Essential Utilities Inc (WTRG) 2004 Q2 法說會逐字稿

Good morning and welcome to the second quarter 2004 Aqua America earnings conference call. (Caller instructions.)

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

Ma’am, you may begin.

Thank you very much.

Good morning, everyone, and welcome to Aqua America’s second quarter 2004 earnings conference call.

We’re pleased that everyone was able to join us today.

If you did not receive a copy of the press release, please contact Tracy [McDonagle], at (610) 645-1090 and she’ll fax you a copy.

Presenting today is Nicholas DeBenedictis, President and Chairman of Aqua America, along with David Smeltzer, the Company’s Chief Financial Officer.

As a reminder, some of the matters discussed on today’s call may include forward-looking statements that involve 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.

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

A reconciliation of EBITDA to net income is contained in the Investor Relations section of the Company’s website, at www.AuquaAmerica.com.

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

Nick?

Thank you, Cheryl.

Good morning everyone from sunny Bryn Mawr, something we haven’t seen too much of with all the rains in the East Coast recently.

We had a good quarter, which I’m happy to present to you this morning and talk to you a little bit about where we see the future going, with the rapid growth we’ve had over the past year.

For the quarter, net income increased 17.3%, from 15.2m prior quarter ’03, to 17.9m.

For the six-months we went from 28.5 in the six-months in ’03, up to 33.44, which again is 17.09%.

So pretty steady increase in net income.

Regarding earnings per share, 19 versus 18.

I’ll note that – and you’ll all be able to figure this out anyhow, the 18 was a weak 18.

It's closer to 17.5, 17.6 and the 19 is right on the target.

So close to 8-9%.

And if you look at the six-months it’s 33 versus 36, or 9.1%.

So it’s pretty steady in the range of the 9% over the six-months.

I’d like to note that that is on a dilution basis of over 8.6%.

You may or may not recall, but May of ’03 we distributed 1.5m shares that were the remnant of the Vivendi ’02 venture.

And then in August, we quickly capitalized the Aqua Source investment with a 5m share offering.

And therefore, for the last three quarters we have been living with more dilution than we usually do.

It's usually a percent or two and we’ve been living with almost 9% dilution.

Come August this year, that negative comparison will go away and we’ll start seeing a much closer percentage of EPS to net income growth.

Yesterday’s meeting of our board, we use the August board meeting as our strategic meeting where we look at where we hope to be in the next five years.

The board was very pleased with progress we’ve made with integration of the 23-24% customer growth we had last year, chiefly as the result of the acquisition of Aqua Source, which I’ll get into more detail on.

And this year we’re looking at a potential 10-12% customer growth, again, with most of it already accounted for with the success of the Heater and Florida water acquisitions in June 1 and then July 1 of this year.

We just brought those in at the end of the second quarter.

And then we’re seeing our typical, what we call tuck in acquisitions, where we think we’ll hit the 30 mark again this year.

We’re starting to see a lot of activity in the South now, now that we have basically solidified our base there with the Aqua Source now being under our belt and Heater.

And part of that is because, I think, Heater was for sale for a couple of years and I think there was some backlog of acquisitions and new franchises they were looking at, but didn’t want to venture out, so they knew what their new [ownership] would look like.

And the same thing with the Aqua Source property.

We have not had time to go out and expand them, because we were fixing them.

But now we’re in the expansion mode, so we’re starting to see some very positive signs there.

The board is seeing the potential not only for this year’s growth, but also potential for future growth in customer count.

And more importantly, a catch up in the return on the assets that we purchased.

If you recall, we were fortunate to be able to buy Florida Water and Aqua Source properties, actually we believe, below rate base.

Which means that we can hopefully earn on that rate base, because that’s allowed in the regulatory process.

But even without that extra kicker, we found that the Aqua Source properties were earning under 5% on the equity they had already invested.

So our first goal is to get them earning what they should be earning, by going in for rate cases.

While we add to it what’s allowable and also all the new capital we’re putting into the systems.

So I think part of our story over the next couple of years will be the help to earnings from the catch up of the allowable earnings power of the assets that we have bought and now fixed up.

Heater, to give you a range there, is about 7%.

When you look at our properties in the consumer states, now called Aqua North and Aqua Pennsylvania, the former Philadelphia Suburban Water Company, there we are earning our normal rate of return, which is somewhere between 10-11%.

You can see there’s a delta to be made up, just based on the regulatory process.

The bottom line out of the board meeting yesterday is the board has decided to elevate the dividend at a faster pace than we had been predicting.

If you remember, our goal was always 4-7-10-5; 4% customer growth, 7% revenue growth, 10% earnings growth and then net income growth, and then 5% dividend growth.

We’ve now gotten to the high 50s in payout ratio.

The board decided to raise the dividend 8% yesterday -- 8.3% to be exact, to 13 cents a share, from 12, or 4 cents total for the year.

And that has elevated the last three years.

I think three years ago we went from 5 or so to 6, and last year we went to 7%.

This year now we’re up to 8% increase.

Because we really do believe the long term holders of our stock are looking for enhanced shareholder value through increases in the dividend.

Because most of them are buy and hold investors, because of the security of a water utility and their [i.e.] product risk and growth potential.

So we’re very pleased that we feel we can do that.

I believe that it’s sustainable, mainly because in our plan it looks as if we go back into the mid-50s again.

So I think it’s not going to elevate our payout in any major way, even though we’ve increased the pace of the dividend increase.

First, the dividend is effective, this 13 cents is effective in our December dividend.

The normal dividend for September 1 will be at the 12 cent rate, which is 7% higher than September of ‘03’s rate.

So we’re very pleased that we’re able to reward our shareholders in that way.

This quarter also marked the closing of two more strategic acquisitions for us, Heater and the Florida Water properties, and I’d like to comment a little bit on either.

We just can’t be more pleased in what we found there.

They have great management team, which we’re maintaining.

It gives us new management desks in the South, which we needed.

We have not kept most of the Aqua Source management.

We quickly consolidated all the services part of [AquaSource] from Ducane’s headquarters in Pittsburgh to our headquarters here.

So there we hired accountants and engineers here to satisfy the need.

But the services in each of the States, we did make changes to almost every State president, engineering and [perfect] development right on down the line on the key staff positions.

Most of those are in place now.

We have a few more positions to fill.

We’re also retraining operators, things of that sort, trying to get what we think is our management and technological excellence built into the system.

And this was the one year anniversary of [AquaSource], as a matter of fact, two days ago.

So we think we consolidated it pretty quickly.

Just one note, we earned more in the first six-months of AquaSource than Ducane earned in the entire year last year.

So although we think better days are ahead, because of the rate cases that I’ll talk to you about, and further synergies we’re looking for in AquaSource, we’re already down to the run rate that I suggested we could get to by year end.

At the conference call, something that we track pretty carefully is what we call our efficiency ratio, which is really the expense way to track benchmarking expenses.

And we pro forma’ed in an O&M over revenue ratio at the end of last year at 41%.

And that was basically the run rate on AquaSource was 65%.

The run rate on Aqua America – we changed our name in January from [indiscernible] Philly Suburban, to about 36%.

Take 20% of the company at 65 run rate and 80% of the company at the 36 run rate, you come up with a pro forma of 41.5.

And I estimated that we would take that 41.5 down 100-150 basis points by year end, feeling that we had a year of consolidation synergies and so on.

Through the [indiscernible] 12 through the 630, is down to 40.4.

We’re very pleased with that progress.

More to go, but we think that we can bring it down a few more basis points between now and the end of the year, being conservative.

But we did bring in another 10% growth at the high end.

Heater is about 55%, and Florida Water, which is now part of Aqua Florida, was over 70%.

So now we have to get the synergies in those two to bring them down to what we think is a reasonable level.

And in doing so, that will take time.

You don’t do that overnight.

So that elevates the number again.

But I still think we can absorb that, plus bring the 40.4 down further and actually get to the high end of the range we were looking at when we started the year, saying we’d get the 41.5 down to somewhere around 40.5 to 40.

So I’m very, very pleased with that.

I also did a separate analysis, because how is the 80% of the company doing?

Because there there weren't great synergies and so on and we were starting to see some creep in expenses, mainly through uncontrollables.

And I think we have that, again, under control.

If you take everything out of acquisitions, which is the bulk of our increase in expenses, as you’ll see the expenses – I mean, our revenues went up 26%, our expenses went up almost 40% and that still left a net income of 17.

Most of those – almost all of the expenses were acquisition related, i.e. AquaSource and Heater now.

If you took all the acquisitions out, our expense line only went up 2.6%, with half of that being pensions, which I think we’re starting to see light at the end of the tunnel, and I’ll go into that with you.

And the other half being legal and accounting, due to the new Sarbanes-Oxley.

I don’t know if any of your other companies that you follow have talked about Sarbanes-Oxley, but we have seen a doubling – Dave, I think at least a doubling in audit fees?

Yes, it’s a little bit more than that actually.

And it’s a, we think, a one time hit in ’04, because of all of what’s called 404 certification.

So it’s all already in the numbers and the projections.

And we hope that next year, after they do all this certification testing and all that we don’t have to go through the same rigorous initiation work that we had to this year and we return to somewhat more normalized – I don’t know what that is anymore in the accounting field – to somewhat more normalized auditing fees.

[The pension] -- So I guess the bottom line is, that’s surprising a lot of corporate America.

Nobody’s going to tell you that shouldn’t be done after the Enron debacle and all that, but the good companies like us are paying for it.

We’re confident we have no problems, but you have to go through all the systems and all this.

And corporate America is doing that as we speak.

The pension is of course the five-year rolling average.

And we’re – the pension cost utilities is the fact that we had the – ’99 was the last big good year and 2000 was a flat year in the market, if not down, and ’01, ’02 were terrible – ’03 was a good year, but not enough to bring it back all the way in the five-year average.

So all of a sudden people were paying into their pension funds in ’03 and in between rate cases, that means the companies eat it.

The good news is we’ve now captured the projections in rates and we’re hoping that ’04 comes in and ’99 drops off and then ’05 comes in and hopefully it’s a positive year and ’00 drops off, which is negative.

So we’re starting to get rid of now all the good positive years which were phenomenal in the late ‘90s are dropping out and now the weighted average is with the – and already accounted for the bad years of the first three years of this decade.

Dave, maybe you want to comment on the pension.

I think that’s such an important issue, because it’s half of our expense this year, if you look at it.

But it seems to be getting under control now.

Right, Nick.

Of course the largest component of our pension expense is the Pennsylvania pension expense.

And interestingly, that’s gone from just $1m when it first kicked in in early 2003, to about $6.4m on a going forward basis.

Fortunately, we’ve capped for that entire amount in the Pennsylvania rate case, which we expect to take effect in the next couple of weeks.

So from the standpoint of pension, we feel the largest component covered on a going forward basis, as we’ve litigated rate proceedings in the Aqua North and other divisions over the last year, we’ve incorporated those increases as well.

So we feel like we’re pretty covered from the standpoint of pension expense for the next couple of years.

So I was very pleased with the control we have on getting our own end of the revenue ratio back in line and also with getting a handle on some of the uncontrollables.

Two things we did also on the pension is we basically abolished pension – defined benefit for all new employees and that includes union employees, and are now dependent on the defined contribution plan, the 401K, which we enhanced, but is much more predictable.

And healthcare, we eliminated retiree medical for all employees, including union, right?

Right.

So we took the long term liability risk away and it looks like the short term hit is now digested and should be pretty stabilized going forward.

And on ongoing healthcare plans we’re looking at some of these new plans, the [HSE] and so on, but all employees are now paying contributions towards the premiums, which has helped stabilize the rapid increase in healthcare which we’re seeing, which is in the [teams].

So, that’s a pretty detailed analysis, probably more than you wanted to hear, about expenses.

The other side is the top line growth, which I think is always more important, growing customers and growing rates.

Growing the customers, I’ve already gone into and we can look a little bit at the growth rates.

And they’re very positive.

The South is growing at 4-5%, which is what we predicted.

As a matter of fact, one of the States is even growing more rapidly, because of developments that were backlogged that we’re now picking up.

And we’re looking at about the traditional organic growth, 1-2% in the North.

So therefore, that’s where we need acquisitions to get up to our target of 4%.

Regarding rate, that’s really, I think, the big story.

Two calls ago I couldn’t tell you – all I could say is what we were hoping to get.

And there’s always a lot of risk when a key year like ’04 is, when you’re asking for a lot of rates.

I can give you now, with clarity, what we’re getting and it’s pretty good news.

And what we are already planning.

I guess the summary would be that for the next two quarters ’05, if we compared in ‘04 quarters that we just went through, forget weather, which has been we had a bad winter and a wet spring.

Other than that it was great weather.

So let’s leave weather out.

Just the basis of same store sales, we’re going to look at next year with at least 10-12, maybe 15% more paying customers.

Along with about 30m more in rates that have been initiated between late June and August and will be coming in later in August and early September.

So they’ll be in the next two quarters – first six-months of ’05, where they haven't been in ’04.

Let me go through some of those for you.

As I mentioned, the important thing for us to do in the new operations, Heater and AquaSource, is to stabilize their abilities to perform.

Much more difficult, but we’re into it for a year now and I really feel we have a handle on it at AquaSource.

Heater, not much problem at all.

We inherited a very good management team.

And Florida Water was just simply merged into the AquaSource.

You could look at that as just another AquaSource situation.

We didn’t take any major management or systems, we just put it right into the AquaSource system.

The rates are really the important part and we have already filed for a major rate case and will start billing in August under the bonded rules of Texas.

And we are looking at a $12m range rate case.

That will get Texas earning its keep up through ’03, which is all the capital that was invested in Texas, as we continue to invest in Texas to get the system up to our standards.

So that was a very very important case to get done quickly and it’s done and we will start August 14th the bills start going out.

The second big case, as always, is the Pennsylvania case.

And we applied for rates last November.

We were awarded rates by the Commission.

The Commission voted about a week ago, at $13.8m, which we’ll be able to start collecting shortly, as soon as the final order is done and the bills start going out.

New Jersey, we filed late last year for a case.

It was awarded in late June, about $1m.

These are all 5-6% rate increases.

Texas was over 10 a year.

In Ohio we’ve been awarded a $.75m rate case in our Massillon Division.

Earlier this year, I think it was February, we got a $200,000 increase in our Struthers Division, and we’re expecting to receive an award from the Ohio PUC, hopefully for a settlement sometime early fall, September or October, in the 1.3 range.

So you can see – and then we have a couple of more that could happen by the end of the year.

Florida Index filing for 40,000 and a Maxim Index filing – Maxim is a waste water plant we have in New Jersey, for 70,000.

And I don’t want to dismiss 70s and 40s and 100,000 in Virginia, but much smaller.

When you add them all up though, it’s about 30m that’s pretty clear we have.

We also have another 6m that we’ve requested that won’t happen until hopefully early next year or mid-spring.

One is Heater.

We immediately went in to recover what Heater had not filed for, because they hadn’t gone in for rates for four years, because they had been in the being sold mode.

And we applied for a – well, four years, 5% a year, almost a 20% rate increase.

But it totals $3m.

And that’s started the procedure now with the North Carolina Commission.

Indiana we’re anticipating filing later this summer, a rate case for our Fort Wayne operation in that same range.

And we have just numerous cases in Illinois, Missouri, Virginia, South Carolina and a major one in Florida that we’re planning all this year, which would start moving the AquaSource take up from that low single digit 5% ROE range, to try to get them closer to the high single digits, as a catch up plan.

And then hopefully two years out, another notch to kick them up into the earnings power where it should be, between 10-11%.

By the way, the ROE in Pennsylvania was 10.6% and we were very very pleased with the language that was given in the language.

And if you don’t mind me bragging a little bit, let me read it.

The Commission increased the ROE award from the judge’s vote of 10, to 10.6, based on management’s performance, which considers the strength of Aqua’s record in the areas of water quality, regionalization efforts – that’s of course, buying small troubled systems – customer service and management’s performance with respect to acquisitions.

So we were very pleased that we received 60 basis points above the judge’s recommendation to 10.6, based on performance.

I think that’s what the regulatory process is all about.

We also received a very positive regulatory order in North Carolina that I’d like to mention.

You’ll see in our Q that we noted how much goodwill we paid for Heater, even though it’s not impaired and of course the deal was accretive from day one.

In order to recover some of that goodwill and get it in rate base, we offered the Commission, and they were in a public policy mode and they accepted, for us to recover the majority of it, about three-quarters of it, based on the fact that we’re willing to step up and take on some of the troubled water companies in North Carolina over the next 5-10 years, that we could earn back that goodwill in form of rate base, in addition to getting the rate base needed to fix these troubled systems.

Example, it’s about a $12m issue, of which right now it’s just on the books as positive goodwill.

We moved that 12 into earning rate base for every dollar that we pay for a troubled water system and then for every dollar that we use to fix it, that’s $2 in rate base buying it and fixing it.

We would get $2 of that positive goodwill transferred to rate base.

This is truly a win-win.

The State wants to clean up its problems.

We want to help them clean up its problems.

It’s the State’s largest water company.

And it gives us a chance to earn on the goodwill, even though the deal was accretive without it.

So that’s the kind of long range thinking that some of the Commissions, like Pennsylvania and North Carolina are thinking, and that’s obviously why we’re investing in those States.

I think I’ve covered almost everything.

Did I miss anything, Cheryl?

I’ve got it scattered around a little bit.

I’m going to give you two other things on the weather.

The spring was not a terribly wet, but wetter than normal spring.

So far, July has been pretty bad in the East Coast.

We had four extra inches of rain through this report being written and over the weekend we got four inches in one fell swoop, so we’re now eight inches over.

It's all coming at one time though.

With the rate cases all coming into play in August, if we can get some warm dry weather and hot weather without rain every other day, in August and September we should recover this quarter.

But it has not started well, because July has been a very wet month.

The analysts in New York and Washington and Philadelphia, I think you’re fully aware of that.

Fortunately we don’t have any waterparks where people have to come on the weekends to get revenues, because it’s rained almost every weekend, which has hurt the recreation business.

The other thing is with rates, our rate case in Pennsylvania, although it’s a big number, 13.8m, represented only about $1.60 a month extra for most residential customers.

Our rates are still well under $40 a month, which is comparable to phone and cable actually less and much less than electric, and is still less than the standard 2% of household income that EPA looked at as affordability.

So, although rates are going up, and that’s part of the reason, because of all the infrastructure we’re putting in and the world has to – the country has to put in, we’re not seeing it hitting the point where it becomes an elastic reaction on the demand side.

We’re still seeing an inelastic supply and demand curve.

So I’ll end this here and open it up for any questions.

Thank you.

The floor is now open for questions. (Caller instructions.)

Our first question is coming from David Schanzer, of Janney Montgomery Scott.

Please pose your question.

Hi, good morning, everybody.

I didn’t think you would have that good of a quarter, given all the weather we’re having.

And most of us here, you’re right, and I can’t identify that round yellow thing in the sky.

We don’t know what that is.

My question actually, just as sort of a refinement about your comments with weather, to what degree did having expanded territory in Texas and North Carolina and Florida meliorate the problems we’ve had in the Mid-Atlantic area?

Well, unfortunately, July and June were very wet months in Texas.

I don’t know if you remember the flooding pictures on the national news.

They had the wettest two months they’ve ever had, so Texas didn’t help.

Although that turns around very quickly.

The hot dry weather in Texas, they use a lot of water.

So that’s helping now in July and August, I take it?

Right, the end of July.

North Carolina had a great month in June and started July, but now they’ve had very wet weather, as you saw the hurricane and everything else down there.

They’ve had about the same weather we’ve had.

The Midwest, Illinois has been fine.

Illinois is right on target with our budget.

Ohio, a little worse, but not as bad as Pennsylvania and New Jersey and of course, that’s 60% of the company.

So unfortunately, the weather did hurt us in the second quarter.

We would have had even a better quarter.

But I’m very pleased with the structural.

I think the good news is the structure is back in place.

Can you quantify how much better the quarter would have been had you had normal weather?

I think at least it [a penny, in this case].

Okay, great.

You were fairly detailed in giving us the results for the quarter and kind of the most important peripheral stuff, which is the rate cases, but I was wondering if you could kind of take a step back and now that you’ve had a little bit more time, a little more experience with working with some of these new additions, whether you could give us an idea about some of the things that might be a little different in these new territories of Texas, Florida and so forth?

Could you give us a sense of whether you’re encountering any kind of what you would call significant competition with regard to any potential additions and tuck in acquisitions in those places?

That’s one thing.

Another thing is, what are the opportunities and do you envision yourself getting involved in desalination in some of those areas?

And then lastly, do you see opportunities for either waste water or actually every now and then seeing an O&M contract that might look attractive?

Okay, let me tick them off as you asked them.

First of all, regulatory, which is so crucial, we can’t be more pleased.

I mean from the fact that as a small company we get to meet the governor, his key staff, in Texas and in North Carolina.

The fact that the innovative regulatory process there gives us a chance to earn back positive goodwill in North Carolina.

In Texas, there’s a process you go through, but if you go through that process, there’s very little guesswork and the ROE is 12%.

I can’t speak more highly than in the regulatory process in those two key States for us.

Not to say Virginia and Florida is negative, it’s just that we haven’t had as much experience.

Regarding the acquisition potential, I think there is very little private sector competition, even to the point where the builders really don't want to get into the business.

They’d rather have somebody like a Heater hydraulics, which is our other company name in North Carolina or our Aqua Texas, be the developers water/waste water system of choice.

I think the third is, you mentioned waste water, I think unlike the Northeast, you have to assume that everyone is water and waste water for us, they’re one of both.

They’re all small systems.

They’re package plants.

There’s no municipal grant that you have to compete with.

And it’s just a matter of if they want us to do both, we do both.

If they just want us to do waste water, we do waste water.

Whatever they want, we do.

So we look at those as even opportunities.

Whereas in the Northeast it’s mostly still water, because waste water is controlled by the municipal government.

Regarding desalinization, we have not ventured into desalinization yet.

And the remnants of Vivendi owning us and US Filter being in their mind the largest desal company, we just didn’t feel we would be a competitor.

Some of the sister water companies, like Southwest are venturing into it.

Obviously, Consolidated Water in the Bahamas, that’s one of their main assets.

Now that we’re in the South and now that we’re in areas like Florida, which are going to need more water eventually, with the growth they’re showing there.

We clearly, probably are going to look at it.

I am meeting shortly with GE, which is as you know, their water unit’s headquartered right here in Trevose.

And to talk a little bit more about where they and Siemens are going in the manufacturing space, so that if there’s a joint venture or something we could do with them, because of our customer base, we’ll look at that.

Regarding O&M, we actually have got rid of O&M customers.

We went from almost less than 1% O&M to almost 4-5 I think I said at the end of last year.

We’re down now, back down to at least 3 and maybe down to 2%.

We have pruned every O&M contract that wasn’t making a fair return.

And I have to tell you Dave, there’s not many that make a fair return.

Heater did not have a lot of O&M.

The only O&M they had were ones that they’d think they could buy eventually, which has always been our strategy – take it on if you think eventually it will turn into an asset sale.

Or if you’re making 10-15% on your money and it’s not causing you a lot of problems.

But to take on O&M and all the aggravation, just to build revenues without any kind of net income, we don’t want to do that.

So we have not made O&M a target.

There’s so much in the regulated side to buy in the key states in the South that had O&M, that we want our new managers to concentrate on that, versus chasing O&M contracts.

Not to say someday we might not get back in it, but I would say at this point we’re not interested in doing it in a big way.

Also, I forgot to mention, Dave, and it ties in a little bit with that, we did prune – remember I mentioned to you that we were not going to stay in States where we didn’t really see good growth prospects.

We did sell our assets in Kentucky this month.

Connecticut was disposed of last year.

And we are in the waning months of our final approvals, we hope, in New York to be able to sell back that to Birmingham Utility sometime this fall.

Thank you.

Our next question is coming from Kevin Monroe, of Thomas Weisel Partners.

Good morning.

Could you guys walk through the internal growth in terms of what percentage of your growth was from rate increases and volume, versus acquired?

Sure.

I think – Dave, you’re going to have to help me with that.

I’d have to guess that the vast bulk of the revenue increase of 20-some percent and most of the expense is at 23% from acquisitions.

18.5 of the 23.2% for the quarter was related to the acquisition, primarily AquaSource and Heater.

And then the rates are about 2%, Kevin.

About 3% of the other sales -- Oh, water sales and other opportunities is 2%, and then the normal acquisitions a couple percent.

So, we’re still doing the normal tuck ins.

That brings in some added revenues and added net income.

But AquaSource and Heater was really the bulk of it, three-quarters of it.

Now that’s going to shift as we get into the second half, because last year we’re still comparing revenue increases this year with your AquaSource mainly and a little bit of Heater for one month, versus nothing last year.

August we start comparing apples to apples, so you’ll see that drop.

You won’t see the rapid increase in revenues or expenses.

And you’ll start seeing more coming in because of rate and Heater growth part of the water growth, because there’s no comparison.

And then next year you’ll start seeing it going back to the normalized rate of growth, 4-5% customers, 7-10% revenue and so on.

And just to clarify the discussion you had on rates.

Heater rate, I guess generally speaking, you’ve got about 30m in rate increases that come in in the second half – that’s on an annualized basis.

So 15m in revenue in the second half of ’04 that wasn’t there basically in the second half of ’03.

Is that a good way to look at it?

I would say not all 15, because some aren’t going to happen until August 15th.

In other words, if you did exactly it would be July 1.

So you’ve got to extrapolate from the 15 for the month or month and a half before they come in.

So to put it in perspective, August 14th is Texas, that’s a big one.

And PA in the middle of August.

So I’d extrapolate 4.5 of the six-months [inaudible] 15th.

But for the whole first six-months next year you can figure the 15.

Plus, we might be fortunate and get some of these cases that we filed and that’s 6-7m and we may get some of those coming in.

And then you can’t forget that we’ll now start churning up dollars because of the surcharge, the DSIC and the [WISC] and all that stuff.

And you can look for, in the first quarter next year, probably 2-2.2m extra and then the second quarter that grows to – is that additive?

Yes.

That’s a total.

Second quarter the total would be about 2.5.

And just final question on your operation and maintenance ratio, I guess as a percentage of revenue, came in around 41.8 this quarter I think.

I just want to clarify from your prepared remarks that you expect to kind of bring that down over the next few quarters as you kind of get further along out [inaudible]--?

If you look at it just on a quarter basis that’s correct.

I was giving the 40.4 on a trailing 12.

Because if you look at last year’s fourth quarter, we were in at 41.5, because we didn’t have AquaSource in for the full year.

Full year was 38.

So what I did is I took 80% of the company at 36%, which is the run rate we were at before AquaSource.

And then I took 20% of the company at 65%, somewhat arbitrary, but that’s about where it ended up.

And when you blend those two, it comes out to 41.5.

So I said if you want to track us, that’s where we’re starting the year of the real run rate, at the beginning of the year.

And I told you at that time I thought we could get it down maybe 100-150 basis points by the end of the year.

So what I took this time was a trailing 12, and the trailing 12, extrapolated for the one month that we didn’t have AquaSource – so I had to figure in 65% for that month that didn’t compare, it came to about 40.4.

So in my mind, we’re on our way to getting where we want to be at the end of the year.

And we’ve taken a lot of cost out of AquaSource in the first six-months this year.

The other thing that I should mention, and we’ll report on it no matter what the results, good or bad, we had our arbitration hearings with Ducane on the final purchase price true up.

Remember we ended up I think 186, Dave, is what we paid, for the access or in excess of that for AquaSource.

But there was a mechanism, if we disagreed on final purchase price, to true it up.

And we argued with quite a few millions of dollars that we think they owe us back.

They think we underpaid by a million or two.

And we had two full days of arbitrations between accountants and lawyers on each side two Fridays ago, I guess it was.

And the judge should rule sometime this month.

We have asked for the minimum price basically.

Because our request brings you well down below the minimum price.

If we win all our assets, we can’t go any lower than, I think it’s 174.

So, the worst case is that we lose and we have to pay another 1.5m for the asset.

The best case is we win our 12.some million to get down to the minimum purchase price of 174.

So it’s about a $15m debate going on that will be ruled on sometime this month by independent arbitrators.

And the way we did the deal was, whatever they say, that’s it.

No court cases after that, things of that sort.

So we’ll be giving you an update.

We’ll probably put a K out of significant – [8K], regarding what the final results of that are.

Thank you.

Our next question is coming from Jim [Lanken,] from Hilliard Lyons.

Good morning, everyone.

Let me get this straight, when you talk about 100-150 basis point improvement for your efficiency ratio, is that for 2005, or is that part of the trailing 12 you’re talking about?

No, I’m saying that when we review our full year ’04, I’m hoping that the final number comes in between 40 and 40.5, based on the run rate of 41.5 when we started the year.

And then I don’t want to predict yet, but we used to say we were going to get 50-100 basis points improvement year in year out, until we reached the level where you couldn’t [get any] lower.

And we used to say that was mid to low-30s.

So I think we’re now starting on that track again after this year.

Because I think we’ll have Heater in for six-months, Florida Water in for six-months, AquaSource a full year and all the changes we’re making at AquaSource will be done.

And I think our uncontrollable expenses that we just had no way of estimating, healthcare and pension and retiree medical, we now have long range plans which have capped them and they’re now in rate.

So I really see us getting back into that more predictable mode of expense control.

And is there anything right now that you can tell us as to how that is trending so far into the third quarter?

I don’t have it on the top of my head.

We just closed July, so we don’t have those numbers yet.

So the weather has not been great on the top side.

But we’re still confident that we can get there by the end of the year.

I think if you look at the third quarter, a lot of it’s dependent on the weather, because that’s when you get most of your incremental sales is the hot summer.

The rate cases will absolutely help us, which we didn’t have in the second quarter.

But they won’t be in for the full quarter, Jim.

The expenses will go up versus last year, because of Heater.

And Heater comes in at 55% ratio.

So that doesn’t help us.

But we’re starting to already see some synergies between our hydraulics in our Heater.

And Florida Water came in at 65, but we’ve already driven that down.

I think we’re at 55 already and we zoned it for a month.

So we may not see dramatic in the third quarter, but as the rates come in and we can get a little more cutting here and there, you’ll probably see some improvement.

The fourth, again, will be the same thing.

Because it’s year to year the same – AquaSource will be at least apples to apples at that point.

Okay.

One last thing.

You’ve historically targeted 5% dividend quotas.

And with the 8% increase, are you going to be looking at a higher number than 5% going forward or should we still look at what you’ve done in the past?

I think the fact that we were in the mid-50s, and we always said we were going to review it when it got below 60% payout ratio, and that this 8 brings us up to the 60, and that our strategic plan that we showed the board based on continued growth and the fact that we thought we could have the rate acknowledgement of the rate base of the Heater and the AquaSource properties well above the 5 and 7% we’re earning now, that we predicted that even at this pace of dividend increases, we would drop back below 60%.

Does that answer it?

Yes.

So I’m pretty confident, but I don’t have a crystal ball of what’s going be here three years from now or four years from now.

But at this point, the board was very comfortable raising the dividend to 4 cents a year, from the 3 cents a year.

(Caller instructions.) There appear to be no further questions at this time.

Well thank you, everyone, for all your time and if there’s any questions that you come up with afterwards, call Cheryl, myself, Dave, we’ll be available.

Thank you very much.

Thank you.

This concludes today’s teleconference.

Please disconnect your lines and have a wonderful day.