Essential Utilities Inc (WTRG) 2006 Q2 法說會逐字稿

Please stand by.

We're about to begin.

We do thank you for standing by and welcome today's Aqua America second quarter earnings conference call.

Today's call is being recorded.

Now, at this time, I'd to turn the conference over to Cheryl Hanson.

Ms. Hanson, please go ahead.

Good morning, everyone, and thank you for joining us.

If you did not receive a copy of the press release, you can find it by visiting the Investor Relations section of our website at www.aquaamerica.com or you may call [Christopher Purchel] at 610-645-1020.

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 a description of such risks and uncertainties.

During the course of 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 the Company's website.

At this time, I'd 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 morning, everyone.

This is the first earnings conference call in over a decade where Dave Schanzer is not with us.

I'd just to ask just a moment for to recognize his passing and all he did for the water industry.

Thank you very much.

We had reported this morning $0.17 for the quarter, a little better than, I think, the estimates, mainly because of we had very strong send-out in our southern states that more than made up for some weakness due to weather in the northern and mid-Atlantic states.

It's been a strange weather pattern.

Let's just take Texas, for example.

Houston, we've had flooding, and there's possible drought warnings in Austin, less than 100 miles away, so -- and we saw flooding here in Pennsylvania, which fortunately did not affect any of our plants.

Our plants are all flood-proofed, and even with the -- what you saw on CNN, they didn't hit any of our plants, even though our plants are along those same rivers.

And now we're experiencing a heat wave, which of course, to the water industry is pretty good.

But all in all, weather is always short-term, and I think we encourage investors in our stock to really look at our long-term model, which I now believe, after a blip in the first quarter and not a traditionally strong second quarter, is now back in place due to a couple things.

And I want to go over those with you today.

First of all, we had over five-year planning session with our Board yesterday.

Every August we do strategic planning with the Board, and we look at a five-year projection of management and where we want to be and so on.

We announced two new Directors yesterday.

One is Ellen Ruff, who's the President of Duke Carolinas, which gives us geographic diversity from a standpoint of the South being one of our fastest growing areas, and North Carolina being our largest state in the South.

And then Andrew Sordoni, who comes from Scranton-area of Pennsylvania, where we've been growing quite a bit recently and does business in New York and New Jersey, where -- are two of other states that we are making major investments in.

Both have utility experience.

Both have been CEOs of their own companies, and both have, obviously, former board experience, so we're very pleased to have them on.

They added a lot at their very first meeting, and it fills in the Board back to where we like to be, about nine, after the retirements of two or three Directors over the past couple years.

As a result of the projections, the Board approved yesterday a dividend increase.

It's the eighth year in a row that we've done better than our 5% guidance that we predict in our 4/7/10/5 model -- 4% customer growth, 7% revenue growth, 10% net income growth, and 5% dividend growth.

It's the fifteenth dividend increase in 16 years and the -- bringing it up to a $0.115 cents, which rounds it off to an even number after -- $0.46 for the year -- after last year's split affected stock.

It ends up being about an 8% increase, but the Board also asked that we move it up to September payment versus December payment, which means it will be a big jump if you want to look quarter-to-quarter '05 to '06 in the projected dividend on September 1.

It's actually 17% for that one payment period, and then it goes back to the 8% after that.

So we're very pleased, and it's something that we feel very strongly about.

We're right in our targeted area of 55% to 60%.

We're in the upper end of that range, and it's something I think our retail investors, especially, but also now many institutional investors, are looking for is growth in the dividend.

The other nature of the long-term model, though, of our Company is, of course, to keeping the above-average growth coming in in customer count.

And during the quarter, we announced the New York Water Acquisition, which will be immediately accretive.

It'll be a platform-builder in a very healthy area of New York, Long Island, and we are very pleased with the reception we've received to-date from the New York PSC, the Public Service Commission.

They've already published it into -- in the -- water into the -- into their documentation.

I don't want to say -- call it public notice documentation.

And we're anticipating being able to answer all of the many questions they're asking us in an affirmative way and hopefully have this closed by the end of the year.

We also have two municipal governments, both of reasonable size -- 3,500 customers.

That's about 10,000 people each -- one being in Illinois, one being in Ohio.

The Illinois one is currently going through the PUC ICC in Illinois approval process.

We think that we'll close sometime early next year.

It should be approved by the commission sometime maybe late this year, but it will be within a month of the end of the year or early next year.

But it'll be a nice match to our Kankakee operation and fill that out.

In Campbell, Ohio, which is a tuck-in to our Struthers division there, the mayor has offered to transact with us for us running and then buying, over time, that plant -- a unique financing scheme.

A couple people complained about it, asked that a referendum be held, and the mayor has agreed to that.

And we anticipate sometime in October, November, that vote being taken, and if it's affirmative, as the mayor thinks it will be, we'll close that by the end of the year.

Also the South, in addition to much more healthy organic growth in the 5%, 4% to 5 % range versus the rest of the country that we serve in, which is more in the 1% to 2% range.

The South is starting to kick in with, on top of that organic growth, some acquisitions.

We announced two in Texas already this year, one just a couple weeks ago -- a good county, which was about 2,200 customers.

And Virginia, we're expecting, too, this year, so they'll start kicking in with acquisitions of reasonable size -- 1,000 customers, 2,000 customers.

And in North Carolina, you'll see a continual stream of small announcements.

These are the small troubled companies that North Carolina has asked us to pick up, which they actually are allowing us to earn back some of the acquisition premium we paid for the Heater properties.

So it's a good deal for the state, good deal for the customers, who have now lack of good service, and good deal for our shareholders, because we get to earn back the premium that's now sitting as goodwill, and we'll be able to earn rate based on that.

The other story, although we don't announce all these, we expect 20 to 30 developer deals, if you want to call them, where we get a new franchise, where the developer puts the water and sewer in.

We put the well in, and then as it grows to 2, 300 customers, they all come in at our rates without any kind of rate proceeding or whatever.

And North Carolina has really -- we've become the water provider of choice in North Carolina, which is very, very rewarding, since we've only been there really four years.

We're also continuing our movement into the septage business.

Septage is what's -- the material that in a septic tank, where people don't have public wastewater service but have their own backyard septic system.

And these companies also do interesting niche products, like porta toilets and taking out greasetraps in restaurants chains and things of that sort, and it's an interesting business.

We use septage haulers because of our own plants, and we decided to look and see if we could -- to get into this business.

And it's been very successful.

We've only done it in one area so far, which is southeast Pennsylvania.

We want to make sure we know what we're doing, and we can do a good job.

It's basically dominated by mom-and-pops, so very similar to what we do with that water business.

There's no national chains that we know of that do this type of work, and so far we're up to about 2% of our revenues, so it's not insignificant.

And we think we could possibly grow this to maybe double that over the next couple years.

We did announce one on Monday, which wouldn't be in this quarter, which is a pretty large one -- paid $5.5 million for it.

Perna, which is the name of the gentleman who owned the business -- 50 trucks, 50 drivers, so it's not insignificant size.

And this will be merged with a small one we did about a month ago, Leary and Higgins, with the one we did a year ago, which is doing very well.

If we can replicate how we're doing after one year in this business, your gross margin -- this is not the same as the utility where it's heavy asset investment and heavy interest coverage and, therefore, the O&M to revenue ratio being in the 30s and 40s.

And this is a business where the operating, let's call it operating ratio, you're EBITDA to revenue is probably 85%.

It's -- I'm sorry, 15% -- much lower than our normal 50, 60%.

And so your gross margins are maybe 15 to 20 or you get about 7 to 10 that falls to the bottom line.

It's a cash generator.

There's no investment needed to be ongoing.

It's just making you're buying out of your depreciation the next truck you need, and it's a management issue.

But it's a directly-related business with what our wastewater people do right now.

So we're excited about it, and we'll keep you posted on it.

Revenue, other than the weather, is obviously done by our rates and growth -- long-term growth.

Once you get an acquisition, it stays with you forever.

And we saw the second quarter back to our traditional goal of 7%.

Unfortunately, the first quarter was not that, and therefore, first six months we only grew revenues 5%.

We anticipate Q3 and Q4 beating our normal 7% goal, and actually, if we take the whole year, we think we'll beat that 7%.

So you can see a lot of revenue growth in three and four.

And I think we're very comfortable with the guidance we gave a couple months ago that with the rate cases kicking in now and with the growth pretty much coming home to roost, assuming we get the developer systems and the small systems in place, that we are very confident we can.

We think we'll meet or exceed the 10% EPS guidance we gave you through the second half, in the next two quarters, contingent upon weather.

I mean, if we a terrible summer, that affects us all.

But everything else being normal, we should be okay.

The -- let me talk a little bit about the rates, because that's what was causing the lag, which I think gave us the first quarter in a long time where we were actually down, which was Q1.

Now, of course, we're stable in Q2, and we're going to see an up in Q3 and Q4.

The -- what I'll call our most risk in our rates planned for this year, which I announced to you at the beginning of the year and then updated to you on the May call, was Pennsylvania.

And we did receive that order.

We received it earlier than anticipated.

We received $25 million, which is an annualized amount.

It went into effect June 22, so it had very little effect on the second quarter -- six days or so.

But it will affect the third quarter, and we anticipate filing our first [disk] in Pennsylvania, which is the part that goes into a pipe and avoids your regulatory lag, probably in Q4 and that will be almost $0.75 million annualized run rate.

And I'll get back to the capital needs in Pennsylvania and how comfortable we are that we're achieving what we promised the commissioners and of course, our customers.

We're starting to see some rate cases come in in the South, and other than spending money and having very rapid growth, organic growth, and now kicking with some acquisition growth, the story in the South is also going to be complemented going forward, as to getting the returns on equity of the money we've invested, a huge amount of investment in capital to get the environmental requirements done, to start kicking in.

And we have some proof of that come -- starting to come through on the validation.

If you look at our returns on equity in our northern states, they range from 7% to 11%.

When you're in for a rate case, get it, and usually you can do very well.

Then the year or two or three that you're out, excuse me, the lag occurs, and you start dropping your return on equities into the 7, 8 range.

So we like to keep it higher.

The South -- our returns on equity imputed into the South using the same 50/50 model we give you, because we paid almost all equity for the South [Florida parent].

But if we equalize it with how we fund the North, we're looking at returns in the low single-digits.

In North Carolina, it's below 5 at this point, so -- and in Florida, it's almost non-existent.

Now, Texas, where we have a rate case that was awarded already and is being phased in, we're at 10%.

So with North Carolina, Florida, we major cases that we're looking at to get our fair return on the assets that we've been investing in those states.

We did get a $400,000 award just this month in Sarasota, where we put over $5 million into fixing that plant, meeting all the standards now, no more consent decrees with the environmental agencies.

And we have another rate case coming forward in Sarasota after we regroup and see how much we've spent.

The Monticello, where we recently won an environmental award for all the work we've done in cleaning up the lake after we were being sued when we started after Aqua Sewer's purchase, we spent over $10 million.

We've gone in for a two-step rate increase, and we are in the final stages of a settlement that looks like we will get about a 60% rate increase, step one, and another 30% in step two.

And that's a huge rate increase, but in fairness to the Virginia regulators, they know that we've invested the money, and the formula works out for that kind of rate increase.

And we were treated fairly, and I think that's important to see that we're starting to get treated fairly by the southern regulators.

If we put the money in and do the fixing, they're not afraid of giving you what is a fair award.

Now, obviously there's a -- we almost have a little bit of a rate factory now.

Every state, we're always somewhere in the rate process -- either a filing for the surcharges or for a major rate case.

In June, we received four awards in Maine, worth about $0.5 million-plus.

In Ohio, we filed with SIC earlier in the year, and we're earning $300,000 on that.

SIC is the surcharge name in Ohio.

And the Struthers division, which is one of our three big divisions, got a 5% rate increase, and that's worth about $400,000.

That was locally negotiated, and we get that every year for the next two years.

So it would be $500,000 -- $400,000, another $400,000, another $400,000.

In Missouri, we're negotiating.

Unfortunately, it was a 100% rate increase request.

We're negotiating now with the regulators.

It will be somewhat less than that, but we hope to come out with a result in Missouri within the next month or two.

And in Florida we're preparing to file a major case of over $3 million for the Florida Water properties that we were granted about two months ago.

And the rate base on those that we're using for this rate case actually came in less than what we paid -- I'm sorry, more than what we paid the Florida Water people, but it's justified by the commission.

So that means it helps our customers and helps our Company.

The Texas case, which we were awarded under bond two years ago and was phased in over a four-year period, we hope, after two-and-a-half years, we've answered all the questions, all the settlements of each of the parties, and we're down to one or two parties that have to be settled with or it goes to final decision by the judge.

A hearing starts the 17th of August, so we're very hopeful by the end of the year we will have clarity in that issue, where right now, it's still under bond.

And we have two major cases, New Jersey where we're in -- this fall expect an award either an award, either litigated or settled, of our $4 million request.

And Kankakee where we're around $3 million, we're in the rebuttal stage, and so that should be -- with the ICC, and that should come home to either settle or litigate in sometime in February of next year.

So you can see, we're very busy trying to keep the regulatory lag away, but when we were spending $0.25 billion a year, it's very difficult to time the cases to the day.

And in some cases, with interest -- short-term interest rates rising, it just accentuates the fact that you don't collect that back until your next case, but you do get it back.

And that's what's happened in this last year with short-term interest rates -- hopefully now peaking, but we've had to absorb all that under something called AFUDC, and you don't get that back until the following rate case in your returns.

The other thing with the capital, spending this kind of capital, and the kind of increase in capital each year that we're spending, which is in the 10%, 12% range, that corresponding amount of depreciation expense has to be absorbed.

You get -- again, get that back in rates, but -- and generate the cash for future.

But when you replace 100-year-old pipe that's on your books for $1, with a $110-a-foot pipe that gets depreciated, you can see how depreciation has to grow as you're renewing your system.

And that's a healthy thing, and it is showing that we're going to be generating a lot more cash going forward.

The one area that is, I think, disappointing -- and we're very careful on this.

We track it every quarter -- is expenses.

Expenses went up 9% this quarter.

But when we take two non-cash accounting issues out, it really gets back much more in line.

We like to see 3 to 4; it's now in the 4 to 5 range.

And 4 of the percent, it's I'll call accounting non-cash, are -- this is the first year we've had to account for stock options, and that's about 2% of that 9%.

And also in Texas, the way the Texas order was written, in order to show the phase-in, they give you the revenue requirement up front, the 10.8 that we had to book, but they then each year give you new cash and ask you to defer expenses.

So each time we deferred almost all of the expenses.

Then each year for the next two years, we bring it back.

I think I'm explaining that correctly.

Dave, you'll have to help me.

But the bottom line is it's almost 2% of our O&M expenses.

Yes.

Actually what happens -- they are phasing in the revenue increase over a four-year period, but the way the case works, they awarded us the full pre-tax income impact of the revenue increase immediately.

And the way in which that's engineered is we got a quarter of the revenue increase year one.

So then to make up the other three-quarters, we deferred expenses.

And then year two, we got a half of the revenue increase, and then we only defer half of the expenses.

So we always get the full impact, but there's a four-year phase in of the revenue.

And now it's starting to flip.

And what Nick is saying is we're now seeing the expenses go up artificially because that's coming back, and therefore driving up our expense increase on a non-cash basis.

Yes.

If you look at the impact of the Texas award, which is under bond and isn't official yet -- that's the -- this hearing's now coming in.

We will be annualizing about $11 million more in revenue, which we're getting over a four-year period.

We didn't get the whole $11 million the first year in cash, but we got it -- we had to declare it under the accounting rules.

So in order to make up the difference, you defer -- you show the cash and defer expenses.

So this thing is leveled out.

It's real dollars.

We're getting the dollars, deferring the expenses, so it's a plus.

But the account -- it skews the O&M to revenue ratio almost by 80 basis points, and that's the reason I bring it up, 2% of our O&M to revenue ratio.

The other is stock options, which is about the same.

That's another 80 basis points or so in the O&M to revenue ratio.

And that is based -- and that's very clearly pointed out in our Q -- how much we've written off against earnings that is non-cash.

Well, if you take that 4% of the increase of the 9%, it leaves you 5% for the growth.

We had 3.5% growth last year in customers, so obviously it takes some money, although not that much, because of economy of scale to run those new customers.

And then the rest is labor, fuel, chemicals and so on.

And I have to tell you, we're absorbing 15% increases in our chemicals.

Power in Texas shot up; although it's pretty stable in Pennsylvania.

This was our long-term contracts.

New Jersey went up last year.

This year hopefully will be a little bit more stable, but that has been unpredictably higher.

And pension costs, which we did get back in the Pennsylvania case, and we're going to see that being modified, but pension costs have gone up.

And I think they're going to start reversing also, because of the fact that discount rate has gone back up, which means that the, again, actuarial studies don't make you charge so much through the pension and the interest rates are higher.

Kind of a perverse way of thinking, but that's the way it works.

Now, the part that is going up, other than the O&M to revenue, of course, is depreciation, which is up 18% quarter-to-quarter.

And again that's non-cash.

It's a good thing, but it affects earning, net income.

And the other is interest.

And the interest is almost entirely from the fact that we're carrying a great deal of short-term debt to pay for our $0.25 billion a year less depreciation.

That's the cash we need to put all this capital in.

And with interest rates going up and more interest being -- more debt being incurred, obviously the interest expense goes up much more rapidly because of the rapid rise in short-term rates.

Now, we get this -- we get it back in our next rate case, because it goes into something called AFUDC, carrying costs.

But on the other hand, it doesn't show up in the quarterly results that you'll see.

So again, this is a long-term business.

It will come back to us, and I'm hopeful that you'll stop seeing this kind of comparison maybe in another quarter or so as short-term interest rates peaks.

And after the Pennsylvania rate case, we now can capitalize some of this short-term debt into equity, which ironically is cheaper for us than the short-term debt.

But we don't want to get too far above our stated 50/50 goal.

So capitalization of equity to debt here is actually a positive thing for future debt income, and obviously for future earnings -- long-term earnings because of the way the rate proceeding works.

Just one note on capital -- we have spent huge multiples of depreciation because -- in the South, which will start correcting itself, because as we get -- go in the rates in the South, now that things are fixed, we'll get a fair depreciation rate.

So that will go up, and that's -- that will be cash coming in on the revenue side.

And the other factor is we had catch up to do after Ducane, which is going to now be probably more growth oriented, which if you have growth, you might not even need rates.

It helps the ratepayers.

It helps the shareholders.

It helps the customers.

But the -- we had to put a huge amount of money in before we could even go in for rates to fix things up.

And I really feel very comfortable -- I told the Board this yesterday.

I couldn't be as confident two years ago that we didn't have some risks.

And some of you brought that up to me -- buying a lot of bad systems, that the fact that we have the staff, the money, the time to fix them.

And the regulators have been very, very cooperative.

We've been under consent decrees, so we had the vulnerability of lawsuits taken away, and we've lived up to every commitment.

And I can tell you, other than, now, maybe some growth expansions in some of our plants, we've now kept Sarasota consent decree in place, the Indiana consent decree in place.

The expansion of the Kyle plant in Texas is now done, and the community is very happy with us.

And the Monticello, which I had mentioned earlier, is now done.

We have a couple smaller ones we're still working on [Chulioto, Landor], whatever.

I can reel five or six off that I track.

But we're now looking at a growth mode in the South.

That's where most of our new capital will go.

And in the North, we have one more plant in Illinois, which is in this rate case, Kankakee, to fix up and expand.

And we have one in Ohio, Struthers, which is -- the design's being done now, and that will be impacting rates in probably '08 and '09 in Ohio.

And we have one more plant in Pennsylvania, where we're going to put major capital next year.

We're finishing up our biggest plant, [Vicker], in this year.

And at that point, almost exclusively, our capital will go to growth or infrastructure -- infrastructure being defined as a tank here or there, a booster here or there, a couple hydrants here or there and pipe.

And most of that pipe will be in the Northeast and the Midwest, where we have these surcharge programs to cover them.

So looking at it going forward from a risk factor, our environmental risk goes down greatly because we're not talking about environmental problems with pipe.

We're talking about leakage and just good service-type issues.

And the fact that in all those states where the pipe's going to be put in, we have the surcharge mechanism, which should take away, at least to an extent, some of the lag.

We'll be exceeding, in the amount of pipe we put in, what's eligible for the SIC, which a 5%.

But so we're going to probably still need more than the 5% to keep going, and that'll -- but the fact that we had the most of it in pipe, gives you a lot more latitude on when you want to do it, the timing and so on.

We're very pleased with that.

And the other is more of a technical standpoint that I just make you aware of.

We did an offering a couple months ago, which helped bring some short-term debt down and start the recapitalization towards our 50/50 goal in equity, which really does make sense at this point in time with short-term rates being where they are.

And the volatility of our stock, which is abnormal for a water utility, over the last couple months -- I've noted that the short position in the stock is now up to a level which is almost 5% or more.

I guess almost 6%, which is an all-time high for us, and -- yes, it's over 6%, and there's almost an 11, 12-day cover period.

In other words, we wouldn't have to have anybody buying the stock but the short-holders, if they want to cover their positions, which I find -- I guess you can look at glass half-full, glass half-empty.

But I think that's -- some of our retail investors have asked me about the volatility in the stock, and I assume that's what it is.

There's some either hedge funds or some very sophisticated investors who are thinking our model is not in place, I guess.

But anyhow, just a note to that -- track that, too.

We track it now monthly.

It comes out every 15th of every month.

So that's a pretty full detail of the quarter and answer any questions you have.

[OPERATOR INSTRUCTIONS]

Our first question will come from Mike Albrecht with Altrinsic Asset Management.

Hi.

How's everyone?

Hi, Mike.

Just a quick question -- you made some comments just sort of letting us know sort of what's been pressuring you in the short-term from an expense perspective -- the electricity and some of the chemicals.

Can you give us an idea of how that's trended in the current quarter?

And when do you see that abating?

Is it just purely a function of just electricity prices driving, just flowing right here into your net income?

Yes.

First of all, probably rather than quarter over year prior quarter -- those we could track for you, and we'll do that and get back to you -- quarter-over-quarter, right, first quarter to second quarter.

And I think they're not going up as rapidly quarter-to-quarter as they were a year ago.

This is just me speaking.

I'm on the board of an electric company, and I think the gas prices shot up late in the last year, and have now levelized.

Now, recently they're up because of this heat wave, and every putting on their peakers, so of course, the gas guys are going to charge more for their natural gas.

But the -- I think electric rates are going to, when we start getting into 3Q, 4Q, are going to look a lot better in comparisons -- but stay high.

I don't see them going down, especially with this heat wave.

Chemicals are being driven more by the cost of oil.

That really started Q3 of last year with Katrina, levelized a little in Q4 and then came right back roaring in Q1 and Q2 with the Middle East unrest.

And that's affecting our gasoline, as it affects you when you drive your car.

I think we drive, what, 18 million miles a year or something?

So you can see the impact.

But I think in all those, short of further rapid rises in inflation, which we're not predicting, we've seen maybe the worst of that.

Maybe one more quarter of it, and then it should calm down.

On depreciation, I think -- which is a non-operating expense, Mike, but I assume you want to talk about all the expenses.

I think that stays in the teens for the next couple years, but that's a good thing.

I mean, our model shows us getting depreciation up to close to $100 million, I think, in two years.

Right Dave?

By the end of the five-year.

Yes, which means we can pay for a lot of our capital.

And then the -- and that's all recovered as real cash in your rates.

The interest rates -- I mean, if I knew how interest rates were going, I probably wouldn't be here.

Right?

But the -- we are predicting -- we are right now higher than we predicted we'd be, so we've hurt our budget.

We thought shorts would stop around 5 this year.

And they're up to 5 -- what are we paying, as we speak? 5 to --

6.

5, 6 -- so we pay 35 over LIBOR, we're not doing bad from a standpoint of working with the banks, but nobody thought LIBOR would be at 5.3, 5.25.

So we're -- I don't know, maybe another quarter, at 8.

I don't know, but sooner or later, I think it turns around.

I see car sales are down, and oil prices are starting to hurt consumption, so I think short-term rates maybe have one more bump, and then they either stabilize or start going down.

And so we think we're not going to see -- probably in another quarter, probably early, probably Q1 next year we'll start seeing levelization on the interest expenses.

They're the three big tickets -- labor, pretty solid 3%.

In benefits we are not getting hurt as much.

We instilled a defined contribution for all new employees, so we've taken the risk out of 50% of our workforce on the volatility that's going to be around for the next couple of years on defined benefit.

And on healthcare, all our employees, we've negotiated three of our four union contracts this year and asked the union to start paying.

No more retiree healthcare, which is an OPEB issue, and we've asked for 20% of premiums, which not only helps subsidize huge costs of healthcare, $12,000 a year per employee or something of that sort, but more importantly now the employees are very concerned with how the plan design works, because they're paying 20% of it.

Mm-hmm.

And that really gives some discipline to the process.

We're not seeing healthcare going up double-digits anymore.

Okay, and then just lastly, some parts of the country just -- the summer seemed to be mild coming on, and then it just really picked up here.

How do you -- how does that affect your business?

Obviously, the hotter, there's more water flowing, but I guess at some point when the municipalities start calling for water, sort of a non-water waste, don't water your lawn, so on and so forth -- where are you, in your opinion, the flexion point there?

As I mentioned, this has been a strange weather year.

Normally you have dryness.

Then it gets hot, and people start water -- using water like crazy.

We've never had a problem like the electrics where you'll hear announcements, 'We're right at the cusp of our generation capacity.

And out system may not hold today, and we're asking for voluntary blackouts.'

We have enough capacity in our plants to give people as much water as they need, predictably.

The flip of that is, though, if you don't -- if the rivers are low or your reservoirs are low, you may not have enough material to put through your plants and your pipes.

And this year, it's been an ironic year.

Usually in the summertime, like a peak July and August, an 80% reserve in your reservoirs is all you need because you could go down as low as 50%, and then it recharges in the fall and the spring.

As I speak to you now, from Danville, Illinois reservoirs all the way to Springfield, Pennsylvania, we're almost 100%.

And that's -- the reason is we've had 25% higher rainfall than normal in the first six months.

And it's not because it's rained every day, but when it rains, we've had like six-inch rains, four-inch rains, and that fills the reservoir up very quickly.

But it also means people don't water their lawns, because they say, well it's going to rain tomorrow night.

There's a thunderstorm coming in.

But we're starting to see now, we've had hot weather, and July wasn't an abnormally great month.

As matter of fact, it was off a little bit in Pennsylvania.

But not significantly, and since we got the rate case, that shouldn't be a problem in revenues.

But the last couple days, it hasn't rained for three days.

They're predicting another 100-degree day today.

And I'm very isolated now in the Pennsylvania, New York, New Jersey area.

In New Jersey, we're pumping like crazy today.

And in Pennsylvania, it's up over budget now for the last two days, basically because of the -- there's no thunderstorm predicted.

As soon as somebody hears it's going to rain this afternoon, they say, oh, I can get away without watering my lawn.

It's almost that day to day in the weather, and that's why I say if you're investing in our business, you really -- because sometimes you have great summers, sometimes bad summers.

But it's really the customer count, the capital that you're putting in, and your effectiveness in getting rates that really make the difference.

Great.

Thank you.

Our next question is from Jim Lykins with Hilliard Lyons.

Good morning, everyone.

Hi, Jim.

How are you?

Doing good -- yourself?

Good.

Just a couple quick questions, if I may.

First O&M -- I know there was a lot of moving variables there with healthcare, pensions, stock options and what Dave explained about Texas, but can you just, if you can, speak at all about what you're maybe targeting there for how many basis points you think you can improve that line item or at least give us a feel for where the efficiency ratio might be say going out a year from now?

I think with the Texas -- one more year of Texas, which is 0.08% up, and New York Water -- New York Water, by the way, brings in about $25 million in revenues, Dave? 24?

Yes.

And they're at -- O&M to revenue ratio is almost 60%, Jim.

Now, obviously that going to -- when we get involved with New York Water, we're going to try and trim that to more of an Aqua America-type level, which is in the 40s, but it's not going to help us the first year.

And it's a union there that we have to negotiate the changes.

But I think probably with New York Water, I think in the future we'll take this septage business out, because that skews it up.

I mean, if you're looking at O&M to revenue ratio, it's the reverse of the -- inverse of an EBITDA to revenue.

Probably we're looking at 75 -- well, actually 80 -- 80, 85 versus 40.

So that's going to skew it for 5% of the revenues.

We'll probably take that out.

I think flat only because of O&M going up and one more year of that skewing 0.08% -- well, options go out next year.

So that should be zero, flat.

But let us get back to you.

I'm doing thinking as we're talking, but I would anticipate because of the additions and due to the fact that we have one more year of Texas, it probably won't go down a whole lot next year.

But if you take the core, take all that noise out of there, the core probably has gone down a half, from 50 to 75 basis points.

Is that fair, Dave?

Yes.

Okay, and we'll drill down for you on it.

Okay, and back to New York.

I wonder if you could just talk a little bit about what you think the opportunities could be for tuck-ins and also when you may be going in for rates in New York?

Well, the rates in New York are very interesting.

It's a self-adjusting mechanism.

They got a rate case that basically accrues up through '08, I think, and we'll probably go in for a rate case very shortly after you're allowed to.

They are putting in all RF meters, which obviously will be -- will permit lower O&M.

So rates might not go up as much as a shifting of the reward in rates to the shareholder versus just paying for expenses, which of course, the shareholder gets nothing of.

You earn on capital that you've invested.

And they're putting in all RF meters, which would make it much more service-friendly, but also much more capital intensive.

And they're putting in treatment, which we will continue with, on all their wells, which are all groundwater, all have plenty of water, but have high iron.

And we want to get that corrected.

That's something our Company wouldn't want to do, so there'll be treatment put on.

At that point, it will be a gross story.

I think you can look for us to look at septage up there.

That's going to be a natural.

Long Island is interesting.

Everybody thinks of New York as New York City.

Of course, here in Louisville it's a little different, but Long Island is like a traditional suburb in Pennsylvania or maybe even in Kentucky.

A lot of people, a lot of lawn watering, much more than we're seeing here.

Homes are a quarter acre, would you say?

Maybe less.

Yes.

Dense population -- that's good for a utility.

And people pay their bills.

And it's all middle income -- some lower-middle, some upper-middle.

Most of the people work in the city, live in there; although Long Island probably has its own economy -- and a lot of people.

So we see a lot of opportunities as a base in a densely populated, pretty economically healthy area.

High taxes is the only thing I would argue is a problem -- high property taxes and high taxes in New York, but we recover all that.

Mm-hmm.

Okay, that's a great lead-in for the other thing I wanted to ask you.

And previously you've kind of targeted about 25 to 30 acquisitions per year, and now that you're in the septage hauling business, I'm wondering if those, the septage hauling acquisitions, have been included in that number for that?

Or will that be revised upward a little bit?

Yes.

We're not counting -- sure, we're not counting March 25 this year or to 30 is not counting septages.

No.

No, I think were going to keep tracking that separately so you can see -- the ratios are different.

You should track this on gross margins there, and cash flow, EBITDA.

That's an EBITDA business.

It's all about management and finding revenues.

Okay.

And actually we'll -- if it was perfect, it would throw off the cash that we need in the water business, which is negative cash, without floating stock and borrowing money.

Okay.

All right.

That's all I had.

Thank you, guys.

And our next question then is from Mike Gaugler with Brean Murray.

Morning, everyone.

Morning, Michael.

Congrats on the quarter.

Thank you.

Listen;

I'm going to follow-on just a little bit on the acquisition topic.

I know that you mentioned earlier that you expect New York Water service will close by year-end.

Is there any chance that it gets done earlier and that it could add to 4Q results?

I would hate to predict.

American took, what, a year-and-a-half to get their acquisition through.

This would be less than six months if we get it in.

We bought -- we announced it May 18, I think.

We filed June 6, which is pretty quick.

And we've already gotten it in the New York documentation bulletin, whatever they call it, their federal register, state register, published in July, which is record time.

Now, they have to have hearings or at least meetings, and that's the period that sometimes take a year sometimes -- and we're hopeful, and they said they think they can live with sometimes in November, December.

So any impact on fourth quarter would be minimal.

Okay.

And just to kind of follow along the same line of thinking.

How's the acquisition landscape looking right now?

Are you being approached more by system operators?

Or is it being primarily driven by internal business development?

I would say internal business development, because they're -- believe it or not, even with all the publicity out there about water systems and everything else, it's almost like if you don't call the person, they don't -- it's one of those things.

You have to give them the reason to say, 'Let me think about that.'

And that's why we've put a person in every state.

You can't do it out of one office in Philadelphia.

So every state has a person who does nothing but make phone calls, go to municipalities, go to all the meetings and just make sure that they know that we're around.

Got it.

Where we are being approached, Mike, is from the developer systems.

Those 30 deals we've done to-date in North Carolina tend to come to us as we've become the provide of choice in that state.

Okay

And the real driver there, Mike, is wastewater, not water.

We always had the -- oh, we can get wells or maybe we'll get Philly Suburban to do it, the old company.

But when you have wastewater, you can't -- as a developer, the number one goal is land use -- we'll buy the land -- zoning and then getting wastewater.

That's really the one of the advantages we have.

In North Carolina, half our customers are wastewater.

So it's -- we're really a water/wastewater business now.

All right.

And then just one last question -- any concerns about potential impacts on your business in Texas from the drought conditions there?

Well, it's only in Austin.

In Houston there's plenty of water, and at Fort Worth, so far -- Fort Worth's not rich in water to start with, but it's so far, so good.

And Austin, they are putting voluntary limitations on people of 5%, so obviously that's not a positive, but I wouldn't -- we're not concerned too much because people are using a lot water because of the heat.

Okay.

Thank you, gentlemen.

Thanks.

[OPERATOR INSTRUCTIONS]

We'll next go to Selman Akyol with Stifel Nicolaus.

Thank you.

Good morning.

Morning, Selman.

Do you guys have on the revenue breakdown, the Delta, the $8.6 million, do you have what's coming from volumes versus rate increases versus acquisitions?

Yes.

We can give you that.

Dave, can you help me with that?

Yes, I'll dig that right up.

When you look at our revenue increase for the quarter, it's about 7%.

And it's almost split evenly between rates and acquisitions and growth.

Rates are about 3%, acquisitions and growth are a little over 2.5, and then the balance is from changes in consumption and other, other slight changes.

Okay, great.

Thanks.

[OPERATOR INSTRUCTIONS]

We'll next go to Jonathan Reeder with A.G. Edwards.

Good morning, gentlemen.

Hi, Jonathan.

How's it going?

Good.

I was wondering, could you quantify just what the accurate amount of outstanding rate requests are?

I know you've got Pennsylvania settled.

That $50 million or $53 million probably comes down substantially?

Oh, yes, absolutely.

Now, we're going to give you what we asked.

You understand that you don't always get what you ask.

Sure.

Okay.

New Jersey -- we'll have to add them up as we speak.

This is right now filed -- New Jersey $4.2, Illinois $3.4, Virginia $2.5.

Texas, if you want to count that as not final yet, although it's under bond, is $10.8.

Missouri is $1 million.

Maine we just got, so we don't count that.

Another small case in New Jersey is for the sewer which is at -- is $50,000, and that's all we have right now filed.

But we're ready to file, probably before the end of the year, between -- Ohio, we're not going to do Sarasota, Florida Water, and there it is, and North Carolina will probably be next year.

Probably another $10 million of --

Another $10 million is ready to be filed?

Yes.

What was the individual amount for Florida?

I had missed that one earlier.

Florida will probably be in the $3 to $4 range -- when we file it, and that will be this year.

Okay.

And now --

That doesn't include Sarasota, which is a third of the state.

So that will be a separate filing sometime early next year.

Okay.

And now you said that you would meet or exceed the 10% EPS growth.

Was that for the full year or just you're talking second half?

No, no, just quarter-to-quarter -- remember early on we said we're going to have a hard time beating last year's EPS in the Q1, Q2.

Matter of fact, they -- I think we recommended they'd probably be down and without the good South, we probably would have been down this quarter, that [gave] us a penny.

But the -- going forward, the next two quarters, we will -- we predict we will do better than 10% for those quarters.

Okay, so year-over-year it will be somewhere in between the -- probably 5 to 10.

Yeah, I [guessed at that] --

And then can you quantify at all the expected accretion that you see from the New York water acquisition?

Like how much of it maybe expected immediately and how much will come just from the rate recognition of investments and the cost savings?

Sure.

I'll give you what we showed our Board yesterday.

The -- it all depends on what you sell your equity for to capitalize it, but if we just use the offering we did a month ago, in June, and say that was for New York Water versus capitalization of this Pennsylvania rate case, which is fungible money and use $22.

The equivalent earnings per share of New York Water, before we even get in there and do O&M expense cuts, based on what they're spending right now is $1.12.

Okay.

And you can calculate we're paying $53 million.

Are we paying $53? $28 and $23 -- $51 million, half as equity, and you can calculate the number of shares -- [inaudible] a little over a million.

So you can see now how that's probably a penny, Dave?

In the end you know, a $50 million dollar deal on a $2 billion rate base isn't going to move the needle much, but it's accretive when we compare, clearly compare the 112 to the 70-something.

Yeah.

And like we always said, other than Aqua Source, this is a singles game in between platform builders.

And you know, but that's a nice spread between you know earnings power this year and $1.12.

Then we see this is a place to put capital and grow earnings in the future and also tuck-in.

Mm-hmm.

And then do you see any other large opportunities on the horizon or --?

Well, the reception we've received in New York is very good.

The regulators want us to look at a North Carolina-type program where -- North Carolina is very unique where they gave us the premium earn against the premium by buying up small troubled systems, fixing them and then letting us turn against the premium.

New York's at least considering that, which tells me that they see us as a company that's going to be around a long time with them.

Okay.

Well that, I think, take cares of all my questions today.

Thank you.

Okay.

Great.

And with that, there are no further questions at this time.

I'd like to turn the conference back to Nick DeBenedictis for any additional or closing remarks.

Well, I just want to thank everybody for all their time, and I appreciate you following us.