Essential Utilities Inc (WTRG) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to your Aqua America fourth-quarter and year-end 2003 earning results conference call.

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

It is now my pleasure to turn the call over to your host, Ms. Cheryl Hansen.

Good morning, everyone, and welcome to Aqua America's fourth-quarter and year-end earning conference call.

This morning we sent out two press releases.

The first referenced last night's honor of our Chairman and CEO Nicholas DeBenedictis by Emerald Asset Management with an award recognizing Aqua America's significant growth over the last 10 years.

The second release was our fourth-quarter and full-year earnings announcement.

If you did not receive a copy of the releases, please feel free to contact Tracy McGonigal (ph) at area code 610-645-1090; and she will send you a copy of the new releases.

Presenting today is Nicholas DeBenedictis, Chairman and CEO of Aqua America, and David Smeltzer, the company's CFO.

As a reminder, some of the matters discussed during this 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-Q, 10-K, and other SEC filings for a description of such risks and uncertainties.

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

Nick.

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

This is our first conference call as the new name Aqua America.

And on the heels of last night, at a growth-oriented investors conference, getting the award in line with a lot of tech companies and bioscience companies, as one of the better growth stocks, I feel like I am the chairman of a new startup company, although we do have about 120 years of history and about 2 billion of assets we have accumulated under the old name.

It's a new era for us.

I also want to personally thank many people on the call actually attended our first-ever analyst event that we held in conjunction with our ringing of the closing bell in New York on the 16th of January when we changed our name and our ticker symbol to WTR.

We are still on cloud nine, excited about that event.

A real, I think, byproduct of it was the chance for the analysts who were there to see the depth of our management team, which we never really have had a chance to show off.

It's always been myself and/or Dave giving presentations.

I hope you appreciated the work that they put into it, and I am very proud of the whole team that came up.

Today's announcement, which is the earnings for the quarter and for the year, it was a very interesting year, a challenging year, but a very successful year.

The weather made it very challenging for us, a cold winter and a pretty wet summer.

But the great news was we were able to buy AquaSource and grow over 20 percent this year at a very fair price and ahead of schedule, because our regulatory approvals moved much more rapidly than we thought.

And whether dumb luck or good fortune, we hit the market just about right on two things.

One, the debt financing; we ended up with 135 million at 4.87 percent and had the S&P reaffirm our rating double A- at Aqua Pennsylvania, the old PSW, and A+ at the parent.

And then we were able to sell through two offerings over 5 million shares of stock.

Once again every offering, the six or seven we have done over the past five years has been at a higher price than the prior one.

This year stayed true to that record.

Because of the financing, because of the timing, because of what we have been able to achieve already in five short months with AquaSource, I feel very confident as move forward.

The five months of AquaSource obviously will skew some of the numbers, so I'm going to try in today's call to break down as much as I can for you and then answer any questions, obviously, you have.

And then sort of say what we're doing as a management team to track the assimilation of AquaSource into the company, so that we can give you the same indicators that we use and that you can track.

Just make sure that the model which is threefold, one, capitalization; second is keeping efficient operating costs so you have more of your rates go to the assets than the operating costs; and then of course growth in new units so that you spread your overheads and your costs over more people and keep rates down.

Let me start with the revenue growth.

Revenue increased 23 percent for the quarter, 14 percent for the year.

But of that growth most of it was attributed to the AquaSource addition.

Drilling down on the numbers, the revenue growth was almost all in the Aqua Pennsylvania and I will call it Aqua North, which is what we're calling it now, group.

It was almost all from rates and from customer growth.

The weather hit us pretty hard in each of those areas.

The good news is I looked at the top 10 industrial customers that we bill, and when you look at the year, you can see the downward trend.

It hit us because they use water more in the summer like everybody else.

It really hit us in the four or five months around the summer.

The good news is eight of the ten were actually up slightly in the fourth quarter, which shows a stabilizing trend.

The two that were down, one was a merchant power plant, which has a take or pay, so that is going to be dependent on spark spreads more than the weather.

The other was a municipality which bought a lot of water from us last year, mainly because they had a drought and had to shut their wells down, and we were bailing them out of their problem, which was not going to be returned this year anyhow.

I think we are starting to see some stabilization overall in the economy and also in the industry use, which is a very small piece of our whole company now, because AquaSource has very little industrial and commercial, consumers had less than Philadelphia Suburban.

So Aqua North has some industrial, Ohio specifically and Illinois; but Maine and New Jersey being almost all residential.

The old Philly Suburban Water, or now called Aqua Pennsylvania, had the highest percentage of industrial; but it's still a very small percentage.

Dave, maybe you can help me with that percentage of customers.

I know it's only about 8 percent.

But percentage of revenues is not that much more for the corporation, now.

You can look that up and we will get back to people.

Customer growth, obviously, most of it was from AquaSource.

We did announce also towards the end of the year a number of -- we did a wrap up at the end of the year, a number of the typical small acquisitions we do throughout the four or five northern states.

We hit 18 this year.

I have to admit I was more intent on the capitalization and getting AquaSource in shape, and all the Sarbanes-Oxley things this year than I was helping out in the corporate development area, which I tend to like to do, and personally I think I add value to.

I will have time next year to return to that.

But we still did 18.

Last year it was like 23, so a little off, but not -- we still grew well over 2 percent just from that in the northern area.

In addition to of course the AquaSource growth and then doing the Heater deal.

So I think we're comfortable.

The team is going to focus now on small all over, including AquaSource, and you will see enhanced numbers on the number of acquisitions and we will get right back to that 4 percent growth normalized growth level.

We are not going to hit 20 percent every year, obviously.

But the normal organic growth level of 4 percent which is part of our model.

The other is the top-line growth, the revenue.

Although it shot up this year, a lot of it again was from AquaSource.

Then we get down of course to the expenses, and then the EPS.

On the expenses, we had pretty good year, short of the fact that AquaSource skews it, because they have a much higher expense to revenue ratio.

So what we usually track here and we usually present to you year-to-year, and we've been doing 50 to 100 basis points a year in bringing it down, is the O&M, overall O&M to revenue ratio.

I'm going to break it out.

If you look at the full year, last year was 36.6.

This year you will calculate from the GAAP at 38.3.

Let me break down.

If you take out AquaSource from the five months, the 36.6 went to 36.

So right in line with where we have always said we'd be, and I will break those down further for you.

When you throw in -- this is for my tracking purposes, obviously the quarter was even higher.

I think the quarter was well over 41 percent blended.

So you can see the effect of AquaSource.

Of course next year Heater comes in, and that's going to be higher.

That's another high 60s ratio until we get it down, grow customers, and get the efficiency of the routes down.

But it will never get to the 30 level as we have with the old traditional systems in the North East.

We have big condensed areas and economy of scale.

Management is targeting 41.5 will be the new ratio that I'm tracking bonuses on and everything else.

I think you are going to see that come down during the year.

I think you are going to see 100; maybe 150 basis points would be our hope.

But if you want to track like I track, that will be the new number, because it's going to be difficult, almost impossible to start breaking down between this state, that state, and so on.

So I will start reporting to you on a gross number of all the states.

And my starting point is going to be at 41.5.

But the core group this year still got the 36.6 to 36, and that is what I wanted to stress.

Looking at expenses overall, because expenses were up huge, let's see what they were up percentage wise.

Cheryl, can you help me with that, what expenses were up?

For the full year?

O&M was up 19 percent.

Right.

Now, obviously, that is all the addition of AquaSource.

But a breakdown is interesting, when we looked at the various breakdowns of it.

The 19.4, of that, if you take acquisitions out, it's 15.7; of course that brought new customers in.

That left 3.7 of the core company that we started the year with.

Of that 3.7, 2.4, almost two-thirds of it, was post-retirement benefits, pension hits and healthcare.

If you add another eighth, we think 8/10 of a percent was because of last year's harsh winter.

You really almost had flat expense growth.

I think we are going to see, as we eat into the AquaSource expenses, because we do think there is some more to take out there, I think we can keep that trend going.

That is why I am confident we can say that we are going to lower that O&M, the expense ratio consistently.

Let me go into some of the issues we took to get to the bulk of our expense growth last year, which is the pensions and healthcare costs.

We have settled all our union contracts.

They just so happened to be up last year, all except for one.

So we settled four of them, and I would say that covers 95 percent of our union members.

And had two significant things occur.

One, is on all but the Pennsylvania contract, which we just signed or we are about to sign, it just got voted on last night affirmatively; there will be no more post-retirement healthcare.

That is for all new employees, all AquaSource employees who never had them, and all new union employees.

Therefore we've locked in our OPD and our -- I'm sorry, our 106 charges and our going-forward pension, which I will get to, with our existing employee base.

All new employees are coming with an enhanced 401, no defined benefit plan, and that includes the union employees.

That's a big concession that the unions gave us.

And on healthcare, no post-retirement healthcare for new employees, except for new union employees in the Aqua Pennsylvania area.

And that will be one of the big issues we go with our next contract.

That was one that was a strike issue, and I didn't think it was worth taking the strike over the little hiring we are going to do in that area over the next year or two.

We will hit that next time.

Now the other piece of that, of course, is the healthcare costs for active employees.

Throughout the company for the first time, employees are going to be contributing in the Aqua Pennsylvania area and enhancing it in the areas of consumers.

In the AquaSource they've always paid towards health care.

I think probably for the analysts on the phone and investors, you think that's rare.

But if you look at utilities that was one of the ideas; you get long-term employees, and you treat them well with their benefits, and the salaries are a little lower.

When healthcare was going up 3 or 4 percent, you could absorb that in the rates; but the number has gone up now 12, 15 percent a year.

Its unfair to ask ratepayers to absorb that.

So that is why we have taken that step.

Obviously that will be a help in keeping costs contained in two areas that really have gone out of sight, and that's the pension costs, and to satisfy the market downturn over the last couple of years.

As you know, it is a five-year averaging.

And of course healthcare, which is out of everybody's control.

It's with the hospitals and the tort lawyers and the Blue Crosses of the world.

The pension, which we are in the hundred plus million range, had deficiencies that we had to put money in.

The '03 numbers were higher than the '02 numbers; and the '04 numbers in our budget are higher than the '03 numbers. '05 is when we start seeing it stabilize.

Then if the market obviously keeps going up, and as you can see we've limited our future liabilities in that area, we should be going towards the positive side again.

If the market goes down, then we're all in the same boat that we have all been in the last couple of years.

The good news is that in a regulated climate, you are able to, under certain state rules, recover that.

So you basically have a true up.

We are asking for that in our Pennsylvania case.

I'm, by the way, calling in from New York;

Dave is in Bryn Mawr.

Dave, I think the Pennsylvania regulations, which cover about two-thirds of our pension issues, could you explain maybe how that works?

I think that would help the analysts.

It's an interesting phenomenon actually.

Most companies recognize pension expense based on SFAS 87, of course.

In Pennsylvania, because the regulators reimburse us for pension expense based on our contributions to the plan, and not the accruals, we recognize pension expense based on those contributions to the plan.

Of course they're going up pretty dramatically.

For the last six or so rate cases there really was no pension recovery in Pennsylvania.

This will be the first rate case in a long time we're asking for a pension expense, and it's quite a significant number.

So that recovery is expected when the present Pennsylvania rate case concludes in mid 2004.

However, the pension expense will be there for the entire year.

So that will be a little bit of a lag until that case kicks in and we begin to recover those costs.

We likely will request -- we have requested and we are hopeful that we will receive a true-up mechanism for future changes in the pension expense, much like the mechanism we have in place now for changes in our SFAS 106 expense.

Such that when the cost changes, that change, either plus or minus, would be deferred for amortization in a future rate case.

So that as pension cost changes in the future we won't have the lag associated with that change, as it would be deferred for amortization at a later time.

We think that the regulators will be positively impressed with the fact that we have looked at our future liabilities, by having all new employees not on those systems, as a positive.

So it can be very well measured.

It's not an out of control issue, other than the stock market.

If anybody can predict the way the markets going, then of course we would know where we'd be.

The other very positive event this year was how we were able to refinance a lot of our debt and do the debt financing for AquaSource.

I mentioned that earlier in the call.

Just to give you some numbers, although interest expense was up 15 percent, our total borrowings was up 18 percent.

So obviously we are continuing to lower the cost of borrowing.

The embedded costs of debt dropped from 6.6 to 6.2; 40 basis points on almost a billion -- well, it's not a billion, but $800 million at least of debt, that's a lot of good refinancing.

Our treasury department deserves a lot of credit.

We also did a little better in generating cash.

You can see in the expenses when you look at the numbers how much depreciation has increased.

Dave you have to help me;

I don't have it right here.

It's up 12, 13 percent, total depreciation?

Over last year?

Yes.

Yes.

Depreciation is up about 17 percent for the year.

So obviously that's one of the big drivers in our need for new rates, as we raise depreciation and get more cash back into the business.

The other big issue in our rate case is, unlike American Water which had a huge security issue, we did have a little bit, but it was well within the realm of normal increases; our big issue in this rate case, other than capital, is really the pension.

The post-retirement type benefit.

The type things which Dave is going to try and address.

And of course depreciation, which has gone up.

But that's positive in the sense that you get generating more cash.

Anyhow the bottom line, we were in the low 40s last year when we were on Credit Watch with S&P.

And then we did our capitalization last summer and sold over 5 million shares and had some more retained earnings.

We were able to increase our book value over 20 percent.

I think it was 22 percent for the year, which is a very healthy increase in book value.

I believe our equity levels now are closing in on 40; is it 48 percent, Dave?

Right.

So I think we're back to be where we said we would always liked to be at the parent.

Obviously in each state sometimes those numbers change, depending how much equity we infuse and how well they are doing by state.

Many of the states are closer to 50 that are key states that we are capitalizing and working in for rates.

So I think we have a healthy balance sheet as we end the year.

I'm very confident that we're moving quickly on AquaSource, and I would like to go into some of that now.

I believe this year we are really going to be -- hopefully the weather, although the winter was great when it started; but it's not so great now.

The weather hopefully will have a swing back to normal weather.

We are assimilating AquaSource, which I will go into.

Rates are a key item in our year in '04.

We have big rate case in Pennsylvania.

We have a major rate case in New Jersey.

We have a rate case almost finalized in Illinois; we will know next month; and a new one to be filed a month later on another division.

We have two major cases in Ohio.

So you can see next year rates are going to be a key part of our success story, both the timing of when we get the awards and of course the amounts.

We'll continue to spend capital at a record pace, mainly because we have a bigger company, too.

But we're looking around almost $175 million in capital.

You can see that's a huge capital; but that's how we build our model to get some increase in pricing and therefore help the shareholders too.

It's also a way to build depreciation, so that the cash flow numbers keep looking better and better as the capital needs start calming down.

We are doing a lot of capital, catch-up capital, in AquaSource, which we obviously want to show the regulators that when we go into a state we invest.

We fix things.

The environment departments then like us.

And then we are confident that the price regulators will give us fair return on those assets, because they were all prudent investments.

That is why the jump in the capital, because a lot of it's going into Texas, Florida, the new states, Virginia, that we are just trying to make it up to our standards.

Regarding AquaSource, our strategy when we bought it was macro'd to see if the O&M piece that we bought -- obviously we didn't buy as much of the contracts that they had.

They were sold to other companies.

But we did assume some of the contracts that were integral with the IOU sections that we wanted.

Of course we didn't buy any of their construction company or the other unregulated.

In the first six months, five months, this is what has occurred.

We have sold Connecticut, which was the biggest percentage of O&M.

We sold that to Birmingham, which is a local company.

They were able to cut overheads that we were not able to cut, so I know they are going to do very well with that investment.

On the other hand we came out with, I think, it was 4 million.

We didn't pay that much, when you break it down in cash, although accounting wise you book it for what you knew you were going to sell it for; so that will be a wash on the accounting books.

But cash wise we did pretty well.

I think Birmingham is going to do well going forward, because they have already made some major changes in management and they are running it very well.

New York, we are running it; it's making money.

However, we have made the decision that we don't think we have enough critical mass to stay in New York.

Again Birmingham is buying that.

We think that will be disposed of by mid year.

It was just too small a base to start on, in a big state like New York, so we decided that we'd exit that.

There again we'll get rate base, which as you know we didn't pay rate base overall for AquaSource.

So how the bookings go with accounting, that's up to auditors; but basically we're coming out whole.

We have sold.

We are trying to sell, and I think that will be approved, again, in a couple of months our Kentucky operations, which are very small, a couple wastewater operations.

Once again we're coming out whole on that.

We just didn't feel Kentucky was the kind of state that we had the critical mass, especially with American there, that we thought we'd build on.

We also sold off in southern Indiana an engineering company and a maintenance services company, and got out of a very very big lease.

The present value of that lease, $600,000; and we didn't need the space.

It was a deal I guess AquaSource did when they thought they would expand greatly in that area, and probably booked too much of a lease and space to ever grow into.

So that was a liability for the future that we were able to get out of by negotiating to sell the engineering company and the services company to the guy who had the lease on the building.

So we are doing little fix up things.

We are fighting a couple condemnations, the biggest one being in Fort Wayne.

There's a couple small ones in Florida and Texas that we are taking a very aggressive stance against being condemned.

Because our strategy is to stay in the regulated business, not just make money by selling it.

The only one that we have we actually ever lost did affect the GAAP earnings in the fourth quarter of last year.

That was a sale of our Ashtabula system, which we did get more than two times rate base; which if you did it on a book basis is probably closer to three, the way we look at it when it is a private deal.

We were able to maintain the operation and maintenance contract.

It was re-awarded to us just about a month ago.

So we are still running the assets, we just don't own the assets anymore.

We were earning very little on that.

They had high rates and it was a hostile environment regulatory in that area.

So I think we came out a little better, although it did skew last year's earnings.

And although GAAP earnings are GAAP earnings, last year's 22 cents is more like 18 because -- Dave, you are going to have to help me with the actual post-tax net income that Ashtabula represented last year.

I think it was 3.7 million?

Yes, 3.7 million, a little over 4 cents.

If you want to do it on an apples-to-apples basis, without Ashtabula our earnings were 18 cents last year, versus this year's 20, which met First Call and gives that trend that we like to see, which is a nice steady earnings growth each quarter.

Of course the same 4 cents come off the year.

So it was a challenging year.

It was a year that we could get AquaSource rolling, and I am very confident with Rick Hugus at the head.

We've made some management changes; we have put corporate development people in each state.

I think in a year we are going to see AquaSource as a key part of our new growth.

A key part of it being getting in rates what we paid, and fair value in those states that allow fair value.

In that light we are filing probably cases -- a major case in Texas; index filing in Florida.

And we have a major -- well, we don't have a major case, but we just were awarded a very favorable ruling and a fair ruling in North Carolina rate regarding our non Heater assets.

Now the next step is to get Heater's approval through the commission and have a rate based treatment on that also, which we think would be a plus for us.

So a lot of it is assimilation for next year, a lot of it is rates.

Our Treasury Department is going to be very busy.

A lot of it is praying for a nice hot dry summer.

But I think the core company is much stronger as we start '04 than when we ended '03.

And a lot less risks.

The capitalization is done.

The Vivendi round-trip is beyond us, and we're starting to see a nice new growth area in the south for us.

The stock acted very well this year.

Again it's been performing very well; shareholder value has increased over 37 percent when you look at your dividend.

If you just want to look at stock price appreciation, it was up 34.

That puts us above most utilities and it also puts us above S&P and the Dow year once again.

Part of that, I think, is the fact that we're getting recognized now as a good solid investment long-term by institutional traders, which really didn't have the capability of buying into the stock when Vivendi was such a large owner.

They had controlled so many shares we didn't have enough float.

We are up to no one owning more than really 1 or 2 percent of the stock now.

We have about 90 million shares outstanding.

We have grown so much mainly through splits, five splits in the last seven years, I think it is, that we now are going to need a new share authorization, which will go before our shareholders, to increase it from current 100 million to some higher number that will accommodate future growth, future acquisitions, and hopefully future splits.

We raised the dividend again, a little more aggressively than we use in our model.

We raised it 7.1 percent, along with the stock dividend.

I think that was well received by our retail shareholders and also the market in general.

I think that had some affect on the price appreciation in the overall stock.

So I will stop there and answer any questions you have.

(OPERATOR INSTRUCTIONS) David Schanzer.

Dave Schanzer, Janney Montgomery Scott.

Good morning, everybody.

Congratulations on another solid year.

Actually, in all the meetings that we've had recently you've covered most of the ground.

So these are kind of odds and ends questions.

What is the status of getting the DSIC in New Jersey at this point?

We filed in the New Jersey rate case, which was filed in late December, for a mechanism to do on a pilot basis the DSIC, feeling that maybe addressed that way it would not look like a major new initiative, legislation, whatever.

I do think it has the attention of a number of the commissioners.

We met with them; obviously didn't talk about our case, but we talked about in generalities how you handle rehabilitation and not get in the way of smart growth, which is one of the key initiatives that they're worried about.

They don't want to promote growth in anyway.

Which is interesting, David, because many states are saying how do we get growth?

But New Jersey, that's one of their key things, smart growth.

I think the way we addressed it in the case I think satisfies their political and public policy initiatives, yet gets us into areas like Phillipsburg and Blackwood which really do need to have their pipes rebuilt.

We would like to do it on a steady basis, versus going in for a lot of cases.

At this point it's separable.

If it looks like it's too much of a policy issue to digest, we will just make the case very simple.

Here's the capital we spent; here's our expenses, which our efficiency ratio in New Jersey is I think 830 customers per employee; overall company average is 660, up from over 450 a couple years ago.

I think an industry norm is probably 4 to 500.

So there is no way that New Jersey is not as efficient as you could be.

So it is strictly a capital case, other than this one mechanism that we called Trip (ph), because we didn't want to call it DSIC, because that's not acceptable (inaudible).

We will see what happens.

At one venue or the other recently, you kind of indicated that there would be some interest on your part, the part of the company, to look at the tiny pieces.

If they are bigger than tiny, let me know.

But the tiny pieces that are left over from the Allete dispersal in Florida.

How many customers are available?

Assuming there's no more municipalities that are condemning, and I think that would be less than 10 percent of what I'm talking about, it's about 16 to 17,000 customers.

Lastly, we've obviously in this part of the world experienced what would I think be termed a fairly miserable January in terms of temperature.

I suspect that it's affected pipes, although I haven't seen a whole lot of digging, around here anyway.

Given probably higher O&M and expenses in January, is this going to affect how the quarter comes in?

I think I would have been a little more optimistic two weeks ago that the quarter would have looked a little better; because we weren't having bad breaks.

What happened was the extended cold is really what hurt us.

As the frost line gets down, and having 10-degree weather three days, four days, give days in a row is when that frost line moves down, that is when the bearing strength hits the pipes.

Most of the breaks we are having -- we had a horrendous weekend last weekend, and at least in Philadelphia we had 80 breaks over the weekend, which is much more than normal -- were crack arounds.

You have to dig the street up, so it still costs you money.

But they weren't severe breaks.

They were just little crack arounds.

You put a wrap-around we call it, which is like a little template around the pipe that seals it up and you go onto the next break.

But a lot of overtime and so on.

So I don't want to say I am pessimistic yet until we see what happens in February.

February could get warm and have very few breaks, and then it would be -- it's going to be tough being much worse than last year.

I will start that way.

Because last year was just horrendous.

But on the other hand, we didn't have the pension expenses last time; and we are going to start seeing a little lag because our Pennsylvania case is two years ago now, and New Jersey is two years.

What you will probably see, and I guess as an experienced person who has followed utilities, I'm comfortable with First Call for the year.

But I'm not comfortable with quarter by quarter.

Because if you get the rate case in the second quarter versus the third quarter, that number could look better.

And if you wait and get it in the third quarter, you might get a higher rate but for fewer months; and so on.

So a lot of it is going to depend on the timing of the rate case.

And of course the summer.

If we have a great summer it just blows everything else out.

I don't want to over imply that the first quarter is going to be great or terrible; it's probably going to be a normal one.

But it's not (multiple speakers)

But it sounds like comparable to last year.

I think so.

We had one story in Maine, over six inches of ice had formed on the meter.

That's how cold it has been in Maine.

Maine is amazing.

But it hasn't been a great winter, I'll put it that way.

Thanks.

Brad Coltman.

Deutsche Bank.

I was wondering, you mentioned some rate cases in what I will call the core Northern operations.

Can you elaborate on what you might be doing in '04 for the Southern operations, I guess?

Yes.

We are going to be filing a fairly large rate case, probably an excess of 10 million, in Texas.

Dave, what is our target date for that filing?

The target date right now is sometime in the spring.

We received a favorable, although it's in the north, but it's one of the AquaSource companies, Indiana.

We did win the case that AquaSource was fighting with, TQ (ph) was fighting with the town of Fort Wayne; and the judges ruled in our favor.

That is a half a million which will be implemented probably, unless the court gives a stay or something, probably within a month, Dave?

I would say, possibly sooner.

We have spent a lot of capital.

This is still the case that they filed two years ago.

They are just getting the return on.

Now we have spent a lot of money and they've spent a lot of money fixing up the system, which will mean we could probably file another case an Indiana sometime this year.

I am going to say probably midyear.

Because I really want to resolve where we are on the condemnation, and the court is going to hear our issue I think within a month in Fort Wayne.

The Virginia's index, which means you can go in 1, 2 percent without a major rate case, and Florida is the same.

The Florida case was just resolved for 365, was it Dave?

390.

390;

Sarasota; so that will be in this year's numbers that were not in last year.

We are doing another major construction; that is a fast-growing area, Sarasota.

We doing another major expansion of our wastewater plant, which means we will be right back in probably for a rate case in probably a year from now.

I don't think it will be late this year;

I think it will probably be more like '05.

Just so you understand we're not in Sarasota City, we're in Sarasota County and Manatee County, and that's the area that is really growing along that Route 70.

The county has its own system, but their rates are about 40 percent higher than our rates.

So it's an easy place to put capital and not look like a bad comparison and risk condemnation.

So that is going to be one of our major investment areas.

How about on the cost side?

You said there are some additional things that you thought you could take out.

What we are seeing is some of these O&M contracts looked good on paper, but relate weren't.

Give you an example.

The revenue stream in Florida, which would be the run rate you are seeing in the last five months, because it just happened.

We asked them to look at all their O&M contracts, which were about 900,000 of their revenue.

I don't have their total revenue for the year, maybe Bob or Dave can help me with that to give you a comparison.

But of that 900,000 in revenue, when we looked at the individual contracts only 100,000 of it was making any money.

So we basically didn't renew a number of contracts.

And the ones we renewed we are trying to get a hurdle rate of at least 20 to 25 percent rate, which isn't as good as our hurdle rate on regulated, but at least it's profitable and it offsets overhead as you grow the regulated.

So our strategy in Florida, Virginia, everywhere, is concentrate everything you can on the regulated side.

And if an O&M falls your way, fine, pick it up.

Any that you have now, make sure you're getting priced so that you're making money on it.

We are doing that same exercise in Texas.

In Connecticut, that was the worst offender, and that's all sold.

And they are going to be upgraded by Birmingham.

We don't have much O&M anywhere else.

I think we had less than 2 percent under the core company at AquaSource.

It jumped to maybe 4 to 5 percent with AquaSource; now it's right back down to maybe 3 percent and probably will stay at that level or lower.

The other expenses are we are mass buying the fleet.

Every state had their own vehicles.

Some were eight-cylinder versus six-cylinder; some were dual cabs.

Trucks are very important to the operators, but we want to have a standardization and that is going to give us a huge saving in operating expense on gas.

But also on buying, which is either expensed or capitalized depending on the state rules.

Customer service, we're consolidating all around the company.

That will give us some savings.

Probably not first quarter, but they're are all long-term.

That's why I think I feel accountable saying you can look at us take 100 basis points out of that, higher now, level of 41.5.

Just a quick follow-up, are you still expecting the Heater Utilities acquisition to close in the second quarter?

I really had a great visit.

I went and visited the Governor two weeks ago, met with the Secretary of Commerce, Secretary of Environment, in addition to all the commissioners.

All I can tell you is it's great being received like they like you.

It's like they want a company down there that's going to invest; and we're going to work with you; and we would like to get your national call center here.

It's not like some of the states where it is almost like you're going to create growth and we don't want you.

North Carolina really wants growth.

So it basically remains somewhat on track.

Oh, yes, It's filed.

We have met all the employees.

We have our game plan in place where the office will be, when it's announced officially.

We have computer systems being -- it's a friendly merger, so we are already working on computer systems, so Day One it will be working.

But I can't guess how soon or how fast the regulators will go.

But we are pretty comfortable by midyear.

Great; thank you.

Trip Rodgers.

UBS.

Nick, congratulations on the honor last night.

By the way I like the Trip acronym in New Jersey.

You are talking about starting out at a 41.5 expense ratio and coming down 100 basis points.

Just to clarify, that's not assuming Heater, correct?

Dave, did we pro forma in Heater on that?

That should be the run rate that they calculate for the year?

We were 41.5 for the fourth quarter, Nick.

And that may be indicative of what it will look like on a going-forward basis to bring down.

It most likely does not include Heater though.

Heater probably is a run rate in the high 60s, too.

But revenues are only about 20 million on Heater, on a 400 base.

If it's 10 basis points, Trip, it probably would be elevated by that.

But I think we are going to take some expenses out of Heater right away.

The assumption for pension and healthcare in that number, given the two, kind of averaged?

Pension and healthcare are going to go against us.

We are seeing 14 to 15 percent increases in healthcare, although we are going to ask employees to pay some of that.

But it won't make up the difference.

Dave, you have to help me with pension.

What are we budgeting pension to go up overall in '04 versus '03?

Our pension budget increase for '04 is over $2 million.

What was the increase this past year?

This past year it was over $2 million, and next year it's expected to be over $2 million.

So 4 over the two years and then it starts levelizing.

A couple technical questions.

Your tax rate, is that going to change much going forward?

We don't expect it to change dramatically, although we do expect it to move north.

Closer to the 40 percent range, then, maybe?

Right.

Finally, your cash position at the end of the quarter?

We have very little cash, as you know.

I think we did have several million dollars in place.

But most of it we sweep and put against our borrowings.

Right now we are showing in the neighborhood of $10 million at 12/31.

But I expect in future quarters it won't be so significant.

Great, thanks a lot.

It's odd to say this for most companies, but having cash like that is a negative, because we should be sweeping our -- we are not earning anything on the cash.

And when we can borrow all we want on the short and we are only paying, what, 2 percent, Dave on the short?

Right.

We want to pay down our loans as much as possible and then build it up again as we need it.

That was probably some payments.

There is something I didn't address, sorry.

On the Duquesne they have sent us a couple checks since the last call, and some of that cash may have been them coming in at year end.

On the working capital we challenged some of their numbers, and we got $1 million returned.

And on the capital side we have challenged some of their numbers, and we have already gotten 3 million back, Dave?

Right, a little over 3.

So that may be there.

Plus at the end of the year is when we settled the Connecticut and got a $4 million cash infusion; and there is some working capital, we think another half million coming.

So some of that just may be an anomaly from the pruning we're doing on AquaSource.

Great, thanks a lot.

Kevin Monroe.

Thomas Weisel Partners.

Just wanted to clarify on the O&M ratio.

You're at 41.5 this quarter.

That is the ratio you're trying to reduce by 100 to 150 basis points over the course of the year?

Is that correct?

Yes.

That's the number that are in people's objectives, to say this is the base we are going to work against.

Obviously then that translates into a higher base to bring down for the AquaSource President.

But it means that the Aqua Pennsylvania President and the Aqua North President also have to keep bringing their bases down; and they are probably in the 30s, but they have to keep bringing it down.

Obviously they can not bring it down 100 basis points.

AquaSource is going to do most of it.

Were there any onetime costs in it, in the fourth quarter that won't recur?

Or this is cost you have to drive out of the business going forward?

I don't believe so.

Dave, is there any onetime cost?

In Q4?

No, when we look at the quarter --

We did have a hurricane cost I think in Virginia.

But nothing significant.

Remember they had that hurricane in Virginia and we had to put a lot of overtime in.

But that could be a bad summer storm next year.

And the gain on the sale of assets; that was the Connecticut sale to Birmingham?

No, no, that was some stock that we had purchased in some other water companies and have a nice profit in it; and we took a few bucks off the table.

Great.

Thank you.

Jim Lykins.

Hilliard Lyons.

Good morning, everybody.

Now that your footprint has expanded to include several states, can you comment on how meaningful your tuck-in strategy could become to your bottom-line results?

When I earlier said that a lot of the attention that we gave to AquaSource and the capitalization; and all the Vivendi distracted a little bit from what we were able to concentrate on in Pennsylvania and the old consumer states, now called Aqua North.

That is the part I want to return to.

That is where the tuck-ins really become what I will call the traditional tuck-ins.

Where you can get a small town that's right on your border, hook your pipe in, and really improve service and not have a lot of increased expenses.

In the Aqua South, the old AquaSource in the southern states, I think it's really going out and buying more systems and/or getting with developers and building more, so you fill in the route.

I think I used this example up in New York.

In the North, a pipe interconnects the systems.

In the South, a truck interconnects the systems.

So the more customers you can get along the pipeline in the North, the better it is; i.e., tuck-ins.

And the more systems you can get along your truck route in the South increases efficiency and helps your -- and that is the tuck-in in the South.

Now obviously Texas, with the volume of people and area, we've got a lot of tuck-ins to do in Texas.

You can look at Texas as a triangle; the Austin, Houston, Dallas-Fort Worth.

That is the area we are really concentrating on.

In Florida we are really, generally, in southern Florida and Sarasota/Captiva; and we are looking at maybe expanding much more in Central Florida.

You broke out the 8 percentage of your O&M expense that can be attributed to AquaSource.

I am wondering if you can give us what the revenue numbers were as well?

I think we can.

Dave, of the revenues how much was AquaSource?

For the year?

And the quarter if you have that too.

Let's start with the year.

For the year we had about $30 million attributable to acquisitions, most of which was AquaSource.

And for the quarter about $16 million associated with AquaSource.

Great, thanks guys.

The reason we are -- next year we're not going to be talking about AquaSource generally, is because we have divided what used to be AquaSource up into three different presidents.

We are going to track our presidents based on the states they have, so we can report to you, how did you do in Indiana?

How did you do in Texas?

But we'll give you general numbers.

That's why I thought using that 41.5 would give you a good tracking mechanism.

And of course all the capitalization of the company just consolidates, so that you can track that.

The revenues will be consolidated and if we can, we can give you ranges of revenues in each of the areas.

But Pennsylvania and the North East still overwhelm the overall revenues of the company.

Stewart Scharf.

One moment. (OPERATOR INSTRUCTIONS) Mr. Scharf, do you have a question?

I don't know if he has his phone on mute.

Cheryl, you know Stewart, you can give him a call afterward.

On the O&M ratio again, you're looking for 41.5 percent for '04.

Basically what is your target for decreasing that to 150 basis points?

Is that an annual figure?

And what is your -- ?

In other words, I would hope to report this time next year to you that our overall operation and maintenance ratio is somewhere around 40 to 40.5, 100 to 150 basis points.

So that is our run rate starting the year that we want to take it down from.

By the end of '04?

Yes, so we will say our run rate this time next year hopefully will be 100 to 150 basis points lower than the 41.5 that we're starting the year at.

Ultimately over the next few years do you have a target you want to get back down to? 35 percent or lower?

I'd love to.

I think the first year, Stewart, will be easier because we're still learning; we're still seeing some costs that we can take out.

After that it will be as much contingent upon rate cases and growth as it is cutting.

Because you grow the denominator, that helps in that ratio too.

So yes, I would like to get back into the mid 30s again.

Getting back to the pension, do you have an expected rate of return on the discount rate?

Yes, Dave, we are using 6.25, and 9?

Is that what you mean, Stewart?

Yes, discount rate.

It's 62.5 for the discount rate and 8.5 for the return on assets.

That has stayed the same from the year before?

No, it is significantly less, which is why our pension costs went up.

We dropped from 6.75, I think, Dave, to 6.25.

Were we at 8.5 last year or were we at 9 last year?

We were at 9 last year.

We dropped the (ph) 9, 8.5.

I think we are pretty conservative in both those areas.

But if you have the luxury of a regulated climate, they want you to be conservative.

So there are no negative surprises.

One other thing, the organic growth, are you seeing 4 percent for the customer, the base customer growth; plus 3 percent from rate hikes or pricing?

Is it 7 percent total organic growth?

The 4 percent customer growth includes both organic, which is much lower than that in the North East, probably closer to 1 percent; and the rest comes from acquisitions.

However, we are seeing in the AquaSource states the possibility of getting a majority of the 4 percent.

But then it's only less than 20 percent of the company, without acquisitions; and the acquisitions would add to that.

It is different each day.

I'll give you an example.

Maine has no growth; but it is only 17,000 of our 750,000 customers.

And we are hoping to get growth, it's just not happening.

New Jersey grows I'd say 3 percent without any acquisitions.

So there you don't have to do as many acquisitions.

Pennsylvania grows probably 1 percent;

Ohio maybe 1.5.

So you can see you need more acquisitions in those states.

I would venture to say Texas probably could grow almost 4 percent on its own, just using developers, without any major acquisitions.

So excluding acquisitions you include just the rate hikes and the customer base?

The rate hikes I think you can count.

It's not going to be the same every year.

Next year it might even be better (technical difficulty) have a number of (technical difficulty) rate cases.

But over a long-term basis 3 percent price appreciation on our total customer volume.

You take your number of customers, which obviously increase revenues, and the volume they use; and then a nice 3 percent price escalation comes from the rates.

Okay, thanks a lot.

(OPERATOR INSTRUCTIONS) There appear to be no further questions.

Thank you, everyone.

This does conclude today's presentation.

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