Essential Utilities Inc (WTRG) 2006 Q4 法說會逐字稿

Good day everyone and welcome to the Aqua America fourth-quarter earnings conference call.

Today's conference is being recorded.

For opening remarks and introductions I would now like to turn the conference over to Christopher Purtill.

Please go ahead, sir.

Good morning everybody.

If you have not received a copy of the earnings press release, you can find it by visiting the investor relations section of our website at www.AquaAmerica.com or you can call me, Christopher Purtill, 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 the most recent 10-K and other SEC filings for a description of such risks and uncertainties.

During the course of the call, reference may be made to certain non-GAAP financial measures.

A reconciliation of these non-GAAP to GAAP financial measures are posted in the investor relations section of the Company's website.

And 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 any further questions.

Thank you, C.J. and good morning everyone.

Start with a little bit of an overview of '06 and the quarter and then talk a little bit about what we're looking forward to in '07.

First of all, '06 was a good year but was dampened by weather, regulatory lag which really was because we spent capital at a faster pace than normal to get all the compliance done in the southern states and get ready for rate case filings.

That and also for the Pennsylvania case which was decided in midyear.

And that did a couple of things.

First of all, more capital to be depreciated and carrying costs mostly at short-term rates until you get your rate case and then you put it into equity and long-term rates.

Unfortunately we picked the time to carry the most short-term debt at the time that the Fed was raising interest rates.

And to make some comparisons, which I'll give you later are astonishing and that's where a couple of pennies I think went in the sense of lag.

And then inflation which we're seeing some very positive signs on moderating now in the fourth quarter but the first three, chemicals up over 15%, electric rates gone up whenever the caps came off in certain states that we're in and so on.

So it was a lot of outside influences affected the year which we cannot obviously predict in '07 but I think at least we have a little more visibility now than we did this time last year.

The fourth quarter was a good quarter, in a couple of ways.

First of all, weather did not influence it as much.

The second, we had the Texas rate case issue which Dave will explain to you because it is a complicated accounting but the good news is that it looks very good on the rate case and won't be decided until the first quarter.

But we were able to reverse some reserves that we were holding as a result of the hearings that have been held to date.

And our expense levels grew at a more reasonable rate in the fourth quarter versus the first three.

And although we closed the year with operation and maintenance expenses up 8% which is very rare for us to get up that high, it looks as if we're back to the normalized 4% to 5% which of course if you are growing revenues more than that you're going to be adding to the bottom line.

Now of course that all depends on the world oil prices, where chemicals go and so on but at least we're seeing some moderating in these areas.

I'll get into some of the interest rate issues later but I think that is important.

It was another year of good growth.

Well, the numbers are in the release but let me just -- for the second quarter net income up 16%, a good fourth quarter allowed us to beat net income for the year just slightly $92 million versus $91 million, a record intact.

EPS because of about a 3% dilution grew about 12% -- 19 versus 17 -- and the year was flat 70 versus 71 in '05.

There were obviously stock option expenses in there which came to a little over $0.02 and of course the lag I mentioned earlier.

And that was the real story in '06 with as I mentioned Q4 looking like a more normalized quarter for us and we're hoping that we're going to see that in '07.

Revenues were up strong, 11.3%.

Some of that came from obviously acquisitions; a lot of it from rates which I want to spend some time on in this meeting.

And not much from send out because we actually believe it or not had less send out in '06 than we had in '05.

So that means all the customer growth didn't add any new gallons and the weather actually was so bad that we didn't have any growth.

As a matter fact, a decrease of almost 8% in the north in Pennsylvania.

That is something we would never have budgeted for or expected.

Let's hope it's better this year.

We did have some tick in revenues and net income from our new business, the hauling business.

But I want to make sure that you understand it's a completely different business.

It is not capital intensive; a much lower margin, higher O&M to revenue ratio business and we're going to start segregating and I think the K was sent out earlier this morning and you will see that that -- we don't mix the regulated and the unregulated.

It's a perfect complement in my mind and a growth vehicle for us but it will skew the kind of numbers I think you're used to tracking the efficiency numbers, how much capital we're putting in because it is a completely different business.

The revenues were about $5 million this year and they will more than double next year with growth in a full year of our acquisitions that occurred in May in next year -- so our July -- I'm sorry -- in next year.

So starting to become a little bit more significant towards segregation.

Let me talk a little bit about something that we very seldom talk about and that is how we manage the business. '06 was a busy year but it was all inside baseball but let me just tick some things off that we had to get done in '06 to really make the company one company versus a lot of small pieces of companies that we purchased over the past three years and to try and get it so that we can measure each state against another state.

First of all very seldom do some companies do one equity offering.

We did two during '06.

And the reason for the second one was to capitalize the Pennsylvania rate case.

We knew we were on our way to buying New York Water which was going to need some capital.

And we just felt that the equity offering we did which is called a forward equity offering was a perfect way for us to plan for the future which we did.

As it turns out we kept our record intact at every offering that is out of the higher price than the one prior, went out about 2250, the stock this morning is higher than that now.

And although we didn't use all the proceeds that were sold, they are sitting in the bank and we're actually earning money on that at a rate that exceeds our cost of our dividend so it actually while its banked, it helps us as we go along.

So we feel very comfortable that we're in a good shape with our capitalization plans.

The other good story was once again we lowered our embedded cost of debt.

We borrowed another $100 million but even on that $1 billion worth of debt we've lowered the total and that's a big ship to turn for about 5 75 down to about 5 7.

At the end of the year right at the end of the year we placed a $50 million [tax rate] at 4 4.

So you can see we're going to continue to keep that interest rate long term is going in the right direction.

We have a couple refinancings this year we're looking at that are finally coming due that are higher priced, 9%.

Now this all helps the rate [payer] and because we go in so often for rates, unlike the electrics which did a lot of refinancing because they hit the interest rate curve at the right time after deregulation, we're not going to sit on those gains for years and years and try and stay out.

Because we're adding capital so quickly we just have to go in at a regulatory lag [hedging].

So this is a good thing to do because it costs our rate payers less, keeps our rates lower which means more attention can be spent on giving us good returns on our own money.

And it's the right thing to do.

It's a lot more hustle.

Kathy Pape, our Treasurer, works on this and has done a tremendous job and at this point I think we get some kudos from the regulatory agencies for it and it really does help the overall financial strength of the company.

We once again appeared before S&P.

We give them a five-year plan every year.

We are very comfortable with their reaction.

And we're holding our rate even after the New York Water acquisition.

And we're in good shape for the growth we're expecting to continue to have in the area.

In that theme, we did achieve our growth goals since we like to grow it twice, three times the normal industry growth, we usually target 4% which we've been able to hit most years and exceed most years.

This year we exceeded it again, 7% growth.

A lot of it coming from New York Water but you can't count them unless they are done and this one got done right at the end of the year.

Six months start to finish.

I think you will track other regulatory approvals and you will find some although they say we're going to get it done in six months take a year, a year and a half.

Again kudos to Dave Smeltzer's team and Kathy Pape who had to go through the process.

We found the New York Commission A, intelligent; and B, very easy to get along with as long as you give them everything they want which is our style and within six months we have a very good order we think.

We were able to book all the regulatory assets on the pension which is always your biggest risk in today's world to have a shortfall in pensions and that has all been booked so there is very little risk of not recovering it.

And New York has a very unique plan where at 10.6 return on equity and if you have a great weather year, you don't get all those excesses but if you have a bad weather year, you are given a rate surcharge next year to make up for the difference.

So it takes a lot of the inconsistency out of the weather and allows you to earn on a what I call a disc -- it is a distribution surcharge so that you're not getting regulatory lag in between rate cases.

We're willing and able to work under these new rules in New York and we think it's going to be very positive for a company who does plan five years ahead and New York regulations I think are perfect for a company like that.

The other thing we did is basically try and run the company as one company.

We centralized a lot of activities.

We put our -- we reconverted all the 23 customer service systems, billing systems we had in the company into one system under Indus is the name of the company the banner system probably the best known in the water industry at least for customer service.

And we have eight of our 12 states on it already.

So far so good.

Not one -- usually I gauge it by how many calls I get from commissioners and I didn't get any so that is good news.

And on the budget side, it is on budget.

We did delay one of the closings by about two months to make sure that our IS staff was up and running but we should be completed the last three states on this actually last four states sometime in April at which point we will be on one customer system.

We've set up three call centers which if you have a snow in Philadelphia, all the calls go to either Cary North Carolina and/or Kankakee, probably be more snow in Kankakee.

But it allows us to man the centers because Kankakee is an hour behind an hour later and an hour earlier in the Midwest.

So it's working out very well and we have people in place, the computers in place and we've been able to bring our abandoned call rates and our time to answer so on all down significantly.

So we are looking for this to be a big plus for our company going forward.

The south performance improved and we made some major changes.

Mr. Hugus who has been our president there retired this year toward the end of a year.

Rick has agreed to stay on part time to help us with rate cases and especially in North Carolina where he is now living and Texas where he is finalizing the rate case he started there over four years ago.

Dave will explain how complicated that process is.

We're treated fairly but it is a complicated process.

Christopher Franklin, who is our former VP of public affairs and who handled the customer service switchover nationally will also pick up the South and he was named Senior Vice President by our Board on last Tuesday at our Board meeting.

We also made other promotions as we look at succession planning in the company. [Carl Kirus] has been promoted.

He will be in charge of the whole Mid-Atlantic operation which is 60% of the company.

As I mentioned, Chris Franklin was named Senior Vice President and President of the South and Senior Vice President of customer service.

Bob Laughman, our Manager in Texas with the success of growth in that state has been named the Vice President;

Kathy Pape, who was a Vice President, has been named Senior Vice President of the Company.

She has all the rate functions and the treasury functions.

And Mark Kropilak, who is in charge of all our corporate development and our growth programs and was also General Counsel earlier and retained that title was named Senior Vice President in Corporate Development.

So you can see I think we have a lot of bench strength.

And we're recognizing that as we get bigger so that each of these individuals can take on more responsibility in their own areas.

Regarding the South, Chris hit the ground running and we're starting to finally see the organizational things that we've been doing over the past couple of years and taking hold basically.

The South just to give you some numbers has dropped from something -- a number I'm proud of -- 60% efficiency ratio, that is O&M over revenue of 61% actually.

It dropped this year to about 58 or about 5% and we think we can to squeeze 10% next year out of that ratio and get it down into the 3 range.

So you can see that is a big part of our program and I think we have the horses in place now and we have the capital infused that we needed to do, the customer service all one operation.

I think we're going to start some of those investments pay off in the way of lower growth rates in the (indiscernible) side with higher growth rates in the revenue side especially in the South.

We also had to handle all our salary plans and our healthcare plans so that we start looking like one company.

We had different plans, different salary schedules in every state and so on.

That has now been all modified and organized and uniform.

It was not easy because we had four union negotiations to go through until we got it.

But let me just give you a broad-based overview and that is that all union settlements were made.

We had no strike.

The wages were a reasonable level around the 3.5% level.

But we were able to achieve the following issues which really are long-term benefits to the company.

All employees will be on the same health plan which now we can negotiate as one plan with the carriers.

The second is that all employees, management and union alike will pay 20% of their healthcare.

I think you will find that is a little bit aggressive for utilities but not for private sector.

No new employees will be eligible for retirement benefits under a defined benefit but only their 401 portable plan and there will be no more OPEB, no longer will we have a healthcare retirement benefits for any new employees.

And right now as we look at our company, probably over 55% of our employees no longer are on the defined benefit and/or a OPEB plan.

So when you see the numbers this year, and Dave can go into them as to what our shortfall was in the defined benefit which is booked as a regulatory asset, does not go against equity drain or anything like that like happens to Ford and General Motors and others that you are seeing.

We feel very comfortable now we have it to a manageable level and that is going to be one of our priorities for '07 is to make sure we can put some rings around that.

Even though it gets charged back to rates, we would much rather get it to a level that we think is equitable for everyone.

And that will be one of our goals for '07 having accomplished the union negotiations and the healthcare planning in '06.

Not that it matters to anybody on the phone, but as we've been growing so rapidly we actually grew out of our space and rather than to move the whole headquarters and the Aqua Pennsylvania Company, we decided to put an addition on our building and that was completed on time, on schedule and everybody moved in by the end of this year.

It started in July and in phases we've moved in.

And although who cares, you moved into a new building, believe me, it's a disruption when you're moving people back and forth and boxes and it does take time out of your day and so on.

And that is all now behind us and everybody seems to like their new space.

I would say the accomplishment and I'll get into some of the specifics on depreciation now and capital and so on.

The accomplishments I would say Aqua is now an integrated company of many pieces still but we have one state-of-the-art utility so that we're ready to compete with whoever, IPOs, foreign companies, private equity, whatever; we won't be the biggest but we will be mobile and we will be agile and I think we have the right horses in place to be able to continue the growth trend you've seen over the last decade going forward.

A couple of specifics now on rates because I think that is a big part of our revenue story.

Just to give you a summary and Kathy is here with us in case you have specific questions when the session (inaudible).

Last year we had some significant rate cases and the biggest being Pennsylvania and we ended the Pennsylvania being a $25 million addition in June.

And we finished the year with Kankakee Illinois with a 20% rate increase, a little over 2 million.

And with New Jersey a settlement in early January of 2.5 million.

During the year we also had cases in Maine where we've got 500,000 to 5 cases.

In Florida a lot of small cases plus one in Sarasota for 600,000;

Illinois about nine small cases over 3 million.

We had three cases in Ohio for about 1.5 million and Virginia 1.8 million.

So you can see it was a busy year unfortunately not enough and not quick enough to make up for the regulatory lag, because depreciation and interest really ran rampant.

We have cases now filed -- well let's see -- just in this quarter if you want to look at it as a quarter, the run rate of $3.5 million of rates came in since the last conference call we had.

We have filed but not yet received about $10 million in rates, the biggest of those being in Florida where we filed a $7 million case. 80 different divisions, we filed for and we're trying to get them into a 15 county by county structure so we can start moving toward consolidated rates.

A couple surcharges, the disk in Pennsylvania and then Ohio represented part of that and then we filed 5 wastewater rate cases in Pennsylvania, none of them huge, 150 here, 60 there, but they add up and we want to try and get a full rate of return on our wastewater investments also.

Now this bigger story is what is going to happen in '07.

Obviously continue to work on the nine or so cases that are in the hopper now but we plan to file 32 more cases so you can see we're going to be very busy in the rate arena.

The biggest one will again be Pennsylvania filed probably later in the fall because we're on a two-year cycle there and with the kind of money we're putting in the pipes in Pennsylvania (inaudible).

New York, we're going to plan for a consolidated cases in the properties we bought from AquaSource and just the normal what they rack filing to the New York water sometime this year.

A lot of cases in Virginia where we are one by one, then we have 70 systems there, getting them up to earning their full keep and then we're work on a merger plan in Virginia.

A major case planned in North Carolina, the first of three, and in Indiana, a major case mainly in the Fort Wayne area, we have a couple of small ones that have already filed but Fort Wayne is the big one.

And that is where we had -- you'll see in the K, opposition from the Mayor who wants to condemn our properties.

But we believe it's best for the rate payers and for everyone else for us to stay independent.

And then Missouri, another large case, we did get a nice return last year in Missouri but we only got half of what we asked for and we believe that our earnings can show that we deserve the other half and we're going back in for it.

And of course, Texas will be finalized hopefully in '07 and Dave can go into that.

Dave, do you want to go into the Texas now because I think that is -- I didn't mention that in any of the things I did?

Sure, Nick, thanks.

The Texas rate case was filed in 2004 and it was scheduled to be about a 40% increase.

And we instituted it with a fairly unique mechanism in that we implemented the rate increase in four 10% tranches one year after the other.

So in the first year we only implemented the (inaudible) increase.

But the unique aspect was the commission allowed us to defer expenses to the extent of the other 30% so that from an operating income standpoint, the first year increase did look like the 40%.

And that changed every year.

Year two we went to 20% increase on the billing and down to the remaining 20% on the expense deferral.

And then year three where we are now, we're at the 75% of the billing or a 30% increase and a much smaller piece on the deferral.

So a couple things to just keep in mind as it relates to that it did play some havoc during those periods with our O&M ratio as we deferred very large amounts, probably 7-some million in the first year of the Texas rate case from the expenses and then decreased that for the next two years to again play some havoc with the O&M expense ratio.

Also as it relates to the Texas rate case both on the billing side and the expense deferral side, we did reserve a portion of that pending some uncertainty as to the potential outcome of the Texas rate case.

And as a result of hearings that took place in Q4, as a result of a much better understanding as to what issues remain, in fact very few issues remain in the Texas rate case, and we're fairly confident as to where heading in that proceeding, we were able to release those reserves both the reserve on the revenue recognition and the held back expense deferrals and go to the full contemplated level in each of those areas in the fourth quarter and that did assist the results.

And as Nick said, we do expect the case to conclude this year with really what we believe are the only remaining issues are the rate case expense which is looking very good and the final mechanism over which the deferred expenses will be recovered.

And at this point, we expect that they will be recovered via a surcharge on the customers' bill much like rate case expenses but a little bit uncertainty as to over exactly what period they will be recovered.

We're thinking probably in the neighborhood of three to five years.

And again when that happens, that will actually also alter our own [M] ratio picture because we will have the revenue coming in via the surcharge but the offsetting expense will likely be via on the amortization line.

That is a quick overview of the Texas rate case where we are very pleased with the end result and the commission down there I think is going to stay implementing an innovative methods that works for both the customers and the company.

Thanks, Dave.

The capital and I think '07 part of our story and '06 part of our story on the lag was the amount of capital we spent.

We decided it was time to fix everything on an expedited schedule so we could get in for rates.

Especially with what happened -- what was happening with interest rates and also the fact that the depreciation was starting to mount up on what we had already done and we'd been doing three years of really major capital improvements especially in the South.

So just to give you some macro numbers.

In 2006 -- I'm sorry -- 2005, we spend $237 million and in 2006, you will see in the K, $271 million, a pretty good sized jump, $35 million.

Most of that was in two areas, Pennsylvania where we experienced lag up through the middle of the year until we could get it in rate and I will explain why when I get into net interest.

But now that is being recovered but as we speak we're building that up again because Pennsylvania is a big consumer of our capital as we go forward.

And in the South, where we got plants fixed in Virginia and Texas and Florida and so on and got off the environmental consent decrees in Indiana -- environmental consent decrees where we had been -- we made our commitments that we'd fix some of the problems that we inherited when we bought those from Heater, AquaSource and Florida Water.

So I'm comfortable to tell you although we had to increase our expenditures quite a bit in the South this year, they will drop drastically probably about 20 million or more next year.

That is not the case for the North especially in Illinois, Pennsylvania, New Jersey where we are on construction programs and where we have the what is called the [quips] or disk or whatever you want to call it, the pipe surcharge program.

What I see '07 looking like is probably -- I mentioned 235 or so up to 270 back to the 240 to maybe 250 range.

It will be growth but it will be more normalized growth from our run rate.

It's part of the expenditures in '06 really stole from '07 if you want to look at it that say would have been a much more linear line versus a little bit of a bump there in '06.

But we wanted to get things done so we can get these rate cases and that was the key and now as you heard earlier about all the cases we will be filing.

Another way of looking at it is we're going to spend of that 240 to 250, a good 150 to 160 in the North -- I'm sorry in the Mid-Atlantic which is Pennsylvania and New Jersey.

Both states we will be spending more on capital than we take in with depreciation and net income so they are cash negatives.

Though lag is relevant on the other hand there are also states where we have an efficient operation and we know that we are going to have to apply and do apply on a normalized regularlized basis for rates at levels that are digestible.

In the Midwest, the Illinois again is going to be spending more than they may take in.

Once again, you've got a whole rate plan in Illinois that is in part of the 39 cases, Vermillion will file, and quips filings and so on.

And in the South just the opposite, we are going to be dropping the amount of capital we spent; earnings should go up with the rate cases we're planning and depreciation will go up with the rate cases we're planning but it will be captured in rates.

Ant there the earnings plus depreciation will be more than what we spend in capital so that excess cash would be used obviously for corporate purposes but it would mean that we don't have to go out and borrow as much for the other states which are not cash positive at this point.

One of the reasons for the reg lag was that we basically spent more capital to get done and they are not in rates yet because most of those cases would be in the South and they are being compiled as we speak.

The other factor is when we do spend capital, we usually fund it with short-term debt, then capitalize it when we go in for rates with long-term debt and you saw the results of that.

We keep lowering our embedded cost of debt and with equity which we talked about earlier about the forward equity program we are in now and our former equity filing in July of '06.

Let me just read you some numbers and I think this will explain it.

So in any one quarter we may be between 80 and $120 million of short-term debt.

If you start with the comparisons quarter to quarter of '05 versus '06, and I'll give you quarter-by-quarter comparisons.

In the first quarter of '06 we paid 464 for our short-term debt versus 272 the prior year, almost a 200 basis point spread on that kind of dollars which we did not anticipate.

In '05 second quarter it was 3 1 compared to 5 1 in 2Q '06, again, 200 basis points. 3Q was 372 versus 5 3, started moderating a little bit, still 160 basis points and 4Q was 431, 4Q '05 versus 535 in '06.

So again, at about 100 basis points.

What we see happening now is that moderating as we look at the '07 and we don't see other than Q1 which probably we're looking at 5 3 to 5 5 as we speak, we don't know what the Fed is going to do obviously.

And then we think it's going to hold steady and maybe even go down a little bit toward the end of the year and that is what we budgeted but at least we're up against numbers like 4 6.

The first quarter is still going to be a tough match, maybe 80 basis points.

But after that we should be within 25 basis points in the second quarter.

The third quarter and fourth quarter we probably will be matched or maybe even could go lower.

And when you are looking at regulatory lag, that is really the interest, It's not the long-term interest because we're able to lock that, get it in rates, it's between rate cases how much short you have out there.

And look, it probably cost us a penny or two when you look at it.

But if interest rates were to drop 150 basis points in one year, we'd have the same advantage on the way down but it is a one-year advantage because it's all short term.

And of course the more capital you are spending, the more you influenced that and biased it.

The other factor is depreciation which I want to give you some numbers on because it's really an interesting analysis and you can see now depreciation is good in once sense.

It's generating more internal cash which means we're supporting a lot of these programs without having to do much equity going forward.

As a matter of fact if you look at our percentage of dilution on equity, back in the '03 era, '03, '04 it was around 5%.

We've lowered it to about 2.5% in the '04, '05 area; '06 it was 1.5% we think we can keep it there or actually get it lower on dilution.

That is because of the cash that's being generated from our net income but also the fact that we are -- our depreciation is so high.

It is hurting earnings but it is helping cash.

And just to give you numbers through '06, '06's depreciation was 70.8 million up from 60.7 million in '05, almost 16% gain and we're looking at a 20% increase again in '07 in our budget.

Whereas revenues obviously are not growing that rapidly so it is hurting our earnings but helping our cash.

You'll see that when you look at your EBITDA numbers how much they are growing almost 10% a year.

But if we look at a five-year CAGR on depreciation, we're up 13% and this year it's probably up 20%.

So it's gone up faster in '07 than it has been over the past five years.

And our revenues have gone up 11%, not bad over a five-year CAGR '01 through '06 and although our revenues probably this year will go up probably 13% to 15% based on the fact that we have New York Water now coming in, normal growth, all the rate cases I mentioned and the hauling business basically doubling because of having a full year plus growth in there.

Still not -- the depreciation has gone up faster than the revenue.

Now the good news is that the O&M not counting depreciation but the operation and maintenance is not growing at those kind of paces and that is where the profits will come from.

But depreciation has gone from about 12% of our revenue to 13%, 13.5%.

This year it will be 15%.

I just want to make sure you are aware that as you do your forecasts because it is good news and it's bad news.

The bad news immediate, but good news from the sense of the fact that it is long-term cash coming in.

But it does add to regulatory lag and that is why we have to move in quickly and get rates because when you replace it -- here is the real reason.

When you replace a pipe that has been in the ground for 100 years, it's probably being depreciated at peanuts or whatever maybe $1. 2% of $1 is $0.02.

You put in a new pipe in at a foot it is $110, $120.

And depreciated at 2% you can see the major gallop that depreciation has just by doing the right thing.

We're not increasing the rate.

We're just increasing the total amount that's of a significant amount.

So good news on interest.

I think we're going to at least be for the year comparisons on our short and we will still always run 100, $100 million or so a quarter but it's at least comparisons will be better and if interest rates drop, that will be a help.

Depreciation I can't tell you there's good news on the earnings side but there is good news on the cash side from [inflation].

And we do think that inflation for chemicals, electric are moderating and we know what our labor costs are and I explained our benefit costs so you can see we think we will be back on the old traditional 4 to 5 range but not anywhere near the 8% increase we had this year.

Let me take two more seconds on that.

I told you on the South we were going to try and drop 10% on our what we call our efficiency ratio and get down into the low to mid 50s.

Whereas we are already in the low 30s in Pennsylvania and it's tougher to squeeze there but we continue to try.

And the North we're in the 40 range where we continue to look for synergies and we could use some more revenues to weather that would help us right there.

Let me give you -- taking out waste hauling, which I think it's an 85% business.

Last year if you look at our numbers you will see we brought in about $5.5 million and spent 4 to $7 million in expenses; that is the dumping cost, the labor cost, the truck cost, the gas cost and so one, insurance.

You ration, your margins are only 13%;

O&M ratio being 87% so you see how that skewed that in next we're going to double the size of that business from the standpoint of revenues just because we'll have it for a full year and some growth.

The O&M expenses will hopefully moderate a little bit and we're hoping to drop that to a -- get a 15% operating margin or maybe 5% efficiency ratio and the bigger we get the more efficient we should get.

But taking that out and taking New York Water out because it is unfair to compare '06 to '07 with one big chunk in there, a considerable amount of revenue, there's $23 million and revenues and that's about 5% of our revenue base.

But the O&M to revenue ratio in New York and believe me the deal is accretive and we're making money but it costs more to do business in New York -- is right now 45%.

We think we can do better than that.

That's probably about 10% higher than our normal northern states so we will take a look at that as we look for synergies.

And then I think in fairness when I compare it to '05, you have to take out about $3 million a year in stock option expense after taxes which we incurred.

And one comment on stock options, we believe stock options are what make our employees work a little harder than what the typical utility employee and it's where they are going to build wealth if we can get this shareholder value up.

And we're not excessive but we continue to give options.

We just awarded them this week at our Board meeting.

Total options for the entire company are 0.5%, less than a half percent of our total shares outstanding and I think most companies are shooting for 1%.

So you see, we are not excessive in them.

But we do think it's an important role but that will stay consistent going forward in these stock option expenses but it hit '06 and will hit '07.

If I take options, New York Water and waste hauling out of the numbers, these are the numbers of O&M to revenue on the base business.

In '05, it would have been 40.9; in '06, it went up to 41.1; and in '07, we think it's going to be back down to 40.8.

Now that's total.

If I take the three out options, New York Water and waste haul, and levelize it, '05 would have been the same, 40.9. '06 would have been 40.2 and we're looking at next year to be around 39.3.

So you can see we're back on that trend of trying to get 100 basis points out of the core business.

A lot of that's going to depend on how well we do obviously in the revenue side, growth and rates, but also how well we do -- and how capitalizing on all these changes we made this year to make one company and make it more efficient.

I think that really gives you an overview of the business side, the depreciation factors and the interest.

And I think it's important to recognize that a year is the year.

I mean the weather was the weather and although we're having a terrible by the winter in the sense of main breaks, almost double the number of breaks we had last year and ironic warm and then very cold winter and that's hurt us in the north.

And there will be some extra expenses in the first quarter because of that.

I don't want to imply it's going to have the roof cave in but I'd rather have less breaks than more breaks.

But other than that, we will see what we do in the next two quarters, Q2, Q3; that is where really the weather makes the biggest difference as to [sales].

But once the options are now baked in, the interest is now baked in, it should go up a little bit but not drastically, we're going to have more and more lag due to depreciation but as I mentioned to you, that is good news in a sense because you get it back with cash.

We're in great shape with our equity and our debt financings and our capitalization structure.

And I think we're well positioned to be an efficient machine with the changes we made this year.

But we will never be able to get that back.

Our new base is basically that -- what we did the this year $0.70, $0.71 add a little bit for weather.

But we think we can build on that and get right back just like you saw the 17 to 19 we think we can get back on that track for the next year.

We always say [4-7-10-5], the pipeline is full.

We think we just did Sea Cliffs.

We think we will be in good shape for the customer growth side.

Rates will be the biggest determiner of whether we do 7% plus on the revenue side exclusive of New York and the hauling because that is a given.

And then of course keeping expenses in line and interest in line and depreciation accommodated for is where we come up with if we can get to the 10% on the net income level which with the fewer and fewer shares needed now to run the business, means we won't have as much dilution on EPS versus the net income.

I feel pretty comfortable we're back on track to be a consistent machine with that model that we've set 10 years ago that we were able to do almost flawlessly up through this year.

And I think we've digested all those rapid acquisitions we did in '03 and '04 and '05.

Sorry for the length, but I thought I would give you a full year of year-end recap and answer any questions you have.

(OPERATOR INSTRUCTIONS) Michael Gaugler, Brean, Murray Carret & Co.

Good morning, Nick.

Congrats on the nice quarter.

Just one question and it sort of revolves around the acquisition activity that we've been seeing recently in the State of New York.

There has been some transactions outside of the ones that you've been able to put up.

Perhaps you can share a little insight as to what is driving that market at the current time and what your outlook is going forward?

Are you talking about just New York?

Just New York, yes.

Of course the New York Water was a negotiated deal with us and the owners of New York Water and they were a willing seller and we were able to get it through very quickly.

The Sea Cliff was one that came to us late in the year and we were able to turn that around.

We don't own it yet because we're now in the process of asking for approval but we are confident we can do as well as we did with New York Water in closing it.

So four to six months we are hopeful that we will be running it and then of course at that point it's such an easy -- it's 18 miles or less from New York Water so it is really all on Long Island.

That came to us from Aquarion.

Aquarion had been contemplating a deal with -- I'm sorry -- Kelda owns Aquarion with Macquarie which is a private equity firm and they had two properties in New York, one was offered to us, the other was offered to United because of proximity of our existing assets.

And of course had we not bought New York Water, we wouldn't have had the chance to buy Sea Cliff.

I can't comment on why they were offered to us but they were and we were able to close it very quickly.

Do you see additional opportunities in New York in the future?

First of all we understand what the commission expects.

It's always good dealing with a very professional group which they do have, well staffed and experienced people.

It's very clear what their rules are.

That's -- all you really need in the regulatory arena is predictability and a regulatory compact that you know if they say this they will do that and that is what we are expecting.

There's a new governor.

There could be new commissioners but at this point we've dealt with the current commissioners and the staff and the staff usually stays no matter who the commissioners are.

Thanks, Nick.

Debra Coy, Janney Montgomery.

Good morning, Nick, Dave.

A couple of questions.

Dave, first back a little bit on the Texas thing.

I frankly don't entirely understand how the O&M ratio has been yanked around because it sounded like you were trying to assign expenses actually with revenues with the deferrals.

Without having to go through all the details, what I'm trying to understand is whether we've seen an usual benefit from that?

And Nick, you kind of threw out a 40.8% target for '07 on the O&M ratio, I presume including all of these things, does that include where we end up on the true up if you will on Texas?

Yes, the 40.8 was everything including hauling in New York --

Right.

Stock options.

Stock options and everything else.

It would be 39.3 without it.

And that includes the true up Dave gave -- that is the final Texas order in their right?

Yes.

Okay.

So that is -- with all of those you things.

So you are still -- if we take New York and the other stuff out you are still looking at a further improvement in Texas going forward?

Yes because the revenues will be coming in and we're growing and organizationally we're getting more efficient.

It's been three years and I'm still trying to understand the accounting, Debra.

So don't feel bad on the Texas.

What I tried to do is ask for apples-to-apples and that is what I was -- when I subtracted everything.

And that is what I was trying to understand as well so thank you for that.

My other bigger question and thank you for the discussion on depreciation and CapEx because certainly that has been an interesting trend.

I was reading through the K quickly earlier and the number that you threw out there in the K for CapEx for '07 is $236 million and you just gave us a 240 to 250.

And obviously I mean the thing that was curious to me is that we are seeing that significant drop off.

I mean 236 would be a little below where you actually were in '05.

It sounds to me like you are looking at CapEx moderating not quite as much in '07 as you had earlier thought?

The reason for the difference is carryover from '06 that we didn't get done that will be billed in '07.

So the 36 I guess (indiscernible) in the K is the exact number that we've looked at as new projects.

You always have that.

You can never pay everything on December 31st so there is always some cash going into the next year which is Bob? -- We were at 271.7 in 2006, right?

That was the actual expenditure.

(multiple speakers) -- and I gave 240 to 250 which is --

So it's about what we would actually expect to spend in '07?

I think what happens is you're asking people to estimate a year in advance and put it into a budget so the accounting group can put it in there.

I've very seldom seen a capital budget come in under.

It's always over.

Just knowing the utilities and how the engineers handle it.

So I guess I gave myself a little bit of cushion there, not a whole lot.

Okay.

And obviously the specific number for our purposes doesn't matter quite so much.

Kind of what I'm getting at here from a big picture standpoint as I listened to you talk through this this morning and clearly we are still absorbing the much higher depreciation rate and even though it helps you on the cash side, investors are still looking at the GAAP bottom line if you will.

And you kind of ended up saying we're back on track for our 4-7-10 plan.

Certainly as you very well know the estimates for '07 on the company are more in the 12% to 15% EPS growth range because of the anticipation that we bounce back assuming normal weather at an above average growth rate.

I'm kind of hearing you say that you have enough headwind that you are still dealing with on the D&A sided that could be a little overoptimistic?

I know you don't give specific guidance but --

Let me put it this way, if we had the same reversal of what -- other than the depreciation -- if we had a reversal of what happened to us in '06 versus '05, i.e., interest rates dropped drastically, inflation were to go down just as it went up 20% in chemicals, it not only stays flat but goes down, oil prices go down.

Then I would have no problem saying we will get all what we lost in '06 and add it to what our normal growth would be in '07.

And therefore double it I guess you could argue because we'd didn't hit our normal target this year.

I just don't feel comfortable telling you that is all going to happen.

Now we may get much better rate cases than what we are budgeting.

We may get interest rates -- we may pick up a penny or two on interest rates because they are down versus up.

We may pay a little more growth than we thought and so on but as you know I'm a little more --

It will be hot all summer and never rain.

Right.

There is a lot of reasons why I'm nervous about saying we're going to grow 20% versus the normal 10%.

Assuming everything else is baked in and not changing, we're comfortable with the 10%.

I guess that is a better way a saying it.

And because we still have to make up for the depreciation which is growing very rapidly, on the other hand the good news there is it is real cash and the other good news is we are using more retained earnings each year to support our capital as a percent than we had been in the past which means we have less stock to float still earned --.

I always show that model in our presentations that if we close (technical difficulty) share stock at (indiscernible), we get 230 back.

Well if you float $23 worth of the retained earnings it doesn't cost you anything and you're still getting that same 230.

So it's good news in that sense and that will start picking up as we get more and more efficient again in the depreciation to the revenue side.

Right.

And that is the ultimate bottom line and it sounds like what I'm hearing also is that barring another sizable acquisition, you're not seeing the need for significant equity issuance in '07?

We're going to probably bring down some -- Dave, what are we still sitting with -- 2.5?

From your forward offering?

3.5.

We have a 3.5 on that shelf which we don't see us doing anything but pulling that down and that could be over a year or two.

I think there is a rule -- I think we have to at least acknowledge a year from now and then we can extend it but they don't have to give us the extend -- theoretically.

At this point I don't know why they wouldn't.

And that is going to be plenty for the next two years.

Maybe a couple of million this year or in any case some of it this year and some of it next year?

Right.

And that is why I said about 1.5% dilution versus the 3% this year because if you take -- let's say you take 2 million shares on 130 million shares out -- 133 million shares outstanding, you see where I'm coming up with the 1.5.

Okay, that's very helpful.

Thanks.

Selman Akyol at Stifel Nicolaus.

Good morning, thank you.

CapEx for the quarter, how much was that?

CapEx for the quarter, Bob?

We'll go pull that out for you and we'll compare it to '05.

Let's grab that from the book here.

Okay and then in terms of '07 in rate cases, I know you guys said you had nine cases filed and you're going to have an additional 32.

Can you give a dollar amount on what you're going to be filing in '07?

We have about 10 million sitting out now in that nine cases and another 70 in the 39 2 file.

Now you never get 100% of what you ask for in most cases.

I don't want to imply you should plug 70 in but we usually get a considerable amount of what we ask for.

The last quarter was about 88 million. (multiple speakers) how it ramps up at the end of the year as projects are trying to be completed.

That would be a run rate of about 350 versus 250.

And then -- you talked about reserves and some were held back in terms of I guess that you were able to reverse this year.

I guess to quote you guys said it assisted results.

Can you give us a dollar amount or an EPS amount on that?

Yes, I would say it is in the financials under the Texas rate case.

It was a little over $1 million of reserves against the expense deferral and about $1.5 million of reserves against the billing.

So it was a little over $2 million probably in the neighborhood of (technical difficulty)

Which of course was taken out of the first three quarters.

Another way of looking at it.

It's actually the first couple of years of the Texas rate case.

Right.

Okay and then just one last question here.

On the forward sale agreement, do I understand you correctly so far you've taken none of that down?

We did 5 million I think, right --

3.5.

3.5 left.

That's what we did and we did some long shares as part of those offerings as well.

On the short offering, the forward offering was 3.5 million shares.

Oh that's right.

The other 1.5 million was regular equity -- we did in October was it last year?

August.

We did 5 million shares, took 1.5 million to capitalize the Pennsylvania rate case basically and turned that short-term debt into equity on long-term debt.

And then we put the rest on the "shelf" I will call it to be drawn down whenever we need it and so far we've been able because of the cash flow coming in we haven't needed it.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS) Ryan Connors with Boenning & Scattergood.

Good morning.

It's a very detailed call.

I don't really have too much left.

But just a quick clarification when you give the number for 20% for '07, is that just the depreciation line or is that depreciation and amortization lines combined?

Depreciation will be about 4 -- depreciation just depreciation.

Just depreciation.

Amortization has not gone up. (multiple speakers) The run rate on amortization is 3 or 4 million?

Yes.

That is all I have.

Thanks a lot, guys.

That does conclude the question and answer session and today's conference.

We thank you for your participation today and you may now disconnect.