring the belt on Jan. 16 and our symbol will be WTR symbolic of water and we think that tells investors what our Company really is, what it stands for and what they are investing in and also says we're more than now a regional company which was demoted by the name Philadelphia Suburban.

However in each day we're not going to call ourselves Aqua America of Pennsylvania or Aqua America of Texas, we believe we're going to be called Aqua Texas, Aqua Florida, Aqua Pennsylvania and we're doing all the checks now with all the trademark lawyers and so forth.

And it also was an exciting three or four months where we've made some major changes in management to look at our new structure one being our retiring -- Morrison Coulter retired after 40 years, we picked up very seasoned executive executive from American Water who is the new president of our biggest unit Philadelphia Suburban Pennsylvania Suburban excuse me and that is Carl Chiros (ph).

We promoted a gentleman named Rick Hugus (ph) [indiscernible] who used to be corporate development to the president of AquaSource and he's hit the ground running on managing it.

But his real potential I think is going to be how he grows it, because that's his expertise.

He's a long-term water industry employee Masters from MIT and he also is been, basically, a senior executive again with American Water and with us for the last decade.

And third part of corporate management was we promoted the former general counsel to PSW to become our new head of corporate development.

He has a law degree from Columbia but recently went for an executive MBA at Villa Nova and wanted to get his hands actually in M&A work and we think it's a nice assignment, based on his recent education and of course his legal experience in having been with the water Co. for over ten years after serving at Morgan Lewis, so we really feel very good about the team that in is place to take us to the next plateau.

We are always preparing for rate cases but we are preparing -- these are extra special ones, two major rate filings which will come over the next month.

One in Pennsylvania -- which is of course the biggest part of our Company still over 45 percent of the Company, that will be an excess of 25 million or right around 25 million.

And the other would be in New Jersey where we're filing for about 2 million -- New Jersey will be about 2.2 million.

Each of these are going to be well within the range of -- in my mind except (indiscernible) and well below the recent rate request made by American Water in those two same states so we're trailing them in and we will be considerably less in the amount of the increase in our rates in both those states will still be lower than American assuming both of us get reasonable relief in our proposals.

This has been the worst year have I had - it's been an exciting year but it's been the worst year I've had since coming here from [indiscernible] uncontrollable events which -- we've reacted to the downturns where we could but you can't in some areas.

Health-care cost asserting everyone.

We're taking some actions we can talk about later.

Pension expenses which -- the market keeps going up we will all be out of the woods but every corporation in America is looking at now making payments into [indiscernible] benefits.

Talk a little bit about that.

Security, which was a nonexistent issue - at least to the degree it is now - two years ago continues to be a cost element that we do think it's all recoverable in rates when we go into these rate cases.

And the coldest winter we had in the last decade which was good for the gas companies bad for the water companies and the wettest summer -- I am going to say could be ever according to the (indiscernible) national weather forecasting bureaus.

But it seemed Ohio was the rainiest state in the nation and North Carolina was a close second and that was all followed up with a hurricane and tornado.

Other than that the weather really helped us this year.

So that I think has to be factored in to some of the results.

We continue to run the business - core business - with the same type of strategy customer growth growing rates and revenues through customer growth and to watch our cost we continue to keep our efficiency ratio and we call it O&M the revenue in the positive trend.

I think we talked another 20, 30 basis points off last year's run rate.

Get into that, now that's where we're also doing better than we pro formaed at AquaSource but AquaSource has a much higher operating cost less in assets but more in operating, we still get same [indiscernible] revenues but changes that formula slightly and we can get into that a little bit.

The other major item, which I think is important, is the S&P rating which we also got this quarter after the offering and after the borrowing of money for AquaSource at a very reasonable rate we think.

And, also, after the analysis of AquaSource by S&P where they actually noted that they think that the AquaSource investment improved our investment profile -- our business profile, excuse me -- and also commented that they thought the favorable regulatory climate in our states were a plus.

I think that is a plus to the regulators who want to make sure that there's a healthy water industry to have some companies who will be willing to pick up small little water companies who really are going to have a hard time staying in business over the next decade and to make the major infrastructure investments that EPA is asking for -- the 150 billion over the next 20 years or so they're saying has to be spent on the nation's water infrastructure and companies and RWE are two companies that are going to be looked to step to the forefront to do that.

So favorable regulatory climate is very important.

Also think it is worth noting that S&P's overall analysis of the utility industry that was published back in October - October 16 - noted that there were 21 downgrades of holding companies and operating subsidiaries in the utility business and only one upgrade.

We were happy to be in that timeframe one of the few was held constant at the A+ so I think relatively it's even better than just getting taken off credit watch and reaffirmed as an A+ and you see what's happening elsewhere in the utility industry and I think that indicates the safety of the investment that our retail shareholders especially [indiscernible] rely on as the type of investor we usually attract with a company like Philadelphia Suburban.

One more thing and then we will open it up for questions.

We did have a land sell this quarter which helped us but this is part of an ongoing program we've head for the last three years and we have -- this was the one we announced that in December with great fanfare with the outgoing governor to have a state forestland made out of one of our reservoir holding areas in Shimoken (ph) which is a pretty depressed area of Pennsylvania and the new governor, Gov. Rendell (ph) and I talked right after the inauguration and he said he wanted to continue with it and we ended up doing a major announcement with him at the site.

That was very positive.

And it was all done in the third quarter so therefore the dollars hit under the accounting rules in that quarter.

But it was something we talked about in the past and it's -- we're about 60 percent through our land assets redeployment.

We still have 12 million of land left that we are out actively looking at - we're not going to sell it at a fire sale but when we get the right buyer or the right use work donation like this one was with a dollar with it, it ends up being very positive to the Company overall but, governmentally, but also financially.

The other is the -- just some astonishing figures.

We dove down into the consumption because it really did hurt us.

If you look at the earnings so far we're looking at 74 vs. 70 and there's some rounding in there.

If you look at last year, it was 69 8 (indiscernible) something like that and this year it's a heavy 74 74 3 or 4 so there is a rounding issue in there.

But, basically, each quarter has been affected somewhat.

First quarter we probably got hit at least a penny by the main breaks extra expenses because of the cold winter not much from consumption but mainly just from expenses.

Second quarter we had a very very wet spring and we were -- I'd say about two cents just out of weather in the second.

We hoped we would all turn around and it'd be a great summer especially in comparison to last year's drought and after the summer, I wish we had the drought conditions of last year.

Look like it is another four cents four or five cents just because of weather.

And I think you're seeing that from the other water companies in the East Coast that are reporting.

Fourth-quarter should, hopefully, go back more to normal.

But we drilled down a little bit to see where some of it was and as you can imagine almost all of it was domestic [indiscernible] people not watering their lawns because they didn't have to.

But we also looked at some of our industrial and most times we like although industrial is not a big percentage of our overall revenue I think it is 10 percent Dave?

Roughly 10 percent but the amounts that some of the companies were down was just very very interesting. (indiscernible)

One thing you don't really think of is one of our big users are golf courses. [indiscernible] We just took a run of the 80 golf courses just in the Philadelphia area because -- it could be extrapolated out every state we're in.

The usage of golf courses is down 22 percent from last year and that was a drought year because they couldn't water -- couple of the weeks during the summer -- and 33 percent just over 2001 and that's a big conglomerate user [indiscernible] one course would be a major user but in that case did make an effect.

And then on the industrial side we were down significantly and I'd say well is that because of an economic malaise?

Answer to that is no.

Basically, because people didn't need to use our water to make their product because of weather.

Example.

Two of our biggest users are powerplants - one at Cogen Liberty Power which we put water to a year ago and Peekco which of course generates electricity for the general area and also sells to the grid.

Just those two to give you an example third quarter to third quarter last year 200 million gallons water less was used by Liberty.

A 86 percent drop and that strictly was because nobody was buying power 'cause it was a ciik wet summer.

The Peekco (ph) was down 20 percent and a lot of those is [indiscernible] flow and that is the reason but still a 20 percent drop quarter to quarter is significant.

We had a couple of industries one has gone from seven days to five days - that hurt us - and another one has changed product line (indiscernible) Illinois the Heinz factory got into a new product line and we (indiscernible) that would temporarily shutdown the line that was using the water.

We have a power plant in our area that (indiscernible) plant which is one of our largest users and they were down 20 percent and when we asked them why they are still generating and burning as much trash they use our water and they pool it in the reservoir and use it so with turbines so all the rain (indiscernible) rather then using our water so they all make sense - the golf courses, the Liberty power plant, the trash steam plant, couple of industrial slowdowns and we sell a lot of water to a couple of municipalities which of course didn't need as much this year as they did last year when they had (indiscernible) water in their wells.

Overall we had a huge drop in consumption - over nine percent in the industrial sector in the top 10, it was even even higher.

Generally across the company 9 percent.

I would say that would be very hard to ever project in any pro forma.

We would've never thought the weather would have been that bad so this really has been a terrible weather year for us and we hope next year's comparison will be very favorable and goes back to normal weather.

I think that explains most of it, I will answer questions you may have and if you want to get into some more depth on of course the AquaSource or the weather patterns are anything else we can.

Open it up for questions.

[Operator Instructions].

Tim Winter at A. G. Edwards.

I was wondering if you can talk a little bit about what out what your appetite is for bigger acquisitions over the next 12 to 18 months given that you're trying to swallow AquaSource right now?

And whether or not there's any opportunities out there?

Well, the -- let me start with AquaSource and how we're integrating it because I think it's important.

And then, therefore, the capacity we have both management and financial to do something similar and where we want to go because that's a strategic question.

Regarding the management question of how is is AquaSource working?

Very comfortable - all the financial systems assistance and you can ask Dave any question you'd like -- having integrated and it is working very well.

We've been able to stabilize the overhead expense I mentioned and we were going to try and cut their 12 million down to about 7 to 7 1/2 and (indiscernible) to be stabilized and everything working with assistance computer systems customer information systems are all switched over with no problems and we are -- we ran parallel for a month and I guess the best sign there Tim is we asked Duquesne (ph) to keep some of their key financial people in Pittsburgh and we paid for them for six months and Dave, you already released them right?

Right.

So we feel comfortable that it is under control.

Regarding the engineering side we put people in each state tracking the environmental issue because mainly, we always ran big systems whereas a lot of small systems may not be big environmental problems but if you get a number of them, they start mounting up so we have the person on the scene, we hired somebody out of the state environmental agency in Texas and we're pleasantly surprised that we're finding nits and gnats, but no major big issues.

We know there's -- I'd say about $30 million there we're going to have spend over the next couple of years just to continue what I know AquaSource was fixing up, but of course that is not all that bad because it builds rate base.

But the major capital needs like you have in the Northeast and Midwest we don't see in the South other than for growth which I think is a very positive because they're mostly newer facilities.

It doesn't -- the pipes are plastic in many cases and you don't have to dig as deep and it's less intricate systems -- you're not talking about big booster pumps up and down hills you're talking about, really, a tank or a hydropneumatic tank - a good well or to and good fire hydrant and services and that's about it, except you only have 500 here 400 here you don't have 400,000 people or 30,000 in the case of some of our consumer sites and that is the difference.

So overall I think the systems are in place and working - we're trimming costs, we probably still have some more to go.

We estimated that we would probably be close to 70 percent O&M to revenue ratio versus 36, 35 at the core company same-store sales if you want to look at it that way.

First quarter first two months of the first, we got it in July two months came in low 60s [indiscernible] is that correct?

We're going to see if we can hold that ran rate, but we've watched our [indiscernible] control, watched our purchases of gas, had to let a couple of people go who didn't understand process process and we made some changes at the [indiscernible] says our culture very quickly rather then wait and wait and wait, we're doing it very quickly.

I am pretty comfortable we have it under control and we could absorb a reasonable size acquisition within the next six months or something of that sort.

And the other good thing about our business is if you do a deal, it usually takes a year almost a year in waiting in the case of AquaSource [indiscernible] 10 months.

But you have to get through regulatory approvals and that gives you a chance to meet and know the assets and the people you're dealing with and make some changes even before you own it so that when it comes into the fold it hits the ground running.

So I don't think -- matter-of-fact I would guesstimate that if you separated out AquaSource probably did about a penny in this quarter was AquaSource.

Coming in better than we had performed and that's mainly better than revenues expected - we think that could have been good weather [indiscernible] fills they never knew about that we found. (indiscernible) the second would be our expenses are less than what we had pro formaed -- nothing we can't (ph) maintain that maybe go a little further.

Talk about strategy now that's a different issue - the southern strategy will be different than the northern strategy which is to try and buy adjacent tuck in acquisitions hopefully some municipal governments you end up paying a reasonable amount for them and then you get them in rate base because there is the asset that's been built up over 75 years so they're there.

You have to prove to the regulators that they are there and you earn on that and you usually need a lot of capital because your final system otherwise they wouldn't sell them so you're building ratebase and that's why the disk is so important because of a lot of it's pipe.

Two-thirds will be pipe -- one-third treatment boosters and tanks.

On the pipe side, the disk has really made the difference in northeastern and Midwest states and one piece of good news I didn't mention - I am meeting with Gov. Taft tomorrow he is signing the bill that puts Ohio now in the ranks of putting in disks.

Surcharges for pipe which will mean we have it in Pennsylvania, legislatively, in Pennsylvania, Ohio, Indiana, Illinois.

So our big Midwest and Northeast and we anticipate asking for a special mechanism when we file our rate case in New Jersey to try and come up with some disklike mechanism in the regulatory process.

So that's the good news and you'll build ratebase and you'll build customers mainly by acquisition with very slow organic growth.

The South, we're finding a whole new pattern and we're trying to put a little bit of that in the Northeast because we never did this before.

First of all we're buying developments and new developers and the example in North Carolina there's 10 already [indiscernible] 10 more to go, all of them roughly 150, 200 customer development.

The builder builds everything under our specs.

And we inspect it before we accept it.

And we pay them when a customer hooks up about 500 bucks.

So you're looking at costing $500 a customer versus a municipality which is like 2500 with no capital in the first example and a lot of capital in the second.

Now capital is not all that bad because it bills rate base [indiscernible] sells stock above book and that's how you grow earnings.

But on the other hand if you can grow revenues just by hooking people up first you generate a lot more cash free cash and second of all, it is still profitable as long as it's costing you -- as long as your rate structure is such that much more than your expenses because you are not putting much in capital.

So you can see a new type strategy that blends in with the 70 percent 80 percent of the Company is still in the Northeast where we still have to produce the acquisitions and we've done I think 10, 11 this year and I expect a lot coming in on the fourth quarter.

And then we are looking at more of the development oriented growth in the South in addition to the normal organic growth we bought AquaSource with developments that were not completely built out we will continue to build out.

I made mention of two other issues.

We're now working with one national developer, we're talking to two others.

Trying to come up with a template where we would work with them, where they're building the golf course ex-suburban type community.

One we're working with out in Illinois - it's a 600 home development we're putting money up front.

So there is a gamble that they will never build houses and they never get sold.

Toll's probably spending 5 6 million investing.

So I'm assuming they have more skin in the game then we do.

And then what we do is own all the assets and then as people hook up we pay them a piece per customer but we end up with having valued assets not paying completely for them and a brand-new system system with some organic growth.

That's what we're looking at as a little bit more of a template in the Northeast rather than just depending on older systems - acquiring older systems - and then adding them immediately and putting capital in so a couple of new strategies we never would have had had we not bought AquaSource because we never looked at the business that way.

The answer for can we digest another one?

We think there may be one or two more that are going to be up maybe up for sale over the next year or two.

And we will be obviously viable better for those for want of a couple of companies probably looking at this now because I think the wave of electrics that wanted to get in our business and the number of companies French, German, and English who were all looking over here and Dutch I should say because one of the companies is Dutch.

We don't see them with as much interest other than the obviously RWE which made a [indiscernible] investment -- recent investment win the American Water.

So I think it's like if I had my druthers I'd say we will tell when we're ready to buy something but that's not always the way it works and I think we have the management capacity to take on another one if we have to because AquaSource is really working pretty well.

Sorry for the long-winded answer but it was a strategic question.

David Schanzer with Janney Montgomery Scott.

Congratulations on a quarter despite the continued deluge here.

At any rate I wanted to follow-up with the last question actually if that wasn't long enough I thought I'd add to it.

Let me take a different tack.

If you -- in considering the AquaSource acquisition and if a state a particular state -- I'm not specifically pointing to any one of them but if we made a supposition that one state didn't meet your expectations and given the fact there's no one that seems to be in the market to be buying companies, would the Company consider possibly spending out that state's operations as a separate water company to shareholders?

That's an interesting scenario.

We've made the decision that we're not like we used to be - never want to sell anything.

We did that a year ago when we sold Astabula (ph) and that was relevant in the fourth quarter of last year where although we earned 27 cents in the fourth quarter it was again like 19 cents the prior year and realistically a nickel of it came from a onetime gain - a good gang - and we used the money but we -- that's the first time our company or our consumers and consumers under us had ever said okay, we will sell.

Usually we want to fight it, fight it, and get condemned and see what happens.

In this case very good settlement we figure we're going to lose anyhow so [indiscernible] no growth and we weren't getting any equity.

At that point when we bought AquaSource we had already basically said we're no longer under this modus operandi that said we will never sell.

And we looked at the AquaSource states and picked 3 or 4 of them and said do we really want to be in these states.

And two of them were very close to a company who wanted to grow actually almost double their size at least significantly increase their size and we've had a very good relationship and a quick sale of the Connecticut which I mentioned in the release where although we -- I guess you could say gained on it because of the accounting rules, we're not going to book a gain we're just going to reduce the assets of the rest of the AquaSource state we're bringing in so it's actually a positive for long-term for our shareholders but we don't [indiscernible] is real cash coming in and will be about 5 million plus assumption of debt in New York for 800,000 or 5.8.

That went very smoothly in there's been no problems and we'll, obviously, have to work out working capital and all the kind of stuff but it has been a very very close relationship.

The next one like an AquaSource were to come with the state that we just don't wannabe in and there's critical mass enough, I mean we could run New York and Connecticut - it just would've distracted management's attention more than we want to grow in Texas, Florida, and [indiscernible] but if it is a critical mass enough, I think there is a market for small water companies.

That you could spit out because we're not paying -- we're basically buying it at the intrinsic value I guess if you call [indiscernible] intrinsic value.

Therefore it has earnings potential if it's run right.

And just wouldn't have as much potential for us and where we want to go but it worked for maybe a different management team and, therefore, they could probably generate shareholder interest.

So, I think it's a very viable way of doing things.

And then, also, at the other end of the spectrum some of us are hearing that some of the foreign owners are not totally satisfied with the investments that they made over here.

Do you think that in the next several years there may be a market for the spin outs from them?

Some of their properties?

Yes, I could cynically say that they missed the best one to buy and we're still around, but I think probably the bottle that the Europeans use and I can only speak from my experience with the Parisians that we dealt with is one of a cash flow model and a lack of recognition of the regulated model where you go negative cash and get it back a year later.

It's really filling up your factory at your cost, knowing you get paid back when you sell all the widgits the following year.

They want to make money on this current year and that's very difficult to do if you want to build pipes and everything else.

And if they continue to feel like it has to be free cash flow, that's their only model.

Then the only thing they really have is the O&M model to depend on, which as you know we don't believe is very [indiscernible].

We don't like that model.

We have now we're going to have to separate out O&M for you all by the end of the year as we sell off some, keep some - we're only to keep the profitable ones - but O&M was a big business for AquaSource.

We didn't pay for it in the assets but we got it.

So we're analyzing that and we will probably talk a lot about that more in the fourth quarter call.

But the -- I believe those who want to follow the free cash flow model are not going to be satisfied with their regulated [indiscernible] maybe would spin them off if they had critical mass.

Just the way I described it we will probably do if we didn't have a state that we didn't want to be in but had enough critical mass there would be investor interest.

Last question has to do with your asset sales.

You say -- I realize it's very difficult to forecast these things and thereby the very nature they're lumpy.

Is there anything that we can look to over the next four quarters that you might have on the drawing board that we could kind of build into our budget or forecast?

I think realistically a penny or two a year.

This was the big block we had up at Brush Valley and I had mentioned this over and over.

This was 8,000 acres [indiscernible] much more of that but we still have 2,000 acres left up there that there might be a federal prison on which we would get going value for it since they want to build a commercial establishment.

We have a big block of land where they're planning a major development around our lake in Ohio - Pinelake.

We have land around our Vermilion lake which we have builders interested in in Danville.

We have a lot of property we got with acquisitions right in this area (indiscernible) township which as you know a hot area, that we could sell off, it's a five acre lot with a building on it.

And we have land around our Green Lane Reservoir which we never looked at.

We have more land around our [indiscernible] reservoir which we've never looked at and the same thing with our Churchville (ph) and we have a lot of land in Maine, we don't have a lot of developers looking for it, but we're actively trying to look at now that MBNA (ph) is up there.

I think there is still potential but I think it runs out in two or three years but we never said it's an earnings builder, we really only looked at the redeployed assets that are earned, because example this one was strictly a goodwill plus get some money that we would never had 'cause that 8,000 acres was never going to be developed and redeployed, but like the Ohio example is a good one.

Here we have dormant land that is earning very little in rate base because it has very little value but we're going to turn into a developer who will have about 300 homes buying water from us, and plus we will make some money on the way which we will not have to sell stock to do so -- just made so much sense unless you need it for some other purpose.

A lot of the electric utilities used to buy land because they thought they were going to into the real estate business and now they're -- some of them are the largest landholders in the region.

And I think you have to look at how you turn that into economic development potential which is what we're doing on a small way.

Brad Coltman, Deutsche Bank Securities.

I was wondering if you guys could just follow up with after the final purchase price and maybe some of the adjustments (indiscernible) on afterwards?

Sure, we're were still obviously working on that - let me just break down the purchase price - I think it was like 195 is what we put in the last Q release.

About five of that was the tax deferral that we will get back.

We paid them for, that's the difference between what they had on their books and what we paid so we paid.

So they wanted some taxes back on that for the loss and we gave them that and we will get that back. [indiscernible] I'm giving you the non-GAAP [indiscernible].

If you want the GAAP, call Dave.

The second piece was working capital where they said we owed them 5. some million, 5.5.

We have been in discussions with them and we both have under the contract the ability to go to our arbitrator.

I think they've already agreed with us, based on all the research and facts we gave them that some of their assumptions were wrong.

And I think we're looking at a decrease from that which would be cash back.

Million two range.

That was five of the 195 - the taxes were five of the 195 and Dave, are you allowed to opine on what you think that 5 million taxes is worth to us?

When we did the analysis [indiscernible] it was clear that the cash flows from that future tax depreciation would be in excess of 5 million.

So we thought it was fair at the time to put that $5 million on the table, it's hard to tell based on the future tax rate and the timing of all those deductions exactly what it is but it's certainly in excess of the 5 million and it is not a P&L item, it's a cash flow item.

Do you expect that to finalize in this current quarter?

5 million?

In terms of the total purchase price [indiscernible]

[indiscernible]

The official timetable requires DQE to send us their analysis of the final purchase price after the conclusion of the Sarasota, FL rate case.

That was one that we agreed to leave open and allow an accounting for that in the purchase price metrics.

So actually they -- it is possible that they would not be in a position to send us their final purchase price analysis until sometime in December or early January, based on the timing of the conclusion of that case.

Okay, so maybe by the time of the fourth quarter conference call.

Yeah, we're meeting with the Chairman and CEO -- CFO -- of Duquesne this week to sort of lay the groundwork where we think we're coming from.

I think the working capital discussions are pretty much at Dave's (ph) level with the former AquaSource CFO and I think we're 90 percent there, Dave, (indiscernible) on agreement so I think that can get worked out, hopefully without a major confrontation.

The tax issue I mentioned - that left 185, Brad, of what we paid for assets.

We have already challenged that 185 - we paid it, obviously.

And that 185 could drop to as low as 169 under the contract, add the 5 back for taxes and that is where you come up with that quote '174' minimum we've been saying but the assets are 169 of it.

And we are now at 185 and just last week under one of the pieces that we challenged, they sent us a check for what (indiscernible) 2.8, almost 3 million.

So you're already down to 182 that we paid, and we think there's more on the table that we're going to be talking to Morgan O'Brien about.

We think that there's rate base and some of the calculations they made on rate recovery that were maybe more aggressive than we were.

We're going to argue that.

So by the end of year, we know where we are but I guess the best comparison would be, you're already in the 183 range, 182 range, with maybe a little bit more on the assets and, roughly, we're still working out how we're booking it with each state and with the Connecticut sale that we adjusted things and so on, but we're probably over 225 in rate base.

Just a follow up on -- and I know you talked a little bit about the integration -- but what else needs to be done in the fourth current quarter and really what I'm trying to get at is what is kind of the run rate for OEM expenses in the fourth quarter?

And how do you see that trailing down as you integrate and get the cost savings through '04?

If you could give us some forecast on that?

Just general guidance?

I haven't really dove into the budget for '04, so all I can talk about is where our run rate is currently.

I think -- I would say our overhead cost at least as -- we are going to segregate AquaSource this year because it came in and it wasn't in our budget.

But next year we are going to present a budget state by state.

And we're going to divide out O&M.

And then every customer will get the allocation of overhead and every customer will get the allocation of debt.

For example, Brad, we didn't know how much it was going to cost us eventually.

So we sold $90 million of stock and we borrowed 135 million of the debt.

Well, to charge all that debt to AquaSource is unfair, because we're not going to use it all.

So all that gets allocated and in the same sense up till now, David and I have been already in the budget so it would be unfair for us to allocate in this like non-GAAP type thinking that we're doing to AquaSource, so all I did is add the extra incremental.

When we start next year we got to spread it over the whole thing.

Having said that, we think that the run rate for the fourth quarter all I can say is, revenues less expenses will add about a penny, based on the overall number of shares which is now up to 70 [indiscernible] new rate on shares? (indiscernible) 74 million.

And the reason it was a little bit better in the third quarter was because we didn't have the proportionality of the shares since they were sold in late August.

The average number of shares was only like 71 or 72 - you will see in the Q. What was the average number of shares there?

David [indiscernible] 72 million?

So actually how the way the accountants have to do it it hurts us in the fourth quarter and helps us in the third.

But I do think a penny is a reasonable number that then we will work into next year's budget.

But I really want to start thinking of Company now because it's an integrated strategy across the way and I want to get -- our hope is in the fourth quarter, we will be able to say, this is how many of our customers if you want to call them that really contracts our OUM, this is the amount of revenue and this is what we're making on them, because now we have more O&M customers than we ever had.

But we're not saying we're growing that business but we want to accurately track it.

And any that aren't really included in the regulated rate - some states want you to include it - are going to be separated out so we know if we're making money or not and one of the challenges for Rick is for not making as much on those and do you really want to stay in there or do you want to put your money elsewhere?

So he's going to analyze it that way.

And then the other would be to show our base growth because I want to show you growth by state vs. in general, because some states are going to grow faster than others because of the patterns and where we want to spend our time.

I don't know if I can answer any more on the '04, Dave.[indiscernible].

Many of activity and [indiscernible] fourth quarter (indiscernible) get at is your expenses as a percentage of revenue in fourth quarter little better than (indiscernible) were in somewhat trying obviously [indiscernible] the operations for a portion of the quarter and so I'm trying to figure out for the fourth quarter, what that percentage might (ph) towards because, obviously, it is probably going to be the highest level it's ever gonna be and as you integrate (indiscernible) finish integrating cost savings (indiscernible) '04.

Basically, can you give me an idea for '04 for the fourth quarter?

I can't - can you?

I don't have a precise number.

I think you can look at what we accomplished in the third quarter with only two months of results and with basically the summer quarter in Texas and Florida, with solid revenues and controlled expenses.

So clearly it is going to be higher in the fourth quarter as you know, Brad, because it's not the summer revenues any longer but these expenses will be fairly consistent although we continue to trim back every month.

So I'd say it's going to be a little higher in the fourth quarter than I would hope the first quarter.

[indiscernible] [indiscernible] high 60s.

Let us do a little work and get back to you on that.

Little more guidance if we can and then, the '04 is going to be more of a consolidated because what we did we looked -- at -- I asked everybody what our run rate is like retailers would do or McDonald's would do, same store sales, how are we doing?

And we did give you that number - I think that is significant.

Even with the bad summer consumption down 9 percent - this would have been a blowout year had we had great weather because it would all have dropped to the bottom line.

But without that it really does affect those ratios.

Let me give you the numbers.

[indiscernible] well for next year too.

Yes if the weather comes back for us and as long as some of these industrials are strictly -- Bob, what page is that chart on that shows all [indiscernible] here we go.

If we take a look at the third quarter and we take AquaSource out, so, this would be another way of backing into your question so this would be consumers and Philadelphia Suburban -- Pennsylvania Suburban with bad weather included.

Last year, we had a drought [indiscernible] bad weather sales wise as this year.

The O&M revenue - the ratio last year in the third quarter was 33 9, this year it was 32 6.

And year-to-date, overall, again without AquaSource and this includes -- remember we had that bad first quarter this year where we didn't have it in '02 which really put the expenses up. 36 4, 35 9 this year so we're still on track of taking the core operating expenses down that we always say 50 to 100 basis points a year.

Now that whole level jumps up probably to 36, 37 percent when you throw a 20 percent of your customers in at 65.

That's what I want to show you and build it up so that we start next year looking at it in a little bit more of here's the new company -- here is what we should grow on the whole base, here's how many customers you have regulated, here's how many O&M and this is what our ratios are on the O&M.

I'm very conscious that S&P doesn't seem to like the O&M business so if we are going to stay in it in any way and I am talking very small, I want to show them that we're staying in really does make sense of allocating overhead expenses over more customers but equally that we're making money on each of those.

Mike Warner, Kennedy Capital.

I had a couple of follow-ups because I missed - do you have 12 million worth of [indiscernible] dollars of land left to sell?

Is that what you said?

Let me see if I have that number.

Yes.

[indiscernible] [indiscernible] New Jersey New Jersey -- sorry what other state?

We're in it right now as we speak we're in it for 2 million (indiscernible) in the briefing stage we just got a case completed in Maine and we're going in for one for another one in Maine.

There's always four or five going on - I just gave you one of big ones so we have one in Ohio we're going to file in December.

We have two in Virginia so there's always small ones.

But the big ones or the big ones, the biggest [indiscernible] Pennsylvania every couple of years that's about 25.

And that's on revenue base probably 250 so that gives you an idea of the range.

And the New Jersey is about 2 2 on a revenue basis, our revenue New Jersey are what about 8 percent?

Give you a run rate on the revenues in New Jersey and then you'll get a feel increase would be.

Pennsylvania's going on right now?

Pennsylvania has not been filed yet.

We anticipate -- both of these we anticipate filing in over the next month or so.

What's the New Jersey yearly revenues [indiscernible] get a feel for what the 2, 2 means, we'll get back to you on that.

Do you have another question?

Yeah are you going to provide formal 2004 guidance after the year end this year?

I guess we don't ever provide guidance.

We usually look at where First Call is and comment on that.

And our model, Mike, is pretty clean.

The only thing I'd say is a variation you're getting that from some of the comments, when you're picking up a 20 percent growth in one year and you're pruning some like Connecticut and New York, what does that mean to earnings?

Is it real cash, is it booked at a higher and how we're going in for rate base.

The real story on next year is going to be a major case in Texas that we're going to have to file which will hopefully capture the value of the Texas properties which we are valuing right at original costs.

We're not asking for any acquisition adjustment like the former owners used to ask for but it's still a considerable size case.

And before we go in on that case we want to make sure we're providing best customer service - that's why we're working on that for the new president in Texas and also thinking up all the nits and gnats I mentioned earlier in the conference call with our environmental person so that everything is fixed before we go in.

But most of that case is going to recapture the share value.

By the way the run rate on New Jersey is slightly over 20 million a year and so the 2, 2s run around 10 percent.

So are you in this call have you stated some [indiscernible] evidence of what you expect 2004 to look like or is that something that you did not do at this point?

No, no.

Basically I gave some of what was the anomalies of the weather this year which you can always work back in your model by saying it is the normal year you would have that detriment.

That would be like this quarter alone was about 7 million loss in consumption revenues.

We gained 11 if you look at our 10 million increase in revenues, about 11 million of it was -- get that out 14 was -- here it is, if you take 12 million from the AquaSource addition and other acquisitions in growth we have this year we got about 5 million of it in rates but we lost 7 million in consumption on the revenue side.

So the net was 10.

If you take that consumption at 7 million figure about 80 percent of it is -- goes to the bottom line tax effective you can see how quickly that falls to 10 cents per share.

So all we have to do is return that and start with a base that's a little better and then we have to grow the company a whole new base and make sure that we clean up any losers that we got with AquaSource quickly or any (indiscernible) as well as the rest and that's the quote 'pruning' that Dave Schanzer was asking about.

At this point, we're targeting 3 or 4 states and going to make decisions quickly and move on them quickly if they don't pass the hurdle rate.

Do you have a long-term earnings growth target that you try to hit on an annual basis?

If we can continue the older model which was based on acquisitions more than this organic growth which is a new complement to it now.

We've always stated that we would like to increase our customer base about 4 percent 3 to 4 percent.

That gets harder as you get bigger but we are still being able to pull it off [indiscernible] this year we will hit 3, 3 to 4 percent.

Actually this year we will hit 25 percent because AquaSource is actually really four years of growth in one year but just (indiscernible) different base.

Revenue growth if you take that three to four you can grow your revenues 3 to 4 what you get through your surcharge of the pipes in the NorthEast plus rate cases we just mentioned because you always have some rate cases (indiscernible) grow that topline 7 percent.

And if we can do that and can continue to finance effectively and continue to spread our operating cost over more people and spread overhead we've been able to generate 10 percent on -- on earnings.

And then that's why we've been able to raise the dividend effectively five or six percent a year and if you look at our last 5, 6, 7 years - you'll see that compounded rate if you normalize for weather and ups and downs.

It comes pretty close to that standard.

We're comfortable we can keep that going.

Now the difference will be the cash flow will be different now because we're -- I think generate more cash out of the South than we ever did in the North.

So we probably will use some of that cash in one area to move to others not rate base but cash -- (indiscernible) sell stock to do what we need in the South and that's going to help us in the [indiscernible].

That may change some of the dynamics but only for the positive (indiscernible) because we won't have to float (ph) as many shares.

Trip Rogers, UBS.

Stuart Sharpes.

Standard & Poors Equity.

Most my questions have been answered but just wondering whether the efficiency ratios for AquaSource were still expected to average in the low 40s or are you bringing those down?

Yes we will be able to much more tell you in detail after we develop a budget with AquaSource in the full year - I think what you're referring to is we said our run rates are in the 35 to 36 range for the core company which is 80 percent and the 20 percent for the AquaSource we estimated high 60s.

It's coming in better than that after two months.

And that's what Brad's question was -- and we're going to try and answer that with the fourth quarter whether we think we can maintain that, but when we start out next year we're going to give you a blended rate and that's where that 40 came from.

And with the blended rate then you can start marking -- tracking our progress in getting that 40 down to 39 to 38 and go right back in again.

But rather than keep giving you month -- quarter to quarter this is AquaSource, this is the rest, we really are looking at this as state by state now and the (indiscernible) are going to be hearing on how that's growing how have they produced cash in their states (indiscernible) good they (indiscernible) rates.

So for us to have it as an AquaSource company there is no such thing as an AquaSource company, really, once we blended into '04 and it's one budget.

And also do you expect to maintain your pay average ratio [indiscernible] 60 percent range and do you see your dividend yield as still being attractive to investors based on alternative investments given the improved economy?

You as an analyst probably are best (indiscernible) your question better than I can.

Seems like people are rushing back to no dividends again while market corrects I guess.

We found a lot of interest because not only because of the ongoing dividend policy we have but because of the safety net of the stock because I think a lot of people looking at these downgrades from S&P and the electrics no longer see the electrics -- I mean there is no such thing as a MaBell anymore so you look to the electrics.

I mean, there are other than Southern, there are few electrics that are traditional electrics where you can do rate base rate of return and if it's good management you should be able to grow earnings three to five percent a year and things of that sort.

So I think companies we're looking at American and also -- (indiscernible) say companies investors and now you can't buy American stock so I think that gives us a little bit of a premium in the yield which is what you're referring to.

Regarding payout ratio, I think we're where we want to be in the sense of the mid -- where are we now?

The mid-50s.

I guess mid-50s (indiscernible) our Board has always been comfortable with paying out between 50 and 60 percent.

And if we end up actually generating a little more cash in the South than we pro formaed that even accentuates it more than we have in his up [indiscernible] more look to [indiscernible] aggressive dividend policy which I think we've had.

Our stock goes up that's why our yield is not as healthy as some electrics which stocks have gone down, but in the same sense, we've been trying to raise the dividend 6 to 7 percent every year.

We think we hope we can continue that.

Deborah Koi (indiscernible) Capital Markets.

Good afternoon long call and follow-ups.

Other questions and could you give us your best view on the finding of the Pennsylvania [indiscernible] [inaudible] that is such a big chunk of revenue (indiscernible)?

Well Dave, why don't you give them the legitimate up legal answer and then [indiscernible]?

Deborah we expect to file the PA case this month so the end in November.

The standard statutory review period is nine months so that would conclude next August.

And if you remember the last case we filed about two years ago took just that nine months statutory period and became effective in August of 2002.

So that would be the statutory period in which the commission has to address that kind of a filing.

If we were in a position to negotiate with the parties to the case and settle it as we had the three or four rate cases prior to the prior filing, it could conclude as early as June, for example, as we have concluded other cases filed on a similar timetable.

So, fourth quarter impact, possibly third. yes.

Yes two other factors.

This rate case is significantly less of an increase in the prior two, which is good news.

Lower the rate increase the better it is for your relations.

And second is the most recent appointment to the Commission is a former commissioner who has come back who is very I think he's joined the water committee (indiscernible) his name is Wendell Holland.

And has taken for his staff person for water a woman named Carol Kozlov, who is very active in (indiscernible) so I think that bodes well for the water industry in Pennsylvania from an understandable and understanding standpoint.

(inaudible) Any optical issue you have weather positive weather comps next year and revenue increases in your overearning - does that play into it at all?

Well you have to project what your historic test here is and that's the revenue float we use.

Obviously that comes into the argument phase, but we've always done it that way.

So it is unfair to say that well this year you should have been better or last year you should been worse -- for the 10 years in a row we've always done it the same way.

So I think the consistency is the way we (indiscernible)

[inaudible]

We're not doing I guess a better way to answer it, is - we're not doing anything different in this case that we haven't done over the past 10 cases.

So they can say we're not gaming anybody - this is what the rules are and we're following the roles.

[inaudible] 25 million [indiscernible] [inaudible]

11 7 5 range.

That's good.

And then my only other follow-up was it was intriguing that the kind of new business model that you mentioned in terms of partnering with the developers and investing in some of these systems, I'm wondering if that's perhaps it is very small and it doesn't matter -- but I'm wondering if -- how it would impact the overall return expectation -- I would assume on that sort of upfront investment that you would require at least under typical developer economics you would certainly require a higher than a 10 percent (indiscernible) given the potential risk of the investment -- how does that work as you roll those things into your rate base if you are making upfront?

First of all, you're buying assets at less than they're worth and then you get the franchise.

So it's not like we're waiting till is built.

For example this Hawthorne we're doing with Toll.

We filed with the commission and we will be able to put it in at the legitimate rate base.

I thought you said you were going to invest money up front before you actually started buying the connection?

Yes but it's already in rate base so it gets accumulated (indiscernible)

[inaudible] investing because it's already been built, it's not like, you're not investing before (indiscernible).

No, this is $10 million of investment that they've already done.

They just need somebody to run it from day one, when the first two houses come on board and also then to get paid back over time by us paying off the houses which would be rate base building there too.

But the initial investment investment is put right into rate base. [indiscernible] how are you handling the the Illinois case with Hawthorne?

That is being debated now.

We'd have to check and see which division Hawthorne is in because we're only in Illinois filing a rate case in one division now so not sure if it is in that particular division.

But that would be the ideal that you'd roll it right in and [inaudible] (indiscernible) not any additional (indiscernible).

No, no, and that's why this uniform rate base is so important, that we're pushing at all the [indiscernible] and we're getting it in North Carolina, Texas has it.

That's crucial because otherwise then you are at risk for a rate case.

Where it gets homogenized with all the other rate base if it's in a bigger state.

And very last question ... ?

But there is a risk, and I don't want you to

If there is a risk you won't get as many (indiscernible) customers [indiscernible] [inaudible]...?

And at some point, the commission says wait a minute, we're giving you full rate return on this thinking you're going to have 100 customers and only two?

It's not a prudent investment so the risk they would have to take a proactive stance to take it out.

That's the risk.

And it is a very small piece as you mentioned of the bigger picture.

[inaudible] and then just on the cost side you have been talking over the last year about all these additional pension health-care other cost even [indiscernible] main breaks and all of that and then when you look at what you've done on O&M, X. AquaSource year-to-date, where is -- where are the savings coming from?

What are you taking it out of that you go from 36.4 to 35.9 that's far this year.

Well a lot of it is well part of it of course is less electric and chemicals because you sold less water but that'll go back up when we start selling water, but we will take 20 percent 80 percent margins any day.

Most (indiscernible) complement control.

And spreading it overhead more customers we don't have any more overhead when we bring people in.

Where're some of the other points Dave, do you know?

We can get you more specifics but...

A good substantial piece of the revenue increased this year offset of course by the decline in sales has been related to our distribution system improvement surcharges in Pennsylvania and elsewhere and of course that is all capital recovery.

There are no expenses (indiscernible) associated with that.

(indiscernible) In addition to numerator.

So the idea then is if we think hopefully pension staff is stabilizing I don't know if you think health-care expenses is stabilized ...?

AquaSource has no defined benefit.

And we say we are not going to have one part of the company without the defined and one without so we now said anybody in our defined benefit which of course is the one in the biggest risk at the market goes down otherwise just basically a 401(k) you are contributing to and instituting -- guarantee that by the amount of salaries you have.

We've negotiated three of our four union contracts that all new employees come in under the strictly your only benefit is a contributory pension plan vs. a defined benefit which means we have at least other one -- we have the largest union yet to go and we're in negotiations now but that would mean that the risk factor now is limited to what the existing employees have.

The fact that we also get it back in rates means this is the last year for the hit because assuming the market doesn't go down again, the actuarial studies are all done and we win and recover in the rates what we are playing on an ongoing basis so we don't have this, we're getting it at rates at least so part is rate base so this rate case in Pennsylvania, a lot of it is driven the pension and health-care.

Health-care, we have gone on self-insured in all areas except for this one here.

Where we have an HMO in Pennsylvania and that's been able to moderate health-care costs in the high 8 to 9 percent versus what you're hearing 15 to 20.

But that's an ongoing risk the industry is going to face as we go forward because I don't see any end to it until the tort laws are changed or some of the federal laws or rules are changed on pharmaceuticals -- that is where the biggest increases are.

[indiscernible] add all that up then [inaudible] weather wise and cost wise and then going forward then [indiscernible] AquaSource (indiscernible) continued opportunities there.

It sounds to me like getting 100 basis points plus and then we assume we start from a 39, 40 percent range is there going to be, frankly, easy?

Well, then, Dave won't get his bonus if it's that easy - you shouldn't say that.

Yes I think if we get rate increases and moderate expenses and we get a little help from weather which is 80 percent margin revenues, it has to help that ratio.

[inaudible].

[Operator Instructions].

Gentlemen, there appear to be no further questions coming from the phone line.

I will turn the floor back over to you.

Thank you very much and thank you for your time and if you have any questions that you want to ask Dave or myself or Cheryl please call us directly.

Thanks.

Thank you.

This does conclude today's teleconference.

You make disconnect your lines at this time and have a wonderful day.