Essential Utilities Inc (WTRG) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2006 Aqua America Earnings Conference Call.

My name is Lakisha, and I will be your coordinator for today.

At this time, all participants are in listen-only mode.

I will now like to turn the call over to Ms. Cheryl Hansen, Director of Investor Relations.

Please proceed, ma'am.

Thank you, Lakisha.

Good afternoon, everyone.

If you did not receive a copy of the press release today, you can find it by visiting the investor relations section of our Website, at www.aquaamerica.com, or by calling Brian Dingerdisson, at 610-645-1191.

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

As a reminder, some of the matters discussed during this 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 description of such risks and uncertainties.

Also during this call, reference may be made to certain non-GAAP financial measures.

Reconciliation of these non-GAAP to GAAP financial measures are posted in the investor relations section of our website.

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.

And good afternoon, everyone.

This is the first time we've actually done our earnings call after the close.

And we called some of our key analysts and asked them if it's disruptive.

Some of them actually said that they preferred it after the closed, versus during the morning, when we usually have it.

So I'll ask that maybe you give us some feedback again because I did this because of a personal scheduling conflict I had this morning.

So I'm anxious to get some feedback on which you prefer.

The earnings announcement, which went out on press release, is $0.13, net income of $16.6 million.

That actually meets our budget, but it's less than last year.

And last year we had a very good first and second quarter, double digit increases in both revenues, and up to 20% in net income, based on the fact that the comparisons of '05 versus '04 was the -- we had some strong rate cases that were carried into the first two quarters last year and also had the results of Heater and Florida Water, two fairly large acquisitions, which were purchased in mid-'04, which basically gave them a quarter over quarter comparison that was significant.

We didn't have that similar-type large acquisition this time as a matter.

And also, a lot of our revenue growth comes from rate cases.

And most of our rate cases, which I'll get into later, are back-end loaded this year.

So as we mentioned in an analyst call we had a couple weeks ago, we anticipate the second half of this year, versus last year when the first half of this year should be the one that grows faster than our normalized number that we usually tell our shareholders.

And you're seeing that in today's results.

Having said that, we're pleased that we had a $4 million increase in revenue, even with the fact that a lost of this is caused by regulatory lag, where the bigger revenue jump will come in the second, third, and fourth quarter, and start coming in a little bit in the second, which I'll get into later.

The term regulatory lag is something that is normal lingo with us, but some analysts -- especially as people who just follow us as one of their few utilities -- don't understand.

It just describes that soft-toothed type quarterly earnings over a year that occurred.

Most utilities, as they build up investment, which is what you earn on -- you have to pay for that investment along the way, and you don't get it back until you get an awarded rate case.

And if you don't have things like acquisition growth above the average, or ways to reduce costs, i.e., bring down the scale growth, or the timing of the case -- you don't get the revenue until after it comes in, and then you see a pop in earnings, and then it starts decaying again.

We've been very fortunate, because of the disks, surcharges, and our constant decrease in imbedded cost of debt -- which we're still seeing this quarter, because we're still taking long-term debt down into today's rates, which are still much lower than they were with our retiring debt.

And we've been able to make up most of that, also because of fast acquisition growth.

But when you start putting a quarter million a year into investment, it's very difficult to make that up with the other three factors.

And that's really the run rate we're looking at.

As we mentioned in the release, that comes to -- if you just take a look at the capital we put in over the last three years -- which is all coming to play in these rate cases coming at the end of the year -- that, I believe, is a 14% annual rate on what we can earn on it after depreciation, after contribution property.

It's the real earnings power we've been increasing at a compounded rate of 14% percent a year.

That's the half of the formula that we talk about as to how we grow revenues and through our rate cases.

And that's the inherent growth that we're investing in at this point, as we fix the pipes, and the valves, and everything else that is being asked to be done by the regulators and, of course, meeting new standards.

The other reason for the regulatory lag in this quarter, and a return to a -- I'll call it a modified soft-toothed type look.

Most utilities have much deeper down than [inaudible] jump up.

The other reason is the fact that in our two investments in '04 -- and actually a little bit of the remnants of our '03 investment, Aqua Source -- we inherited properties which needed a lot of work, environmentally and service wise, before we could gain approvals, and then go in for rates.

And I'll give you one example, which is a stark example.

We bought the -- in the Aqua Source Companies -- which would have been mid-'03.

And one of the facilities in Virginia that we bought, which we paid about 15 million for, when you look at what we bought the facilities from Ducane for -- excuse me, we paid about 8 million - with an operation Lake Monticello.

If any of you are Jefferson fans, this is where he reportedly had one of his homes.

And they called it Lake Monticello.

It's along the Rivanna River.

Well, the day we took it over, which happened to be Fourth of July, '03 -- I remember the date very well -- I got a call from the head of the Virginia Environmental Agency saying, "What are you going to do about this property that you just bought."

I said, "Well, we've owned it for about three hours, so let me take a look."

As it turns out, it was polluting the Rivanna River, the sludge had overflowed.

It was just a mess.

They slapped a fine on us which, eventually, the previous owner did pay, because we sued for it.

And we also got told that they were putting an immediate ban on all new building and this was one of our faster growing properties.

And third, but not least, they said that the builders that wanted to build houses there were going to sue us.

Other than that, it was a great Fourth of July.

What's happened since?

First of all, the building ban has been released because we've invested over $14 million.

The lake now has people swimming in it.

The lake had been polluted.

The Rivanna River has never had a discharge and has ever had a violation since.

All the fines were cleaned up and paid for by the previous owner.

The sludge has been cleared out.

And we've invested in a brand new, state-of-the-art plant with ultraviolet treatment that makes it one of the best plants in the state.

As a matter of fact, just last week, we got the award from the Virginia Department of Water, regarding our performance there.

So it took almost three years.

But, basically, the ban is off, the growth is starting to incur again after three years of very little growth.

The investments have all been made.

We're getting acknowledged by both the citizens who live there and the environmental agency for our work.

However, we've spent almost twice what we bought the operation for, which obviously means we're not earning our keep.

We filed a rate case about six months ago in anticipation of having it completed.

And to give you an idea of the scope of the rates, we're looking at asking for a 60% rate increase, year one, which we're in now; and a 40% on top of that or 30-some percent rate increase in year two.

So, really, you're looking at almost doubling your rates, which nobody likes.

Everybody likes their clean water, but when we look at what we're asking to ask for fair return on our investment, that's the kind of rate case we need.

We've been treated very fairly by the Virginia regulators.

And we have been able to put our first rate phase in place.

It just happened last month.

It's in bond, which means it's not final yet.

We may have to pay some of it back if the final ruling is different than what we put in.

But we're in discussions with the regulators.

And I think we are being acknowledged for being the kind of company who will make the investment up front, fix things, knowing that we'll get treated fairly.

Now, we could have gone in for a 100% rate increase right away.

But we decided, for rate purposes, it would be much better to transition it, and do it in a couple phases.

And I think that's appreciated by both the customers and by the regulators.

On the other hand, there's a limit as to how long you can wait, i.e., regulatory lag, to get there.

So this 14 million -- including the 8 million, which probably wasn't earning its keep, that we paid for the property when we bought it -- it has never earned a penny towards what we always talked about as our 4,7,10 plan.

It helped us with the 4, but it didn't help us much with the 7 and the 10.

However, later this year, all through next year, and then hopefully the following year, if we're given a fair phase two requirement, it will be helping.

And I can duplicate this with our Florida Water story.

We bought that in '04, a year later.

Florida Water, the 60-some operations we bought from them.

All had not been in for a rate case for over 10 years, some as much as 15 years.

Clearly, they weren't earning their keep.

It took us a year to get the final ruling from Florida Water on what they were allowed to earn on it at less than what they originally asked us to pay for.

So, last month, we received 1.6 million refund from Elite to put what we paid for these properties in line with what the regulators have said the rate base is.

So it ended up we paid roughly about $900-$950 a customer in rate base for these 16,000 or so customers.

Now, what's happened?

A lot of the rates aren't earning their keep, even on that lower rate base, because they haven't had rate increases, so operational costs have gone up for over 10 years.

The second thing is that some of the facilities immediately needed repair.

I'll think of one which, again, was another story like Monticello, where the people were upset.

They couldn't water their lawns, there weren't enough wells, there wasn't enough water supply.

We fixed all that.

We're now putting in a new wastewater plant, because the area is growing so rapidly.

And that's investing $4 or $5 million.

Here, again, none of that is being earned, yet, in rates.

Our plan in Florida, now that we are official and actually own the company, and we have an official rate base in Florida Water, is to merge that with our Aqua Source properties, which we bought a year earlier, and go in for a uniform type rate case.

The way we're going to do it in Florida, since it's a different regulatory process, is go county-by-county, and try and get rates by county.

Because some counties -- like Sarasota County, Citrus County, DeSoto County prefer to regulate you themselves, versus going through the PSC, which is the Public Service Commission.

The rest don't.

So we have to go through the Public Service Commission.

It's a little more work, but we think if we want to make sure we follow the rules that each county wants -- because that's who eventually pays the bills -- their citizens pay the bill.

But we're going to be filing a major rate case sometime this summer to recapture some of the Aqua Source facilities, and then all the Florida Water facilities, which have never earned their keep.

Roughly nine to 12 months, probably the process takes.

And then sometime in mid-'07 these numbers will start coming in.

And we'll hopefully start earning our full keep.

Some of these cases will be high also.

But we're very encouraged that the regulators are living up to the regulatory compact.

And although they may ask for phase-ins -- like they did in Texas, and like they did up in Illinois, where we got 150% increase over four years.

Here, they may ask for that also.

But we, at least, will start earning our keep.

And these are big numbers that come in.

Just the Sarasota case -- which we filed and are in final discussions with staff.

And staff, we believe, is going to recommend between $400 and $500 million increase in Sarasota -- $400,000 or $500,000.

I wish it was $400 or $500 million.

You can see that the system is starting to work.

We've been doing this for probably a hundred years in Pennsylvania.

The system is pretty consistent.

And in Illinois and others probably for 50 years.

This is the first time there will be a normalized process in many of these southern states where we're growing.

And you just don't do it overnight.

But it's starting to come about.

Now, the grandaddy of the regulatory lag, though, is Pennsylvania, where we probably spent almost 40% of that $250 million I expressed earlier.

A lot of pipe, a lot of new plants, meeting all the standards, although the rate increase needed in Pennsylvania was much less -- I think it was just a shade over 10% -- it still takes a while to go through the process.

A litigation case takes 11 months in Pennsylvania.

And we filed last November for that relief.

Yet, we're still building as we speak -- probably in the $10 to $12 million a month range.

And that has to be recovered.

The good news in Pennsylvania is, we have settled with all the parties who were protesting, and it's now before the judge.

And with a little good fortune, we feel it's a very fair settlement.

With a little good fortune, we may be able to start putting in rates a higher number, percentage wise, prior to the litigated time frame, which will be some time in, probably, September -- 11 months from November.

Hopefully this summer -- which will definitely help Q3, but maybe even the tail end of Q2, if we're very fortunate.

And those numbers will be in place earlier than normal.

And that will cut the regulatory lag in Pennsylvania.

In Illinois, add 4 million to that.

New Jersey, 4 million to that.

And you can see these are real numbers -- start adding up -- which will all be third and fourth quarter, and going into the first two quarters, and maybe the third quarter, of next year.

The other thing that I have to tell you we did not anticipate a year ago, when we were looking at our five-year plan, was the rapid rise in water production cost.

It just really hit us in the last two quarters.

If you look at our expense -- up 8%, which is a disappointment, because we usually keep them right around a little more than the inflation.

Two factors really hurt us this year.

One is, about 20% of that 8% -- or a percent-and-a-half, almost 2% -- comes from a non-cash expense, which is options.

The other comes from unexpected increase in three things -- chemicals.

Gasoline, which should be no surprise.

We drive a lot of miles in our trucks.

And the numbers were up over a dollar between quarters, per gallon, on charges.

I can't even put a percentage on that.

It's probably in the thirties.

And the other is chemicals.

A lot of them are petroleum derivatives.

So those were also up considerably.

The other non-cash item which I'd like to let Dave explain is how the accounting works for our Texas rate case.

We get the revenues.

But when the revenues go up, the deferral of expenses no longer occurs, which means it hits expense, even though it was already attributed to in the prior quarter.

So let me generalize, Dave.

And then maybe you can explain the specifics.

Because I don't think we've ever really explained it specifically.

It's been in the Q and K, and there's been very little questioning.

But I think when you see an 8% increase, which is not our norm, I want to explain.

If you take the eight, you're probably down to five, if you take two elements -- the stock option expenses, which is the heavy side of one-and-a-half to two; and then the Texas deferral expenses.

Then if you take the five that remains, over half of that increase came from the oil shock between our transportation, our chemicals, and our power costs which are going up.

Because, as you know, as natural gas goes up, and oil goes up, the power companies -- under the unregulated scheme -- can charge you more for the generation that's hitting us in most of the states, although it's starting to calm down now.

Dave, maybe you can explain the accounting, not cash one.

Sure.

Actually, the Texas rate case is a very innovative rate mechanism because it does two things.

It allows us to phase in, over four years, a 40% increase.

So four increases at 10% during that period.

But rather than most phase ins, which a company would bear the cost of, this one allows a company to achieve its goals in year one, by combining the 10% increase with expense deferrals to make up the other 30.

And those dynamics change over the four years to keep the company whole.

So, for example, in year two, when the second phase of the revenue increase hits, the expense deferral decreases by a similar amount.

So there's really no change to pre-tax income, as a result of phase two, to the Texas rate case.

So, in that instance, for example, in a year, although revenue went up a dollar, expenses also go up a dollar.

So the impact on our O&M ratio, for example, is fairly negative, because it's 100% attributable to that aspect of the Texas rate case.

And the impact on Q1 '06 expenditures was about a million dollars, simply related to the decrease in deferral in Texas.

So the good news, if you look at actual dollars of expenses in Texas, other than power, because Texas utilities went up a huge amount this year, other than power, our expenses are right in line, 2 or 3% over the prior year.

So the real cash expenses are right in line with where we were except for one element, power.

But the accounting deferral is the one that adds to it, based on the way the regulated operation in Texas works.

Let me explain.

I said earlier about -- we went in for large cases.

Texas was really almost a 40 or 50% rate increase.

Politically, it just would never happen.

On the other hand, 10% a year for the next four or five years was possible.

So the only way you can do that, from an accounting standpoint, is to -- I'll explain how that worked.

If the revenue -- 10% a year.

The real dollars are coming in, cash wise, 10% increments for the next four to five years -- or 45 it ends up with, because you get paid for the lag.

However, the non-cash charges -- you book it all the first year, and then you take the deferrals back at the [inaudible].

So it's complicated, but I wanted to explain it a little bit, and so on.

The other thing that I want to take a little time on is depreciation, because that is really rapidly growing.

Depreciation was up 15% percent.

So, once again, much more rapidly than all other expenses and/or revenues.

Now, for those who haven't followed the industry, usually people see what we spend -- $250 million -- and what we depreciate, $70 or $80 million -- and say, "My gosh, this is a terrible cash drain."

Once you get over that hurdle, and realize that's how we build wealth and how we build by doing the right thing by what the regulators want us to do -- is reinvest in the systems.

That actually is if your stock sells above book, and you capitalize it, is how you leverage earnings.

Now, part of that is that depreciation has to go up as your investing $250 million, and you're getting 2, 3% on your assets, not a very heavy depreciation rate.

So we're not robbing from the future right now.

This is real engineering, long, live study.

But the dollar figure is significant, because we started from such a low base.

So we went up almost 15% this year.

Now, what's different with a utility company versus a manufacturing company -- it's not lost forever.

Because what happens in our next rate case -- that 15% increase in depreciation gets locked in, you get the revenues from it, and it's absorbed.

So it's no longer a regulatory lag.

But you're actually getting paid for that extra depreciation in the revenue stream.

So as we continue to spend three times, four times the depreciation, and the number gets higher when we're spending $100 million a year.

The depreciation number wasn't as much a month, basically.

But now, if you have to wait 11 months on the depreciation factor, it becomes a little more significant.

So that will also be helped as we go on through the end of the year.

The good news there is, once you get it, it's always at that rate.

And we passed the -- we're closing in on $2 billion in rate base now.

So you can see the depreciation rate on that $2 billion starting to rise.

And we're getting more and more internally generated cash to continue to pay the needed capital investment going forward for the foreseeable future.

The EPA has recommended $250 million just for the water industry over the next 20 years.

And ours is a share of that.

So this will give us some internally generated cash, i.e., retained earnings that we can put right back in, versus continuing to have to sell new equity to do the same thing that we've been doing with building shareholder value.

One piece of good news we threw in -- we passed all our tests with the accountants.

We actually didn't pay as much this year in audit fees as we paid last year.

But, still, it's a phenomenal amount of money for Sarbanes-Oxley compliance.

But I guess if we had spent all that money and didn't pass, it would be a harder thing to say.

So we got a good ruling.

And Dave's team deserves a lot of credit for very few of the controls that they checked into, that they didn't like exactly what was going in.

We had no material weaknesses, and we had no -- an unqualified opinion on our books that closed a month ago, mid-March, when we sent all that out.

So I think that covers most of the explanation I wanted to give you from a standpoint of where we are.

Acquisitions continue.

We did seven in the first quarter.

Last year, I think we hit a record 30.

So if you want to extrapolate, I guess we're on mark to get between 25 and 30 this year.

But I really think that it's not the numbers as much as the quality.

And we have one that we closed the first quarter up in the fast-growing area of the Poconos that we're very pleased with, Masthope.

That's a fast-growing community of North Jersey, New York people moving into Pennsylvania for year-round.

And that's growing pretty rapidly.

And we're doing one in Texas.

As soon as we get the final word from the PUC, and I think that should be in a week or so.

It's a reasonable size we're going to announce.

We're working on one that has been publicly announced, although we haven't announced it to the investor community because it's not finalized yet -- but a major development outside of Washington, D.C., in Virginia.

It's an hour from Washington, D.C., which believe it or not is now a suburb called Lake Holiday.

And we did publicly announce -- although we haven't gotten final approval from the commission yet -- a fast-growing town along -- right near where the third airport is going to be in Illinois, Manteno -- which has agreed to sell us their system.

It's about 3,500 to 4,000 customers.

We're working on two or three other nice ones that we'll announce when we have the chance.

And I did mention the analyst briefing.

And I hope to have one of these ready to announce in a week or so.

That's the small, little, wastewater, unregulated businesses for septage.

And septage is septic tank waste that has to be cleaned out periodically.

And we're starting in Pennsylvania to see if we can make a success of this.

And then if it is, we plan to do it elsewhere in the country wherever we have our water/wastewater systems.

So I'm pretty optimistic with our pipeline on the acquisition front.

And, of course, all of these are needed so that '07 and '08 look good because these all take six months, nine months to close.

You have to fix them.

Then you go in for rates [inaudible].

I'll open it up for any questions you may have.

[OPERATOR INSTRUCTIONS]

Michael Albrit, Altrinsic.

Good evening.

I just had a quick question regarding -- in the press release, and on the conference call, you talked about some of the cost pressures due to the higher oil price.

And you note in the press release that some of these, you believe, are in one part due to the regulatory lag.

And then it seems also the possibility of passing some of these during recovering in rate cases.

Are you referring to those costs that are associated with the oil?

I'm just trying to understand if regulators typically -- given that it's a bit more variable over time -- if they're willing to imply some give-back there, given the extreme high of oil at present.

Michael, the answer is yes.

That is absolutely part of the regulatory lag, because they don't give you forward-looking for expenses.

They give you what you actually spent in the year you filed the case.

So you really have to go in and ask for an amendment in the case, during the settlement discussions, or wait until the next time you file to get it back.

But once you're approved in your case, then you would get the new, higher figure.

So most operating expenses have been pretty stable over our last two or three rate cases in our older states of Pennsylvania and New Jersey.

But this happened in the '70s, when oil prices were driving electric prices.

Because a lot of our electric companies, believe it or not, still burned oil.

And what happened was the commissions actually started giving fuel cost adjustments.

And, therefore, you could go in and get your fuel without going in for a full rate case.

We've gotten, in a couple of our states, what we call index filings for expenses.

As a matter of fact, in Florida, ever year, you can go in and get a couple percent just because prices went up.

Even if you don't file for your investment, you get your expenses.

And that's a very good feature.

Obviously, when you're spending, like we're spending on investment, it gets dwarfed by the regulatory lag of -- two times what you paid for the property and the vesting.

But once we get our full earning on our systems, which are all now fixed, the kind of growth you'll get in new customers to compensate for inflation -- then there's also this factor that you can go in for index filings.

So it's a long-winded way of saying yes, we'll get it back.

It won't come back until we get the final rulings, which aren't for another three to six months.

And we're looking -- it looks like this is not just a six-month blip in the price of oil, and it doesn't hover in here since transportation is such a big part of our product, and power -- we're probably one of the largest power users in any industry, in each of the territories of the franchise electric companies.

And we'll probably look for some kind of relief there.

And then, just quickly, secondly -- in the past, you talked about your targets for O&M expenses.

And, obviously, as you've spoken on the year end last year, as well as this quarter, there's some new things in there, such as stock options expense.

Can you just talk about what you, going forward, think is your target internally, how you think about the new O&M, and what that sort of new target -- when you sort of take into account these new expenses on a run rate?

Sure.

I still think, including all these non-cash expenses -- the one Dave just mentioned, which is probably over $1 million a year -- probably up a half-a-percent on our O&M -- the Texas.

Do you have a number?

The Texas was almost a million dollars for the quarter.

Just for the quarter.

And then the option expense, which is going to be $3 million or more, this year that -- again, it's non-cash.

But it goes in the expense column.

Sure.

And until we get the revenue stream increasing into double digits, when you get your rate cases coming in, in the 3Q, 4Q, you're going to see the O&M to revenue ratio probably hurt the first two quarters and then look real good in the next two.

Last year, I think we ended the year at 40.9.

I'm hoping that even with these non-cash charges, we can hit that, or we can do a little better.

But if you would give credit for Texas as an accounting "anomaly," and the stock options, which is -- once it's in, it's in.

We don't expect them to keep going up.

It's this year, and that's it.

That probably gets you closer down to the 40 or so percent that we were projecting on an operating basis.

And then, after that -- we still think we're going to take this thing down 50 to 100 basis points a year.

I'm not backing off of that trend that we're going to see that O&M ratio continues to go down.

The blip is the option expense this year.

But once that's billed in, you just have a new, higher base, because it's always going to be in there.

And then the oil -- I have to tell you why I didn't figure in our numbers this year.

Thank you.

Hike Door, Janney Montgomery.

Hi.

Two quick questions on the regulatory front.

Nick, thank you for the update on Pennsylvania.

I was wondering if we could get an update on New Jersey and Illinois.

We heard talk that New Jersey might be fully litigated.

So we were wondering what kind of timing you were seeing there.

And, second, in Texas, is this one-to-one flow through that you're seeing for the next couple of years only because this one rate increase was so high, or is that a trend you expect to continue?

Let me start with New Jersey.

New Jersey, supposedly -- and this is all rumor -- wants to start litigating cases again, which is really not the norm.

Most commissions like settled cases.

If you can get all the parties to settle -- but, for some reason, the rumor is that even if you can settle a case, they're going to want to litigate it.

And the way I'd answer that is, if you can settle a case, your case is pretty clean.

So, therefore, going full litigation is just more timing and more expense for lawyers.

But you'll get, eventually, what you were supposed to get anyhow.

And when you settle, usually, present value [inaudible] anyhow, what you think you're going to get.

So if we have to fully litigate, we probably won't get a ruling until September.

And if we settle, maybe it's August.

So it's not the end of the world.

But in the same sense, we think we have a pretty clean case.

And we're very comfortable with what we submitted, even though it's in the teens -- I think is what we asked for.

But I'm sure there will be some slight argument over our ROE request, which was about 12%.

New Jersey hasn't given the 12% ROEs.

But we think we'll get treated fairly, and there will still be a significant increase.

And Illinois?

Illinois has always been very -- if you hit their number, and it makes -- if you ask for a 25% rate increase, and the number you deserve under their rules -- i.e. what they think ROE is -- which is currently in the -- I think the last one was 10.4 in Illinois.

They'll give you 22 percent.

As you know, in some states, there's a little bit of a barrier to giving close to what you ask for.

Illinois doesn't have that barrier, but they have very, very detailed requirements that the staff ask for.

And it's exactly 11 months to the day.

And very seldom do they settle.

And it usually goes full litigation, and so on.

But we've been treated pretty well.

And, just as a matter of fact, in the last year -- actually this year -- we filed them last year.

This year, we've got two small cases.

In one, we asked for a 62% rate increase, and we ended up with 55%.

That's not bad.

And the other one was similar on that.

I think it was 50.

So they're not adverse to giving you what you deserve, even if it's a huge rate increase.

And what's the timing for that?

When is the 11 months over?

Well, in Illinois, we just filed for the quips, which was filed.

And we're already receiving that.

That's about a 2.5% increase that will flow through in Q3, 4, and 5.

And that's statewide, because we also filed one in Vermillion.

About a month-and-a-half ago, we filed a case in our biggest division there, Kankakee.

And I think the request was over 25%.

Well, it was close to 25%.

And 3.4 million is what we're asking.

I would anticipate that will take the full 11 months.

So probably any effect this year will be minimal, if at all.

And it will come in January or February next year.

And Texas, is that a one-time?

Texas, we got the full rate increase, under bond.

Remember, this is one where you get it, you start charging for it, but it's subject to final approval, which we haven't received yet.

It took Aqua Source almost 3-1/2 years to get their case.

We're in our second year now of testimony and everything else.

They do a very, obviously, thorough job.

But we anticipate Q3 this year, at worst Q4, getting a final ruling, at which point we know if we bonded and reserved the right amounts, and so on.

And I'm pretty comfortable we're doing the right thing.

However, the commission could say, after three years, we want to start over again.

It could be that disastrous.

I doubt that would be the case, because there's never been any indication that there's anything but -- they agree with what we're doing.

Here's another state where we had a consent decree, which was about 120 items long.

We're down to getting full relief, because we've been spending about $30 million to fix all these problems that were left to us by Aqua Source.

So I think there's no way the same agency that regulates rates, TCEQ, won't recognize that we fixed everything they wanted us to fix, which is the same agency.

But I wanted to give you the worst case.

Now, Dave can explain how the rate mechanism is booked, accounting wise.

The cash comes in over five years -- 10, 10, 10, 10, 10.

The expense deferral is the part that accounted for all the gain in the first year, right?

Well, three-quarters of it.

The first year was about a quarter revenue and three-quarters expense deferral.

And that gets tweaked.

Every time there's an increase in the billing, the expense deferral goes down by that amount so that your pre-tax income is consistent.

So our O&M ratio is adversely affected in Texas, even though it's not new expense the next three years.

Sure.

When you compare to last year, it looks like expenses went up by that million dollars, but really it was a decline in deferral.

Right.

Now, the good news is we're going 6 or 7% in Texas.

And that's good news because even with these rates, which are pretty high compared to the Northeast, I think the rates in Texas are closing in on $60 a month for water bills.

So it's not insignificant.

But the growth is pretty phenomenal in Texas and in North Carolina.

Great.

Thanks so much for the clarification.

Okay.

Kevin Monroe, Thomas Weisel.

Good Afternoon.

Hi, Kevin.

How are you?

Good.

I was just wondering if you could -- of the 4 million increase in revenue, how much is from rates, how much from volume, and how much from acquisitions acquired in the last 12 months or so?

Almost the entire amount was from rates and acquisitions.

Our acquisition -- I'd say the rate -- about half and half, Dave?

A little heavier on the rate side.

Okay.

Which were the surcharges that were coming in, and maybe a couple of these small cases I mentioned.

We have not had a big acquisition, although we had 30 last year.

The total customer growth, as a result, is I think just shy of 3.5, 3.6, or something like that.

So it's a good year, but not a blowout year.

We had had those 20% and 18%.

This year, if we get a couple of the ones that we're working on, and can close them by the end of the year, whether we close in December or January, makes a significant difference in the year-end numbers, but not really in the long scheme of things.

I think we're looking at more significant growth, which would get us back into making up for that one year of lag.

So it is respectable, and that's where we got a lot of it.

Consumption was not good the first quarter.

And I don't know why.

It's usually not a big quarter for us anyhow, because it's the winter.

And I don't know whether warm weather, cold weather -- one rumor is, if you have cold, cold weather, people leave their faucets on to keep their pipes from breaking.

And I don't know if that's true or not, but if they do, they use more water.

And if you don't have as much -- we didn't have as many breaks.

I know that was good news.

The system didn't get abused as much, because the weather was a little warmer.

But consumption added very little if any to our numbers.

And that basically came in the Northeast.

In the South, it did, because we are continuing to grow.

And we had some dry weather in, I think, Florida.

But in the Northeast and across the Midwest, it was pretty flat to down.

Thank you.

Selman Akyol, Stifel Nicolaus.

Thanks.

Good afternoon.

Was there anything in the tax rate at all?

It went up slightly from the prior years.

I was just wondering.

That's interesting.

That's the options.

Why don't you explain that, Dave?

It's almost entirely related to options, because they come with a very low tax deductible rate.

It's 20%, low 20s.

So when you merge in that low rate with our previous 39% effective rate, it winds up moving the whole effective rate up to 40.

That was another hit on the net income.

Although our imbedded cost of debt is still down year-over-year -- we're in the mid 5's now -- interest expense was up I think 10%, 11%, because we're borrowing so much money to carry these investments.

And we're not getting that back in rates yet.

As soon as we get it back -- one way of correcting the lag is slow down spending.

But I'm not sure that's what we want to do for the long-term health of the Company, and the long-term health of our systems.

So, unfortunately, with this kind of volume, we're into a little bit of a soft-tooth this year.

But next year's comparisons will look pretty good, quarter-to-quarter in the first and second quarter.

All right, thanks.

Michael Boggler, Brean Murray, Carret and Company.

Good evening, everyone.

Hi, Michael.

Nick, just one quick question.

I didn't see anything mentioned in your discussion on operating expenses in your press release regarded to infrastructure costs.

I know you consumer a fair amount of pipe and valves, and a lot of the produces of pipes and valves are seeing increased scrap iron costs.

And I was wondering if you're starting to see any price pressure pushing up from the manufacturers?

Actually not.

It's interesting.

I asked that question the other day, Michael.

Of course, that's all capitalized for us.

Right.

So that's in that quarter billion, not in the $200 million of operating expenses.

Our meters actually went down because of the volume that we spitted out again.

Our pipe work -- I can only go by Pennsylvania, where I tracked some of the bigger bids -- are actually coming in under our estimates.

But I think it's because there's so many -- there's less work in the electric and gas being done because they're not spending as much, I guess.

So we're getting a lot of new contractors who never even looked at the water business bidding on our stuff.

And, of course, when you have seven, eight, nine people bidding, versus three or four, you get sharper pencils.

And I don't know if it's coming all out of the labor side, or if it's coming out of the pipe side.

I would imagine it's coming out of the labor side.

I'll have to ask and get back to you on that, as to whether pipe prices have gone up, because the contractor buys the pipe.

We monitor it.

So I can get you that number.

And valves, also -- hydrants would be the other thing.

I'll get you that.

And I know you're probably one of the companies that does Mueller Hydrants.

I'll check if hydrants are up on our bidding.

All right.

I appreciate it, Nick.

But you're right, metal is up too.

So I assume they're composite's up.

All right.

That's all I had.

Thanks.

[OPERATOR INSTRUCTIONS]

Debra Coy, Stanford Washington Research.

Good afternoon, guys.

Hi, Debra.

Just a question on cash flow.

Nick, it seems with some of these -- certainly the stock option item and the Texas accounting -- that the focus on cash flow, perhaps versus the O&M ratio and actual GAAP earnings will become more important.

You guys don't report that until you publish the Q, so I can't see the number.

Would this imply that cash flow is, in fact -- operating cash flow is the same as last year, and that you're still continuing to grow cash flow because the higher costs are at least partially non-cash?

As you know, we don't look at -- at least I don't track it on a daily basis.

Well, no.

I know.

And, typically, we haven't historically for you, but I'm wondering if it's a number we should be paying more attention to.

That's a good one.

We'll get back to you.

I don't have it right here handy, because I very seldom get questions on the actual cash flow versus overall investment over depreciation.

That's how we usually do it.

I'll get back to you on that.

I think we are going to be generating -- we are definitely internally generating a higher percentage of our capital needs internally.

So in that sense, I'd have to say it's positive.

But I don't know what this year's numbers were exactly.

The first quarter is always a little bit odd, because at the end of the year, we accrue a bunch of our CapEx to get those final projects into the year's budget.

And then we wind up paying those bills in Q1.

So Q1 is always a little bit odd from the standpoint of payments, because we're bringing down accounts payable.

Oh, I see.

Okay.

But you know what's going to be interesting -- and Debra's question is very insightful -- when we look at Q3 and Q4, you're going to both be covering -- the depreciation is higher, so the new cash is coming in at a higher rate, which has to be positive for cash flow.

We will track it and get back to you, and give you ideas on --

That's just my general thought process, not even so much on this quarter, per se, but whether we're just trending for a period where operating cash flow is going to be a clearly improving metric for you.

Our EBIT and our EBITDA are still pretty strong in the 60's or high 50's.

All right.

Well [inaudible] obviously partly captures that, as well.

So the higher we get our revenues, the more EBITDA we're going to be coming in.

It's pretty steady.

I mean, it dropped after we bought Aqua Source, because Aqua Source had polluted the Florida water and all that -- because it had higher operating expenses that we're finally getting to.

And other that the oil price, I would have been a lot more pleased with this year's numbers if oil hadn't gone up.

We drive a lot of miles in the South, because the systems are far apart.

We're still in the high fifties there?

52.5.

We've been in the low to mid-50's for some time.

Okay.

Great.

So we'll continue to talk about that.

Yes.

My other question is -- I know you did talk about this when we had the analyst meeting just a couple of weeks ago.

And then you mentioned that you -- sounds like you closed another acquisition on the septic side.

Can you just talk a little bit more about what you're seeing, in terms of the growth opportunities there?

You threw out a pretty big number, in terms of potentially where your revenue could grow on the wastewater side, both on the management side and the septic hauling side.

How big of a focus is that on the acquisition side?

Just looking even over the next 12 months, where do you see your opportunities on wastewater?

I'd like to divide.

I think one of the questions at the analyst meeting was, what's your wastewater now?

Where do you think it will go?

Right.

And when we started, we said, we're going to tiptoe into it.

This was five years ago.

We think we may eventually get the 5%.

Well, we're already at 9 or 10% right now.

And I said, I think, at that meeting that I could see us getting to 20, 25%.

And the reason is, I don't see federal grants occurring.

I see more construction, external like small systems, which cities don't want to chase anyhow.

So if we could get in on the ground floor, especially in the South -- we do not only water, but we do water and sewer.

And that's where I meant on wastewater.

I would argue that the septage, although there's a direct link, it has to go to a sewer plant eventually.

And it's the same regulator looking at it.

Since it's unregulated by the economic regulators, I was looking at that completely separate.

I'd say that's a regional business.

It's all a matter of if you have the management team and the trucks, as long as you have the systems in place.

And we are only building it up right now along Philadelphia, although we're already starting to do exploration into what other divisional areas have those markets.

And the regulations in that area are very light at this point.

I think there's going to be some -- and obviously we'll be encouraging it -- much more stringent regulations.

You have to have your tank inspected once a year.

You have to have your tank cleaned out once a year, and so on.

Some people go three, four, five years, ruin the tank, and then start having their back yard a problem.

And then it ruins the neighborhood.

So I think there's a real reason to do that.

At which point, obviously, if you're the biggest one in the area, you'll pick up a little more business.

I can't say we've-- I can announce our second one, but it's close.

And I think there will be a couple more right after that.

These are all small deals, so they're not going to make the New York Times, or the Wall Street Journal.

But there's only 12 in the greater Philadelphia area who operate.

So when you get to the point where you basically have five, or six, or seven under one roof, it gives you some economy scale and, obviously, maybe even some pricing power.

So I think it's a great business.

I've been bugging our guys to get into it for five years.

It's not a very appealing thing to talk about at a cocktail party.

It's the kind of business you're in.

But, yes, we're seeing margins --

Dave, what were the margins?

28% to 30%.

28% to 30%.

Okay.

Thank you.

Now that's pre-tax.

It's 28 pre-tax.

[OPERATOR INSTRUCTIONS]

There are no further questions at this time.

I will hand it back over to Ms. Cheryl Hansen.

Please proceed ma'am.

I guess we'll just close out the call.

Thank you for joining us.

Ask for feedback as to whether people like it after the close or before.

Please let me know if you have any issues with the call timing.

And I look forward to hearing from you.

Thank you, everyone.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.