Essential Utilities Inc (WTRG) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the AquaAmerica 2005 earnings conference call.

My name is Anne-Marie and I will be your coordinator for today.

All participants are in listen only mode.

We will conduct a question-and-answer session towards the end of today's conference. [OPERATOR INSTRUCTIONS] I would like to turn the call over to Cheryl Hansen, Director of Investor Relations.

You may proceed.

Good morning, everyone.

If you did not receive a copy of the press release you can visit the Investor Relations section of our website at www.AquaAmerica.com or by calling Christopher [Patel] at (610)645-1020.

Presenting today is Nicholas DeBenedictis, Chairman and CEO of AquaAmerica. along with David Smeltzer, the Company's Chief Financial Officer.

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

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

During the course of this call, reference may be made to certain non-GAAP financial measures including the company's EBITDA and EPS and efficiency ratio including one time gains.

Reconciliation of these non-GAAP to GAAP financial measures are contained in today's press release and are also posted in the Investor Relations section of the Company's website.

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

Good morning.

I want to go over our fourth quarter, the full year, and then talk about what we have done this year that gets us ready for '06, this year meaning '05.

We ended the year with a solid quarter which I will get into in much more detail.

That will let us cap of a record year for this Company.

We had net income of 14%, EPS up 11% after a 3% dilution needed for shares to continue our acquisition and capitalization program for the quality investments we have been making, revenues were up 12%.

We did a record number of acquisitions.

However, in '05, different in '03, and '04, we're back to bread and butter type acquisitions.

We did 30 small acquisitions.

We came around 4% customer growth, just under 4%, whereas the two prior years we didn't do as many small ones but we did the AquaSource in '03 where we grew over 20% and the Heater and Florida Water were two of many we did in '04.

That got us up to 10% growth.

Part of the story in '05 and continuing into '06 is the digestion of those two larger acquisitions which we generally got below book because they needed a lot of capital and a lot of work and a lot of organizational rebuilding, which is in play now, and we are starting to reap the benefits we will continue to do so through '06 and into '07.

We did a record amount of capitol, we were up 20% in our capitol spend between 2005, and 2004, and 2004 was an all-time record.

And we spent close to -- more than $225 million in capitol, which will go up again this year, we're planning to spend a quarter billion dollars in 2006.

I want to take two seconds to talk a little bit about the capital spend A lot is to do the catch-up in the southern properties which needed a lot of work to meet all the environmental standards and prepare them for what we are seeing, very good organic growth getting ready for now acquisition growth in the South.

The capitol spend in the South will slow because this is all catch up.

A lot of it was asked for by environmental agencies under a consent decrees which we are now complying with, and that spending limits are expected to level us off.

However, in the Midwest and the North, the spend continues mainly because a decaying infrastructure which is part of the entire story of the water industry, whether you be municipal government or private water company.

If you are in one of the older areas of the country, where most of the population lives, pipes don't last forever, fire hydrants don't last forever and so on.

That is where a lot of spending will continue.

There is a subtle shift, we'll go more towards that area and also increasing depreciation which you'll see we mentioned in the report, which means more of the cash needed for this will be self generated.

We will still spend more than we produce in cash between increasing earnings and increasing depreciation, but not quite the multiple of cash flow we have spent in the past, meaning we will use our own money rather than float as much stock and do as much debt as we go forward.

That relates to reality, that until you get the spending rates through the regulatory bodies, there is a necessary lag.

That is starting to hit us a little bit in the fourth quarter.

Although not the old sawtooth type you use to see with utilities.

Actually, although the first call was not met, if you look at some of the numbers which we will drill down on, you will see we did as well, as could be expected, actually better than expected.

It is just the expectations in rounding -- I will get into that.

The key is that this spending has generated a backlog of already filed cases of a over $50 million comparable to our complete year end revenues of 500.

That will be part of the story for 2006 when those cases are awarded, probably most in the Q3/Q4 time frame.

Some that we settle could happen as early as Q2.

Because a record acquisitions, record earnings and continuing strong revenues, up 12%, we were able to raise our dividend in 2006 up 10%.

That is much more than the 5%.

Our goals have been 4% customer growth which we basically hit in 2005, 7% revenue growth which, because of the first two quarters and the comparison against Heater and Florida Water where we had no comparison in 2004, that revenue growth, a lot of it was because of the issue and that brought expenses with it too.

We did more than meet the revenue goals we had.

We always like to show net income of at least 10% and it was up 14%, again held by those first two quarters of revenues and some rate cases we got in 2004 played out in 2005, the second quarter -- if you get a rate case in 3Q, 2004, it is a favorable comparison up until 3Q, 2005.

Those quarters had a good comparison of New Jersey, Pennsylvania, prior rate cases.

Therefore, we were able to raise dividends more than our normal goal of 5, and we did a 10% dividend increase.

We also split the stock, stock at a healthy move in 2005, up over 40%.

We split the stock, the fifth time in seven years or eight years, and that may have caused some of the confusion in the first call setting, unfortunately, because when you split a stock you have to readjust all the numbers.

They were only readjusted in the fourth quarter and if you look at the numbers, you will see, what we ended up with, strong 17.

Many of you have 18.

And I think your basing it unfortunately, of the numbers in 2006 -- 2004, excuse me, which included a onetime sale of Geneva.

Overall we are very pleased with how we ended the quarter and the year, right on target with where we thought we would be.

Let me drill down now, into the fourth quarter.

Bear with me, we don't like to sell systems, but we to once in a while when it is in the interest of our shareholders and when the municipal governments appear to be wanting the property, and willing to pay a fair price for it and they can do it as well, as we can.

In that case, and it's a very rare case where we sell, it happened last year in the fourth quarter of last year when we sold Geneva.

If you read these statements you'll see we put the exact numbers of dollars that were allowed for it, what happened is the way they were accounted for properly was to deduct from O&M.

It made our O&M numbers look better than before.

We told you that last year, and we told our real numbers looked more like 40.9 for the year, not 40.3, but if you take that base, it was really $0.16.

We came in at a strong 17 and of course it's all rounded because of the four for three stock split.

In addition, in the fourth quarter, we had a 6% revenue growth, fourth quarter is never the best quarter.

We didn't have any rates comparison, exceptional rate comparison or comparison like the first two quarters with Heater and Florida Water against not having them the prior year, which is why the revenue stream was up so much in those two quarters.

We hit some expenses in the fourth quarter that you would not have been able to predict.

I didn't predict them.

One was the fuel increase mainly because of the Katrina and the blip that when gasoline went up to $3, that hurts us because we have thousands of trucks every day riding around the country doing our service work.

And health care.

Health care was in double digits last year.

We took some star measures that they don't really kick in until the next year of your premium payments and your contributions from employees.

We think we have are back at a reasonable level of 7%, 8%, well down from a 13%, 14% we were experiencing last year.

Pensions, once again, because of accounting, non-cash, we had to charge off pension expense mainly because of the lower discount rate which is affecting, you're hearing it every day in the market, regarding people freezing pensions and a lot of that is accounting driven but a is to recognize what future liabilities may be and we have to charge it off today, even though they are regulatory assets, and we have taken some measures in our pension for basically allowing no new participants in our defined benefit plans so we're capping any kind of future increase in that sense.

And then fourth, We actually took a write off which probably would have gotten us -- Not probably -- would have gotten us up to $0.18 a we took the right of being prudent, for an acquisition, fairly large acquisition we worked on for three months that we did not consummate and we took all the expenses, legal, accounting, and consulting fees, banking fees, and wrote those off in the fourth quarter.

So as you can see, I think most of you were on target if you knew all of the things I just explained to you, that you would not have been able to experience unless you're running the business.

I am very pleased with $0.17.

It caps off a great year and the real story is where you go from here and that is the base we have built with our acquisitions.

We see the pipeline fuller than ever.

We appear to be at this point, one of the few of the handful a larger private water companies still in the market to buy these small companies, plenty of them out there.

And in many cases, buying them below book, fixing them, [INAUDIBLE] the capital expenditures and going for regulatory relief, and many of the state regulators are very pleased with that process and actually giving us incentives to do this type of work.

They would like to see water quality improve in a lot of these small and undercapitalized systems.

The other large companies we're one of the few that were U.S.-based and U.S. owned on the market, many are European owned but U.S. operations, and we're starting to see speculations, announcements, more actual announcements many of the European owners are trying to sell their assets in this country.

We are looking at sticking to our knitting.

We're not going to pay too much, even if one of these larger companies come on board and if it is the right price, we will buy it.

If not, there is plenty else out there.

Maybe a little slower, tortoise and the hair, but we will get it done.

That is what we're looking at as we go into 2006.

We have quite a few municipalities and small private companies that we're looking at and we will fill our acquisition pipeline.

So I'm comfortable we'll look at another year of acquisitions like we looked at this year, perhaps even a little better.

Regarding the capital spend, it's a bigger company, we're still spending money in the South, although that's starting to slow.

I can tell you I feel a lot better this time this year than this time last year with having only six months of experience in the Heater Florida Water, in the sense that we have either build already or we're in the process of building in meeting every standard the regulators have asked us to meet regarding the environmental spend.

Texas was the biggest spend.

I would anticipate spending drops half of what we spend this year.

Florida, same thing, we're building two major new plants there.

Virginia, we have invested a lot of money.

It makes me feel good as a former Environmental Secretary that we are getting these things fixed.

It would have been very bad had we not bought them out.

We did get good news toward the end of the quarter were the Florida Commission ruled we now, officially own the Florida Water Properties.

We bought it, but we had to get official approval.

That is the way they do it in Florida.

The good news is they have knocked another $1.5 million, to $2 million, which is 10% of purchase price off, so we are asking for a refund from the electric company we bought it from for that amount.

That will bring those properties in well below book, just as we bought the AquaSource properties, and we've already started to fix them so now we'll be going in for rates and get a fair rate of return on those some time during the 2006 time period.

The other thing I mentioned in the release that I think is important is the fact that we are starting to generate a lot more cash.

That doesn't mean we're going to cut back on spending or that we are going to be cash positive.

We will still be in the market to sell stock and to borrow money.

That is part of the regulated model on how we actually build shareholder value.

However we are going to use more of our own money, and our own cash, borrow less from banks and use more of the cash generated from our depreciation, which is good for the rate payors.

And also the same way with our shares, rather than splitting as many shares as we would five years ago, three years ago, the retained earnings part of the earnings growth is growing, so therefore, that's good for the dividend, the policy is going forward which will decrease over 5%, four years running.

I'm optimistic the Board will look at it again this year.

It also gives us more retained earnings cash to put back into business equity which means we don't have to flow stock for that.

So you saw a 3% dilution this year.

You will see closer to 2.5 so it will start going down to the point where it we won't be diluting -- the difference between net income growth and EPS growth, it lessens each year.

Looking at next year, because the Street looks so carefully at what First Call says, next year hopefully, I shouldn't say that, maybe we will split the stock of the stock goes up or whatever.

Without a stock split, we should at least have some continuity throughout the year so that the numbers in each quarter looks the same.

The second issue is next year, we will be reducing our earnings with a non-cash charge, which is the option expense.

We do not give a lot of options. .5% of the total outstanding share, which is not a lot compared to what most companies and what the high-tech firms use to give.

We find them very helpful.

We give the options way down in our organization, 30% of our management.

And non-exempt management get it, and it has worked.

It ties them in with the shareholder and also the customer.

Rates are important but if they get too high then you'll get a reaction from the customer so employees all understand that delicate balance.

The charge however, and I want to make sure people who analyze our company understand, the assumption they weren't adjusted in the First Call for option expense because we didn't announce we would do it until right now, we're starting in the first quarter.

It appears to be at $0.02 to $0.03 charged, non-cash.

That is the difference if we compare this year's earnings to next year's earnings, options this year would have been $0.025 to $0.3.

I just want to make sure that those of you who put guidance out on us understand that in your calculations, so there is no surprise.

Also, I mentioned the $50 million backlog in rates.

We're probably going to be filing for another 15 to 20 cases that are now, being worked up, ready to be filed mainly in the South, and Indiana.

But once those are filed they usually take 9 months to 12 months to get done so some may come in this year if we settle, some will be in for 2007.

But because there is so much money already spent and so much in our big states, Pennsylvania especially, Illinois, and New Jersey, which are right now in the process to be reviewed and probably won't happen until the third or fourth quarter, you should not look at our quarters as being equal this year.

Our first two quarters will be not helped by any of these rates, they will be helped by our normal growth in our company and and that should offset expenses.

And we think we have expenses because of the -- moves we made on pension and health care and hopefully gasoline prices stay where they are now, back in line with a normal growth pattern.

But 25% of our increase in a O&M next year will come from the options, which are basically always have been given, it's just a new way of accounting for them, it is not a cash issue so you understand, and Dave can explain this more.

It is almost an equal amount off EPS because there is variable tax effect on these options until they are actually exercise, 7, 8, 9,10 years from now.

That is when you get the tax benefits.

It is almost one for one hit to O&M pretax, and from the bottom line, the tax issue on your EPS.

We won't have any major -- like we did in the first quarter were second quarter of last year, we won't have any major acquisitions that we did late in the year that is going to help show the comparison.

So we're up against the two quarters that were from end loaded in 2005 that we are up against which will be a normal operating quarter.

Realistically, probably fairly flat.

With going back to the normal growth pattern of this company that you have experienced, hitting in the third, and fourth quarter.

So I just give you that so that you have a little bit of guidance on how our quarters may fall out obviously, you'll have to do your own models of revenue streams and what expenses and so on.

Our organization is in place now, we made every change in the old AquaSource.

Unfortunately, every manager had to be changed out.

We have a new organizational structure in North Carolina, when we merged three entities into one during last year, which is now being fine-tuned and should be in third year in 2005 and fourth year in 2005, and fourth year in 2007.

I am very comfortable that we are in much better shape this year than we were a year ago, especially with our acquisition pipeline and our backlog on rates.

But like every business, we have to wait until they come home, at which case they will start showing up in the bottom line.

A little more detail than normal especially on the guidance, but with so much emphasis now, on First Call versus what you do, I think I want to drill down a little more on that 17, the Geneva, actually, last year was even a little more than it appeared to be, but when the one stock split it made the rounding even more difficult.

We are right in there between the 17, and the 18 and you see that when you take your split adjusted 9 months and then add the 17.

You see it would have been 70 and then it actually comes in at 71.

So be it.

The other thing we always track is the O&M to revenue ratio which this year when affected for Geneva, we ended 2004 without the higher cost of southern properties, Florida Water and when I say higher cost I mean higher cost to revenue, operational maintenance.

Florida Water, we brought down from 80 to 70 but nowhere near the usual 35 to 40 that we like to see in the North.

Heater, we brought down to that it's 60s, mid 50s, and then Texas, we're in the low 50s now.

So you can see we're starting to get a handle and as we put more controls, more automated controls on the wells, that things of that sort, we're starting to get to the more efficient labor.

So when you look at the 40.9 that we adjust for the end of last year, and you consider the fuel costs, the pension and the health care, and the fact that for two quarters this year, comparable to the first two quarters, we had high O&M to revenue ratios against nothing, meaning low, the 40.9 is a substantial improvement 2005 over 2004.

In 2006, we are going to be in the same range only because the 25% increase that isn't in this one from options in O&M.

After this year, you will start seeing -- we can reconcile the numbers and show you we're still getting 50 to 100 basis points out of the overall numbers, but after this year, I think you will see it without all of these comparisons, short of another major acquisition, O&M or whatever.

The option, and we will go after the call, if you want to call Dave or myself or Cheryl, we'll give you actual numbers and how it affects each of the line items.

I think that is it.

I think I covered most of it.

Sorry for the length but complicated explanations.

Because of all the accounting things, we have to let you understand how to true up the numbers.

I will open it up for questions.

[OPERATOR INSTRUCTIONS] Your first question is from David Schanzer with Janney Montgomery Scott.

Please proceed.

Good morning, how are you doing?

A couple of questions.

You alluded to the possibility of some acquisitions, your normal tuck-in acquisitions, and you mentioned municipalities, and given the age of the infrastructure with the municipalities and the EPA concerns, are you seeing larger municipalities show interest?

What would be the optimal size right now?

I know the larger cities are not interested in being part of an investor-owned utility, but what would be the optimal size in the way of a municipality that you might be looking at?

The sweet spot, because it is some manageable and you can merge them right in your organization and you don't have as many problems with unions and the politics of municipalities, would be in the 5 to 15,000 person town, that would be 2500 to 5,000 customers, which is a considerable -- that would be, 1% -- that would be 3%, 5,000 customers, just to give you a feel as we talk about 4,000.

Are you seeing anything in the way of 25,000, 30,000 population being interested?

We have a couple we talked to.

They just take longer.

Those, we're seeing more in the waste-quarter side, because what is happening on the water side, they have always kept their rates somewhat up with the need for O&M and capitol, but on the waste water side many of them got free money from the federal government 20, 215 years ago.

Built it, never raised rates, and now it's time to fix it.

We are starting to see a little bit more interest on talking to us on waste-water on that side of the municipality, but of the water side, the sweet spot is that 10, 15,000 person town, city, municipality, whenever you want to call it, because it is just not big enough to due the next edition for whatever it be, arsenic, PHMs, all of the new regulations that are coming about, and still fix pipes at the same time.

That leads me to the next question which is a waste water in general.

When do you think waste-water will start to make an impact on earnings at AquaAmerica?

We had a very successful -- if you look, I think we break it down this far -- Dave can give it to you.

It is in other column.

We bought a small wastewater sewage hauling company which is called Honey Dippers.

These are the people who come to your house if you have the septic system and we bought one of those, it's under a different line than the regulated, completely different.

We did much better than I thought.

Pre-tax margins and revenue, it actually beat all of our goals on that.

We're looking at a couple more of those because there are a lot of small players in that area, three, four trucks, four or five workers.

We think we can -- Especially in concentrated areas in our own backyard.

Where we already have the waste-water system.

Waste-water, which used to be 1% of our revenues, is now, 8.5% of our revenues.

I don't want to imply we're not concentrating on it.

It is one of our faster growing elements.

But before we tackle on a big city, which would jump the revenue side very quickly, we want to make sure we can assimilate it, whereas there is a lot of the start up, new developments where we have the best shot at getting.

This unregulated piece, which is the skeptics system which has a completes synergy with our business line.

And the third would be the smaller size cities to medium-size cities which won't get smaller size cities to medium-size cities which won't get federal grants any more.

They're still holding on hoped for federal grants, but every year that passes, the more the EPA cites them, the more they feel it is not going to happen again.

The last question, you talked about backlog of $50 million in rate case requests.

And I don't know what you're saying, of 20 million this year.

We have actually filed $50 million, $50.2 million, that is already in the hopper and we're in interrogatories and hearings and everything and there are another $15 million that are in the process to be filed over the next couple of months.

My question is, do you see any roadblocks, regulatory changes that might impact those rate cases?

I know Illinois is going through a very trying period.

One of the reasons that the rates are a little higher this time than they have been in the past is O&M has gone up faster.

The three elements in that, or actually four elements, health care and pensions, which are legitimate expenses, but we are taking the lead among a lot of utilities and actually asking for contributions and we are asking all new employees not be part of the defined benefit plan, only the 401, which cuts down that non-cash hit if you have an unfunded liability and things of that sort.

Fuel is fuel.

We can't run the trucks without fuel.

We have to buy bulk, all kinds of controls on who gets to use our gas at our operations centers but you still have to pay the going rate and Katrina gives a hit on that.

Expenses, but our power, because of gas prices, oil and natural gas prices, power has gone up and competition, the deregulated states, not completely free and that is what is happening in Illinois and Ohio, not so much Pennsylvania, a little bit in New Jersey and they are doing these options and we are hit with that also.

Pennsylvania, our biggest state is somewhat protected as we bought out the transition charge five years ago and that turned out to be a very good move, wise move for us.

Pennsylvania's rates are frozen through 2009.

We're okay there.

We are not seeing the same reaction has some of the electrics are who haven't been in for years, but their rates haven't dropped that much because of the transition charges and degenerating piece going up so much it looks like major increases, 20%, 30%, and I think there is some backlash forming.

So far we have not felt that and we haven't even gotten challenges regarding the new prices we're putting in for power which is just realism, that's what the costs are going to be.

So, I would say first of all, I think there is a realization among the regulators that are ROEs are starting to inch up, and you're seeing that in a couple of states.

That's good news, and that is reasonable since interest rates are inching up and I think people realize water is still the least expensive of all utilities and basically if we're going to improve the infrastructure and get it were EPA wants it, we're going to have to put the rates in.

That is a long winded way of saying we're not seeing any negatives at least when I go to [Nayrouk] and all the other conferences.

They want investment in water and part of that who will invest?

The municipalities aren't investing, small players aren't investing and the large players, there are only a couple who are American-owned and there is a big fear that when the Europeans sell, if they sell to traditional utilities or not.

There is a recent purchase, a couple recent purchases by private equity funds, and it is going to be up to the regulators to see how they regulate them versus regulating a normal capitalized company, a public company and if the financial model works, if their financial model works, they will pay a lot more for these utilities.

That is fine if that is what the regulators decided.

That means we could use the same model too.

Maybe enhance earnings.

Or ,we're not invulnerable, if they're going to pay those kind of values the shareholders may demand be [INAUDIBLE] or something of that sort.

I just think that's a new wave, we have the Electrics come in and then we had the European investors come in with a different model, their model is more O&M contract maintenance, and we have another new wave of private equity investors.

It is starting to hit the front pages.

I saw the Bruckshire Hathaway President of Buffett talking about them, not in a very positive light in his letter.

Forbes front cover story, they called it the Dot-Com bubble ready to break on private equity.

It's starting to get to the front pages now and we will see if the model works in our industry.

We are the only one out there buying and fixing at this point, other than the California companies, and I think the regulators realize that and why we're being treated fairly.

Thanks.

Next question is from Tim Winter with A.G. Edwards.

Congratulations, there certainly is no reason to apologize on 14% increase in EPS year over year.

One of the strongest we have seen in the whole sector.

But if you could spend a minute and talk about where the ROEs now are, the earned ROEs on AquaSource, Heater, Florida Utilities, and how much room you have to grow, I would appreciate it.

Sure.

Pennsylvania, we close of the [disk] is 50% of the company, 40-something % of the company.

We are able to maintain the ROEs, they will deteriorate over time because we're spending so more money, $90 - $100 million a year in Pennsylvania.

But then when we go for a rate case they come right back, and we're looking at mid to high 10s in Pennsylvania. 10.6, 10.7 range.

They will deteriorate maybe into the high 9s, low 10s between rate cases.

I would say the consumer states, New Jersey has been tighter.

I look at that as positive because they can only go one way and that is up.

There were at 9.75 the last case we went in.

We have been able to maintain in the 9s there, but with a rate case is going in now, we are anticipating back into double digits in New Jersey, so that will enhance a little bit.

Illinois, Ohio, pretty solid, because they are stable companies have been around a long time.

They may have 100-points deterioration.

They are all earning, Illinois went for two major rate cases, so they probably carry it down to 8, maybe 8.5, but they will bring back up, we have 10.4, 10.5 in our two case we just got in Illinois.

Indiana is hurting very little because we haven't been in for a rate case and we put a lot of money into it but we are winning every smaller battle and we are ready to go in now.

That is where we have condemnation threat at Fort Wayne.

But we have not stop investing.

We put in over $20 million, fixed everything.

We are ready to go in for rates.

I think probably we're earning, in Indiana, I'm going to guess, less than 5%.

Now the AquaSource states, Texas we are earning very well because we got the rate case, but in Texas you have a great case in a bonded nature, whereas you take the risk until it is finalized, we expect finalization of the case some time during 2006, but we are already banking the earnings in it.

It is earning its keep as we speak.

Probably a little north of 11, I would imagine.

We will get these all for you.

I will give you my rough numbers.

The other AquaSource states, I gave the Indiana, I gave you Texas.

Including Heater and Florida Water.

I think they're doing 3% to 5%, but remember, we bought them below the book.

We put a lot of capitol into them and we have made major organizational changes and as we are growing, we are growing into that organization now, so that is why you're seeing growing by customer count, we grew in the South almost 6%, 7% organic last year.

But as you see, the rates come in, that is where you will see that O&M to revenue ratio really get much more in line, and I am going to guess that we are probably still in that 3 to 5 range if not lower because we haven't gotten any rate cases, other than some small indexes, but probably at the end of 2006 we will get up to 6 or 7 and then in 2008, 2007, excuse me, we will get closer to 10.

North Carolina gave us 11, I think, was and then the ROE, yes, 11.

Florida gives you a roving scale which can be as high as 10.5 to 11 with a lot of equity included.

I don't see the question about the ROEs, the South, the ROEs, and regulatory climate, isn't the issue.

The growth isn't the issue.

It is getting the expenses grown into the size of the organizations with the right management.

That is happening as we speak.

And then getting all of the capitol we had to invest to make the environmental people happy, back in rates.

Now, to give you an example of the rates, and we're getting them, Texas was almost a 50% rate increase.

And we phased it in over four years, very creative accounting, creative being in a positive way by the commission said that the rates could be phased in but wouldn't be rate shock for their customers that we agreed to, that we can explain to you offline because it affects O&M and revenue.

They deduct O&M one year and add it back another, and so on.

It manipulates our O&M to revenue ratio, but the dollars are coming in.

The other is in North Carolina, there I think it was an 11 ROE, they gave us the incentive and goodwill to write off -- earn on the goodwill as long as we buy small systems, troubled systems and fix them.

In Florida we did very well, although it took a year to get the finalization of Florida Water and it turned out very well, for us.

I can't complain about the regulatory climate.

As you know, the utility business takes time.

You don't turn things around in a day.

And I thing you see some of the new players coming into the field realizing that very quickly.

You don't get a merger done in 3 months.

It takes 9 to 12 months and the regulatory scrutiny, that is why we are regulated.

We get the benefits of it and one of the negatives of it is it takes time because, rightfully so, the regulators have to opine -- they are giving the money, they have a right to set the rules and make the rules.

I would say we still have some kick coming out of the South as we get these rates in.

You're going to have to help me, Monticello is 120% rate increase?

These are huge rate increases.

Wimberly, we got 112, 1 to 14 approved a rate increase in one of the small facilities in Indiana?

The Commission gave it to us, that a huge rate increase because we deserved it, we fixed it and we're getting the rate of return we are allowed and we have cut costs, expenses down to a minimum.

In Illinois we did two rate cases this year, we went in to 60% rate increases and we ended up with 52, 51.

The regulars are treating us fairly.

I wish we didn't have to go in for 50%, 60% but that's because AquaSource never went in.

They just bought them and never fixed them.

Once we get through this very difficult period of rates which is the 2006, and 2007 times period, then we will be closer to the North where it is a normal 4%, 5% a year type increasing, and we will be back more on automatic pilot there.

It would seem to me that it has come the second half of 2006 through the next 12 months after that, that there might be some fairly material earnings growth, absent the options issue, from bringing these things up to their full ROEs in the Pennsylvania rate case and other rate cases that are pending.

Is that an accurate assessment?

You're absolutely right.

It is Q3, Q4, is when you will see the good comparisons and you have to work in, though, the fact the 2005 did not include $0.02 to $0.03 in O&M and EPS type hit because of the options.

You're absolutely right.

And when we get them, they will follow through into Q1, Q4 of 2007.

Then we will have to judge, the acquisitions we two in 2006 in the fact the 2005 did not include $0.2 to $0.3 in O&M and EPS type it because of the options.

You're absolutely right.

And when we get them, they will follow through into Q1, Q2 of 2007.

Then we will have to judge, how many acquisitions did we do in 2006, how many rate cases are we filing, how much capital, I'm telling you, I think we are doing a 250 in capital.

There will be another backlog built up for 2007 as we go into 2007.

We have been around a long time, 120 years, we are patient.

If it takes a couple extra months to get a good, sound case, we will wait, we are not going to just settle so that we can make a quarter's earnings.

That is the way we run the business.

That is what bothers me about some of the new players.

If you are driven only by financial, you can't afford to miss a quarter, if you are public or an earnings report if you're private.

You do that basically by living off of depreciation and not putting the investment in, and had we not put the investment in, $245 million and paid the interest wire carrying costs while we're waiting for it to get back in rates we would have done better this year.

Absolutely, we would have blown away the fourth quarter.

That is not the we build the business long term.

Thanks and congratulations.

Next question is from Jim Lykins with Hilliard Lyons.

Good morning.

A couple questions.

First of all, the $0.02 to $0.03 in options charge, will that be an annual number, is that just the portion of the first quarter?

That is for the year.

That will come in the first quarter?

Rather than me, maybe you should call Dave afterwards.

He can tell you quarter by quarter.

Second question, you mentioned that the acquisition pipeline is fuller than ever, I'm just wondering if you can you talk a little bit about that and if you think it will enable you to get back north of that 4% customer growth rate?

If they all come to pass, it definitely will get us past the 4% growth rate.

And we have this year going into this year, and people we are talking with, we have more municipal government entities that we are talking with than we have in the past two years because we have been so busy with, I'll call it the private -- electric disposals of their privates, which took a lot of our time.

We did look at one of the larger companies that's been sold previously, it was back on the market.

Spend a lot of time on that.

That was part of our surprise cost in the fourth quarter.

By accounting rules, to keep everything clean, we decided to write it all off in the quarter since the deal wasn't consummated even though we were still -- could have had a chance of consummating, but now, it is finalized, we will not.

That has allowed us to pay more information to what I call the smaller but sweet spot ones we talked about earlier with Dave.

Did I answer your question?

Yes, that is helpful.

Lastly, the $250 million in CAPEX, can you break that out between growth and maintenance?

I would say since the South is -- In the South we are calling it maintenance, but the reason it has to be built is because all of these small towns and little places have grown to the point where the old plan is in non-compliance because it is not big enough.

I don't know if you call it maintenance or growth but that is the problem in Texas, Florida, and Virginia.

In the North, I would say it is 50/50 because the maintenance I would call disk work, and probably half of the money in Pennsylvania each year and growing, is going into pipe repair hydrants and so on.

And as Bob just pointed out, in the Q, or in K, you see the $65 million of the $223 million was eligible for disk this year.

That gives you a feel.

That's going to grow.

The maintenance in the South and the non-disk states like New Jersey, I would say is in about that same percentage, which would be about 25-30%.

Maine is higher, Maine is probably 60%.

Not a big state, but.

In the South, I would say you could call it maintenance but we can't continue to grow unless we fix and expand the sewer plants, and then they release the ban on building and people start growing again.

Either way, I give you a percentage, it's going to be wrong there, depending on how you interpret it.

Thanks.

[ OPERATOR INSTRUCTIONS ] Next question is from Stewart Scharf with Standard and Poor's.

Just again on the O&M, you said it is going to increase 25% based on the options?

The answer is, of our increase next year that we are budgeting, a quarter of that comes strictly from the non-cash charge of options, but it is in our O&M column, so when you look at it next year, and you do your analysis quarter to quarter, realize that about quarter of that increase is strictly from the options.

So, um --

Let's give you an example.

If O&M next year, when we compare at the end of next year, if the O&M line is up 8%, 2 to 2.5% of that 8% is going to come from options.

The rest will come from fuel prices, health care, pension benefits, labor.

We're doing very well controlling the controllable costs, labor, vehicle expenses, things we have direct control over.

In the fourth quarter, gasoline got away from everybody in the country.

That is coming back in line.

Health care last year I said was up double digits, 13%, 14%, we're projecting this year closer to 7%, that is higher than we like to see it but that elevates it.

And the pension this year is going to be up again too.

Pension expense, which is, again, non-cash, but since the discount rate continues to go down each year, that elevates your, quote, unfunded liability 20 years from now, and therefore you have to charge it currently to your accounting but not cash.

That is in there, too.

So the efficiency ratio for 2006 would generally, including options, would be about the same?

And subsequently you see it still averaging -- maybe 100 basis points?

I would say this.

This year it was 40.9 versus 40.9 and the reason it doesn't look like it went down this year was the fact that we had two quarters in 2004 with zero maintenance to revenue from and then Heater and Florida Water Properties which was 10% of our revenue stream.

But this year they were in 70s and 80% so obviously that elevated the 40s.

If we adjust for that, we probably hit that 50 to 100 basis points.

And in the net we did.

And Geneva

Next year, let's start with the 40.9 because that is a full year of Florida Water and Heater so it should be a better comparison going into next year..

Next year will be apples to apples except for the fact that O&M includes option expenses which a 25% of our increase in O&M.

That is what I'm saying.

After this year we will have the options and there will be a much clearer comparison year to year.

Without the options, we'll break this down and call you back, but without the options, I am very comfortable that we will hit that 50 to 100 basis point reduction and be back on stream.

Thank you very much.

Next question is from [Beshell Sharmah] with Stifel Nicolaus.

Good morning.

I have a housekeeping question here.

Your tax rate was 35% this quarter compared to 39%.

Is there anything going on?

Income tax rate.

You are looking at quarter to quarter?

Yes.

We had the benefits in 2006 of the Tax Act.

2004.

I'm sorry, 2005.

Of the Tax Act providing the credit for production assets.

That certainly lowered our effective tax rate for 2005 and previous years.

That was not spread evenly across the years, so you may see that having fluctuated from quarter to quarter.

Going forward, 39%, is that a fair assumption?

I would look more at the annual rate, for what is a reasonable rate going forward.

Same thing with the taxes other than income taxes, seem to have been slightly offline, is there anything there?

We operate in a couple of states in which all of our property is reflected in taxes other than income taxes.

The extent that we have significant capital additions in some of those jurisdictions tends to dramatically increase the taxes other than taxes that we pay.

That is why it goes up, it's a direct correlation to --

They are completely recoverable.

Some of those are state taxes, some are local.

And unfortunately, some local communities use us to gain taxes.

So it looks like they are getting taxes through the water bills versus levying new property taxes, however we recover them.

Unfortunately we recover of when we go in for our next rate case which could be six months, a year, a year and a half after they are initiated at the local level.

Those are always recoverable.

It just could be some lag.

Some states like Pennsylvania, allow you to true up taxes in between rate cases and that is very positive.

Some don't.

It is not one that if they go up sharply it can affect your next rate case but it is not going to -- It will be included in rates.

They very seldom don't allow whatever the tax code says you have to pay.

Income taxes have been up and down over the past couple years because we didn't do much in the R&D area.

Ours was more in the investment tax credit area with the pipes and so on.

That expired at the end of 2004.

That is why the difference, it was lower in 2004.

This was American Job Creation Act gave us some credits for the water production assets in 2005.

That will probably be one time, or are we still doing that?

It continues.

Thank you very much.

Next question is from Michael Albrecht of All Transic.

Morning.

I just had a quick question, you noted $0.025 to $0.03 in options flowing through.

What is the actual dollar amount?

I can back into it using my expectations.

We think it is three and the quarter, 3.25, 3.2 in the O&M area. $3.5 million in O&M and that only translates to 3 that the taxable line because you don't get tax reduction until people exercise the option.

3.5 is on the O&M but it flows to 3 because a tax reduction?

It didn't want you to take the normal 60% after taxes.

It is not that much.

You noted earlier in your comments just how you're going to be using more of your cash rather than issuing debt and I wanted to understand how that will go forward, do you plan to use that to trend down your cash a bit or how to use the that playing out?

Since I have been here over a decade and we never had a cash problem because we've always been investing more in our infrastructure that we bring in, so we are always borrowing money or floating stock.

As long as you float stock above book, it is actually accretive to the shareholder.

However, if you generate enough earnings and retain enough after you pay off dividends, you don't have to float stock for that piece.

You can use your own money versus floating all stock.

When we started this strategy we were almost 90% payout.

Our dividend was taking $0.09 out of every -- $0.90 out of every $1.00 of earnings until we only had $10 left out of $100 to put back in the Company.

That is when we started our policy of increasing earnings 10%, we increase the dividend 5% and that is how we were trying to bring the payout ratio down.

Over that 10 year period we cut the payout ratio down from over 90% down to between 55%, and 60% which is where the Board feels very comfortable.

That is why last year we gave a very hefty dividend, 10%.

At this point, let's take some examples, earnings are $90 million, if you pay out 55%, at least 45%, that is $40 million, five years ago we would have maybe $10 million.

That 40 is going to be put right back in the business to build pipes, install new pipes, new water plants that meet EPA rules, build new towers for pressure and so on, and because depreciation is our fastest-growing expense, because we're putting all of this new capital in and we are getting it depreciated to 2%, 2.5% level, not egregious by any means but when you're living off assets that were on your books for nothing and now you're replacing that tank at $2 million, 2%, that's all the sudden new depreciation.

I think our depreciation last year, 2005 over 2004 went up 12%, 13%, and that means it hits earnings.

But it's good news because we're generating cash so that we can build new things that are needed.

This year, 2004 -- 2005, 2006, and our budget goes up more rapidly.

Depreciation each year is taking a bigger chunk of our revenues, percentage wise.

That is not all bad because it is generating the cash we need so we don't have to borrow as much, which the ratepayer has to pay for it.

All in all, it is exactly what the regulated model is supposed to do, but is positive when you can get ahead of the curve, not pay out all of your earnings in dividends, which we have gotten to what we think is a reasonable split, between 50 - 60%, 55-60, and use the rest to rebuild the company without floating too much dilution.

That is why I said earlier our dilution factor is going to start dropping from than 3% level this year slowly going down to where some day we may not need cash.

I won't be here at that point because the water industries -- EPA is talking about billions of dollars over the next 20 years.

Some day it should be getting enough in depreciation to maintain your system at normal growth.

Thank you very much.

This concludes the question and answer portion of your conference.

I will turn the presentation back over to Mr. DeBenedictis for closing comments.

I appreciate everyone's time.

This was more complex of a conference call than normal.

But with all of the changes under Sarbanes-Oxley and everything, in order to true up your numbers, we wanted to make sure we are going through in our budgeting for 2006.

If you have any other calls to just feel free to call Dave, myself or Cheryl.

Thank you for your time.

Once again, ladies and gentlemen, thank you so much for your participation in today's conference.

This does conclude the presentation and you may now disconnect.

Have a great day.