Essential Utilities Inc (WTRG) 2007 Q1 法說會逐字稿

Good day, everyone, and welcome to the Aqua America first quarter 2007 earnings conference call.

Today's call is being recorded.

For opening remarks and introductions, I'd like to turn the call over to Christopher Purtill.

Please go ahead, sir.

Great.

Thank you, Robbie.

Good morning, everyone, and welcome to Aqua America's first quarter 2007 earnings conference call.

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 by calling Brian Dingerdissen at 610-645-1191.

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

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

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

During the course of the 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.

Thank you, C.J.

And good morning, everyone.

Let me start by, of course, the release was out and anybody who doesn't have that should call right away, and I'll try and track the release, but will start by saying the basic core business plan is on track with a number of acquisitions early this year, fueling good customer growth.

And our investment in infrastructure, predominantly to fix water quality issues in the south and a continuation of infrastructure, meaning pipes and tanks in the north and Midwest, and the resultant rate cases are really the core of our, of our program, and I'll give you much more detail as we proceed in the call, but they're on track also.

What wasn't on plan in the quarter was the, was the weather.

And we had a very warm January and just like last July I thought we were going to have a record summer, and then it started raining in August and never stopped.

We had a very warm January which surprised us, we were getting a lot of our capital work done early, and then it just turned cold and February was our coldest February in 25 years, and it was about 6, 7 degrees below normal.

And this sudden drop actually caused us much more pain than normal, a steady cold winter is actually better than this ups and downs.

We had a record number of main breaks, and just to put it in perspective, and I think you'll hear this from every water company, whether municipal or private --in our Mid-Atlantic and Midwest area where we have the oldest pipes, the most mature systems and mostly iron, which is more subject to the, the expansion and contraction.

Pennsylvania alone we had, our main breaks were up 300% in the quarter, 162 last year which was a very good year, but 520 this year.

And to put it in perspective, all of last year we had 550 main breaks, so we're probably going to exceed that by the end of May.

It's -- I wouldn't call it a normal year, it's a worse year than normal, but '06 was a great year.

Now, the good news is until the fourth quarter you probably won't hear about main breaks again because it's back to the normal, you know, so many a week, eight, ten a week.

In the north we had the same problem, although we do depend on well water in the north in some of our areas which is a pretty steady temperature, it doesn't drop below that 38, 37 degrees, where you start cracking pipes.

In some cases where we did have water plants we had, most breaks were up at least 50 to 75% year-over-year.

Now, what that really did was zoom overtime, and we had to get off capital work which means that capitalizing the labor, and on to expense work, which means 16 main breaks and repaving streets.

And when you look at the combined, just in the north and the Mid-Atlantic, it probably cost us over $1 million or, you know, close to, close to three-quarters of a cent right there.

Ironically, the cold snap started when the Punxsutawney Phil, which is our famous Pennsylvania groundhog, said when the winter was over, and it turned out being the worst.

And now April it's been the rainiest April in -- the second rainiest April in history in the Mid-Atlantic area, at least, with rainfall about 6 inches above normal.

Now, the good news is all of our reservoirs are full and it wouldn't have to rain all May, June, July and August and we'd have plenty of water to serve people.

And flowers are growing and, hopefully, as we start May and it starts getting warmer and dryer, then people will start using the, our product to keep those, the flowers good.

But I'm not worried yet about the quarter because April usually is a pretty steady month with rain, but then it, it gets drier towards the end and that's when people start using gardening water.

We will just probably pick it up in May.

But when you pick the weather impact and you couple it with a onetime gain we had because of -- it was real cash we got, but the way you got it was we had a deal last year that we broke-off in the first quarter, we received $1.5 million, which was all obviously in the Q and the K, of what do we call it, Dave?

Walk away, or whatever?

A fee, fee.

$1.5 million fee.

But the way the accounting treatment was it reduced expenses rather than add to revenues, although the cash came in.

So if you take that $1.5 onetimer and you add that to the weather you probably have about $0.015 difference over last year, and that's why I say our core business plan is on track had we not had those two [items.]

Now, revenues were up very strong, 16.4%, and I'd like to dissect those for you so you see where they came from.

About 6% of that increase is, was New York Water, which was our big acquisition we did on January 1, and other acquisitions that we did in the first quarter, although that was dominant.

And I also added to that the acquisition of the [Septage Hauling] business that we did last July because it's comparable, and that's about 6%, leaving 10.4% from the core company.

And breaking that down, about 1 to 1.5 is rates and organic growth, and, excuse me, organic growth and consumption and so on, and about 8 to 9% is rates.

As you can see, the rates really have helped and that's the story for this year, also, and we'll get to that later in the presentation.

Our sales to our industrial was pretty steady, up a little bit.

Of course, rates also made the revenue stream go up.

And our organic and consumption was pretty steady.

We've seen a little drop-off in housing starts in the north and Mid-Atlantic, although that's not our big organic growth area anyhow, but they were off maybe 10, 15%, for example, from about, you know, maybe .91 down to .8, something of that [inaudible] growth.

The growth in the south has continued.

North Carolina looks like it's on track for another 6% year and Texas for another 5 to 6% year.

We have not seen the slow-down in building in the southern states, mainly because we're in the suburban and I guess that's half vacation area, so maybe that has not slowed down as much as the traditional urban or residential housing.

And our new mix, by the way, with the rapid growth of over 50%, we basically were since 2002, you know, in that last five years, we've grown 50%.

We've had some growing pain, but also shifted our demographic mix much more to residential which is a much more weather oriented variable but a much more consistent cash flow because of the fixed charge, you don't have to worry about industry going up or down, or whatever.

And the new mix, just for your facts, it looks like we're around 75%, almost three-quarters is now residential.

The remaining 25% breaks down into about 20% of it is, or 17% is, oh, about 3% to 4% industrial, and then the rest is the basic municipal charges for fire hydrants and so on.

It's a very steady stream.

And if you take that very small 3 to 5% industrial it actually was pretty steady, up a little bit, so that's good news, that means that production and manufacturing is doing well in the north because that's where most of that is.

And then the commercial is much more economic sensitive at small business, apartments, and so on.

I'd like to note a couple other areas on the expense side, just to give you an idea of where we are now and where we're going, and then get into the growth side.

The -- excuse me -- the depreciation was up 20% in the quarter, and that represents $0.015 right there.

And, of course, we get it back in rates, it's just the lag that costs you and some of it is already being picked up in rate, some is to be picked up when we get our rate cases finalized.

So it's a bad news, good news story.

The bad news is it hits EPS.

The good news is it's generating more cash to help us in our investment programs.

The -- we think, I think the growth in '07 over '06 for the full year will be running at last at that 20% rate.

This is a big year.

It's [growing,] the depreciation is, is now up to almost 14% of revenues, which is a big amount, at least the target when we were a smaller company, just in Pennsylvania, it was in the 12 range and maybe 11 range, now it's up to the 14, 15 range.

And I think it'll stabilize there and, I don't know, Dave, if you can predict if it stays in that range, 14, 15?

Yes, I think following 2008 it probably does stabilize in that range.

Okay.

It might continue to go up a little bit.

Okay.

But for your modeling I thought that would be important.

Now, the good news and we're showing in our presentations on IR, tracking EBITDA now because it has such, much more influence as to how we're internally funding our growth programs and adding to the investment potential.

EBITDA if you look at a 10-year chart has been up a [KAGR] of 10 to 11% consistently.

If you take trailing 12 through March even with the bad weather we were up 10% year-over-year.

And the 263 versus 288 would be the exact numbers.

And all of those 6, our EBITDA number was 282, and we expect it to grow a little faster this year because the rates start coming in towards the end of the year, and we think maybe EBITDA would be up in the 12, 13% range here.

But on a consistent basis I think growing EBITDA 10 to 11% is really our story.

It eventually translates into EPS, contingent upon your, obviously your depreciation and you're getting that back in rates, and your interest stabilizing which I want to get into, and your share, your share count is becoming a little more stable.

The, and let me go into that number of shares, we diluted, again about [2%].

And if you take a look at over the last number of years, you'll see a nice trend which I think, again, for prediction purposes as to how to tie your cash generation and your investment potential to the company and with the EPS.

In '04 because of the acquisitions and quick growth we've had in the Company, we grew shares 6% '05, 8%, and then it started coming back into the 2% range, 2 to 3% range in '06.

'07 I think you're going to see the first two quarters be 2% or so, and then the next two quarters be closer to 1% growth, and then it'll blend out for the year at about a1.5%.

And then contingent upon how many acquisitions we do in the rest of '07 and going into '08 and looking at our five-year model on our capital, I think you can look at the share growth to be more in the lower range, in that 1% range more than the upper range that we've been seeing.

The other thing that, of note in the first quarter, you'll see other taxes, that's not income tax, it's state income taxes.

That's property taxes and special taxes, franchise taxes, gross receipt taxes, and state, were up 47% or for, from $8 to $12 million, so it's not a big percentage, although it is 6 -- it went from about 5 to 6% of our revenues to 8 to 9%.

That's almost completely the result of two things.

One, New York Water, where in New York, local taxes are collected through the water bill and it's a huge percentage of the rates, but you do get it back.

So every dollar in this increase we're getting back in revenue, but obviously it doesn't help your O&M to revenue ratios, your efficiency ratios, the SKUs, and all that.

The [Perta] was a -- we challenged the tax and we won that case, but it was in place for a year and it's the second phase, it comes in in July, and so it came in July of '06 and ends July of '07, but it's a comparable couple million dollars there.

And we are collecting that as a surcharging rate, and then we won the appeal at the county level, so that, that rate will be in fact lowered and more realistic as we go into the next fiscal year for the State.

But I just wanted to note that since it's up so much.

The interest, which this is a twofold story, as we continued to grow, continued to invest in infrastructure, continued to buy acquisitions of considerable amount, like the New York Water and Sea Cliff, we just announced a few days ago at $7 million, New York Water was $50 or so million, deals, we have to obviously fund that with partially equity, partial debt, so we had -- interest was up, but the other issue was interest short-term rates, which we tend to use a bit and then convert them in the long-term right around rate cases, and carry them in the short-term.

That has not been as, in the last year, positive because short-term rates have gone up so, so rapidly.

Now, the good news is that rapid increase ended in the third quarter of '06, and it's been pretty stable since then.

We have not been stubbornly stable, we haven't seen it go down.

Just to give you a quick comparison, it's 4.

6 first quarter of '06, 5.

3 is what we're paying, at the first quarter of -- it's still pretty good -- at the first quarter of '07.

I think it's 60 basis points.

Now, what we've done is we've lowered our short-term debt carry from the 150 range down to the 100 range, you'll see that in the Q, because we felt at this rate we could put it in the long and probably do just as well in long, and that's what we've done.

So you'll see our long went up from the that 9.50, 9.41 last year, up to 10.90.

Some of that is new, new capitalization for acquisitions and infrastructure, but some of it is, about $50 million of it is a shift from short to long.

Now, the good news is the long-term debt is costing us almost in some cases less than the short-term.

We borrowed $50 million under an IDA in Pennsylvania in early January at 4.3, so that's better than the current carrier of the short.

And we've, with all the various states at the parent and at the various states we borrowed another $50 million, [corporate] unsecured, and that was -- I say unsecured, Kathy, it is all unsecured?

It's not indentured, and it's 5.7, so pretty comparable to what we're paying on the shorts, so we may as well go long, and that's what we've been doing.

And when I say go long, it's not five years.

We've gone long 30 years in most cases.

So that's a management shift that we made, started to make late last year just to protect ourselves in case shorts kept going up.

Now, if they start going down we'll start probably using the short again heavier.

We've stabilized it pretty good.

And the good news is when you look at our embedded cost of debt, we probably have one of the lowest in the industry, and also with the electric combined, and we were in the 8 range way back.

We're down to, last year we went under 6, and this analysis, latest debt, if you look at our run rate at the end of March we're down to 5.65; is that correct?

5.65 is our new embedded cost of debt on all our $1.2 billion of debt.

O&M expenses, if you look at the O&M expenses you see they're up 17.5%, which was very disturbing.

But I drilled down on it, where they are, at 17.5, but first you can take 6.5 off right off the bat which is what we'll call our acquisition, that's New York Water, you had to add expenses if you're adding the revenues.

And, also, the year ago we did not have the unregulated business the [septage] business, so taking that out that's 6.5%.

And then 3% is that onetime $1.5 million deduct last year from the expense side on that waiver of a contract.

And if you add that back in that's worth 3%.

So you really are looking at an 8% year-over-year cost to run the same store business, which is still too much, but I just wanted to give it, put it in perspective.

Of that 8% most of that labor, labor and production costs, chemicals and electric is probably over 60, 70% of it, let me just drill-down on those.

You also have bad debt, which was up slightly in the first quarter.

Insurance, we had a claim or two, so that was up.

But the bulk of it is labor.

And if you take the labor and look at it, it was up 8 to 9%, way too high, but the core amount was only up 5%, which was salaries, benefits, healthcare costs, pensions, which I think is not way out of whack, especially with healthcare costs with the rest of the world.

The other half was basically the overtime that we had to put in because of the main breaks, so we'll see that coming back down into a more reasonable range in the rest of the quarters, where we don't have main breaks to influence it.

Production is a different story, it's stubborn.

The chemicals, although we think it's, they're going to start levelizing, we've had one more quarter because they started really going up rapidly.

I'm talking about chlorine costs, caustic, a lot of that's because of the cost of oil that goes into the production of many of these chemicals, and natural gas, and so on.

So, and just basically you're able to raise the prices, you hadn't been for years, so we're starting to see a levelizing, but the chemicals are still going up year, over -- quarter over quarter I think they were up 15 to 18%, so it's a pretty heavy increase, not because of usage but because of pricing.

But we see it -- we're starting to see some light at the end of the tunnel there.

Electric is basically we're in states that went deregulated, and I'll give you an example, now we've locked in prices for two years, so you're not going to see this rapid increase, but First Energy where we got our energy from on our western Pennsylvania and Ohio operations, the electric piece, the generation piece, was up 68% year-over-year.

Luckily, Pennsylvania is still, pretty stable and that was only up 4 or 5% so it kept the overall increase up.

We did negotiations in Illinois and got about half of what the [collar] went up, which was 50, and we ended up with a 28%, that's still a huge increase but there, again, locked in for [two] years.

So I think you're seeing that now the hit on that probably is going to be stabilized.

Well, all of these obviously affected our first quarter.

A lot of one, onetimer, the weather, which hopefully we don't see another crazy winter, I'll call it, than like this one.

And they've had some affects on the O&M, the revenue ratio, but we're still doing pretty well.

If you take the onetimer out, not taking weather out, but take the onetimer out, [inaudible] I think we're down to about 100 basis points, year-over-year?

If you, if you proforma that $1, $1.5 million out?

Yes.

Okay.

So we're on track to try and get that down.

We made our change in the south.

That's where most of the new [inaudible] will come from.

Hopefully, the chemical costs and electric will start stabilizing, which will help us.

So I do, you know, although I spend a lot of time on the costs and the, you know, the capitalization of the Company, I think most of those challenges, the capitalization, especially with what you're seeing, we're getting in debt and the fact that we're not going to be floating too much more stock because we're generating cash internally, I think you're seeing our time, my time is much more going to be spent on the other side of the Company, which is the growth side.

And I think when you realize that since we grew 50% over the last three, four years, a whole new organization in the south, a lot of small systems, a lot of environmental problems, you can see why a lot of time was spent.

But now we're in the final stages, the President there, he's making some changes, we're going to see some cost cutting.

And the key is capital, excuse me, getting the capital in rates that we've been spending.

And that's, you know, [inaudible] this year, while we continue to grow.

We've had a good first quarter with New York Water, Sea Cliff, and [Lake Holiday] and Virginia.

We just announced a 700-resident system in Florida.

It's our first one in Florida.

And I think you're going to see a lot more acquisition announcements as a result of the southern states, now that the management can go beyond fixing their environmental problems and filing rate cases to start looking for the kind of growth that we've been seeing over the last 15 years with the core company in Pennsylvania.

Illinois we have a 10,000 to 12,000-person municipality that we think will close in the summer, and we still have the basic organic growth coming out of North Carolina and Texas to provide air cover.

Rates continued to be the big story.

Rather than going through too much detail on it, we'll give you anything you want and [inaudible] call.

[Kathy Pace] is available for any questions.

But just to summarize it, we've had some very good rate cases.

North Carolina, excuse me, New Jersey in early January, 12% increase, [$2.5] million.

Illinois, 20% increase in Kankakee, $2.7 million.

Monticello, our biggest operation in Virginia, 126% increase, $2.5 million.

In Ohio, our normal indexing, half a million.

So, basically, about $10 million already beyond us and in rates and moving ahead.

We have cases filed and we will be filing other cases this summer in North Carolina and another case in Florida, Indiana, Illinois, which represent about $30 million.

And then later in the year two big cases, Pennsylvania and New Jersey, which represent about $40 million.

So you can see, this is a big rate year in [ASK] in the filing.

We've been doing very well in percentage received of what we asked, based on our budgeted amounts.

And, but every time you expose yourself to a rate case, it's work, especially in the south where we're not asking for 10% rate increases and where we're asking for 100% increases.

Now, once we get them, we're stabilized then, and then we're going to be into a situation of how fast can we grow, how much can we cut expenses, because they're not going to be the capital drain like the north in the sense of old pipes.

And they actually could start generating cash if we [build] fast enough and keep our costs down, but not until we get our base amounts and rates, which is [filed] in '07, some will come through in '07, most will come through in '08.

And at that, at that point the shift will be to the more periodic, every other year rate cases, and where we are putting most of our pipe work in.

So I'm seeing a light at the end of the tunnel on the expense side.

Obviously, [inaudible] and you predict inflation, and we can [inaudible] to the T, but I do see opportunities for growth and I do see the south making that turn at the corner to become more of a growth engine in addition to a revenue source for -- because of the rates, covering the depreciation, covering the interest we've put up and so on.

A huge amount of capital, but that's starting to wane in '07 and goes way down in '08.

Open it up for questions?

[OPERATOR INSTRUCTIONS.]

We'll go first to Debra Coy with Janney Montgomery Scott.

Good morning, Nick and Dave.

Good morning.

Nick, just to follow up on the comments on the higher taxes.

If I understood you -- and a couple of other smaller things -- if I understood you correctly the higher tax rate coming out of the New York operation should impact through '07, but then drop-off in '08; is that correct?

Yes, for quarter-to-quarter and year-to-year comparisons, because we get a $1 for $1 back.

Uh-huh.

It -- obviously, it elevates the O&M to revenue ratio because every dollar you spend you get only $1 back in revenue, not, not 60%, not the 40% ratio we usually go after.

The [Perta], which is Pennsylvania, which was unique, again, is $1 for $1, but we don't know what our final bill will be this year but it'll, it should go down mainly because of that reevaluation.

Okay.

I think I understand that.

And then, and then coming back to what you said as you ran through the rate cases with a lot pending, that the cases that you filed, you said it's bout $30 million, do we expect any of that to come through in '07 or is most of that into '08, as well?

Well, let's see.

Obviously, any of the surcharged ones come through.

Right.

And that's, but Kathy, I think -- Kathy is here, too -- the North Carolina, the Sarasota, the Florida case might come in towards the end of the year, I guess, the second phase, or not?

It'll be in the beginning of '08.

'08, beginning of '08.

And the Illinois case would be the beginning of '08, and we're filing that in June.

They usually take, as you know, Debra, they usually take 9 to 11 months.

Yes, uh-huh.

I'd say most of this flows in in '08.

And your big pending filings in New Jersey and Pennsylvania, the $40 million?

Right, and they're usually -- we always usually file those in the November, December timeframe and this is a cycle when we will be filing those.

So the, so this would be, we would think about getting those sometime around the middle toward the end of '08 for the big cases?

Yes, if you, Pennsylvania is pretty consistent and if you settle it'll be June, July.

If you don't, it'll be August, early September.

New Jersey is not as consistent.

This last case, although we -- I think we were treated very fairly, we got a 12% increase, but it ran an extra six months, and I'll tell you why.

Because the [GX Exalon] merger backed everything up in New Jersey, and the IPO announcement on the American.

Assuming we don't have any of that going through, we might do a little better and get nine months.

But what's the official time.

Theoretically, you should have it in 9, so if you file in November you should have it by September, August, September, but it doesn't always work that way.

Okay.

Fair enough.

And my last question is I actually thought you did pretty well on the operating expense line given the additional main breaks and so on in the quarter, and if we assume normalized weather and we get rid of some of that, can we, do you think look at crossing over into an improved O&M to revenue ratio relative to last year as we look ahead, or do you think that we're still going to be lagging a bit behind?

Well, I'll tell you, if you allow us to adjust with that $1.5 million which was a deduction in expenses versus a onetime gain on the revenue line.

Right.

Because of the way accounting is, and we would take out the -- I think you'd want us to take out the unregulated, the [septis] businesses, that's an 85 [inaudible] business.

Right.

And New York Water is just one year it's in, one year it's out, we could take that out just for comparison, I think you'll see that O&M revenue, O&M to revenue start dropping.

And then I think '06 was about 40.9 without -- yes, 41, so we're looking at about 40.

Yes, I think, I think you'll start seeing that old trend where we used to say we could take 100 out.

Now, that's all assuming that we don't, you know, have new spikes in electric, new spikes in chemicals, but I think we're over the hump there.

Okay.

That's helpful.

Thanks, Nick.

Thank you.

Thank you.

We'll go next to Ryan Connors with Boenning & Scattergood.

Hi, guys.

Hi, Ryan.

I just actually had a couple kind of high level questions on acquisition strategy.

Number one, you know, just kind of looking at the geographic focus, you know, it seems like obviously the northeast has its own attractiveness from a grow the rate base, you know, capital investment point of view given the infrastructure problems, but clearly the south has a -- is more attractive from an organic customer growth standpoint.

So I'm just wondering if now that we've added a major piece in the north in New York, does your focus kind of shift back toward the south to try to offset that or is that not the way you think about it, or if you could just talk about your regional focus there?

Well, we have to, the answer is absolutely correct on the, on the -- we're trying to get the south to support itself, and having the organic growth actually, plus net income, actually outweigh the need to go in for rapid rate increases all the time because bottom line the rates are already up there.

I mean because it's small systems and inefficient, so that's our strategy.

And then to grow organically, but there's also a lot of opportunities that we're seeing.

Florida, now, now that we're looking, there's opportunities there.

We did the one in Virginia.

We're looking at another one there.

There's two or three in Texas we're working on, in addition to the organic growth.

And management in fairness to them, didn't have the time to go out and hunt for new stuff until they fixed the old stuff, and we had a lot of fixing to do.

[Aqua first] did not leave us a well, a well oiled machine.

Having said that, I think we're, you know, at the [seven-eighths hole] on the fix-up.

We're probably at the half mile post at the rate base in the south -- I'm sorry, not rate base, but rate cases.

I mean they're -- they know what we need, they're filed, we're doing depositions, but it's another six months to a year before you actually get the dollars.

In the north, part of -- I mean we just have to fix the pipe and that is a routine, the surcharge, and that also helps, as you know, it helps your investment, too, your earning.

But on the acquisition side, what we're seeing in the north -- so I don't want to rule out that you'll see ones in New York, Pennsylvania, Ohio, because what we're seeing there is mainly municipals are looking at whether they want to stay in the business mainly because of the, you know, pensions, liabilities, all the kinds of things that all businesses have been facing up to, the municipality is starting to see now, healthcare costs.

And so we want to be a player.

We bifurcate or we segment, I should say, the opportunities in the north.

We're not looking at the big cities which was the old United and [RWE] strategy of operation and maintenance, and we're not looking at overpaying for a new large facility, which I think you'll see a lot of activity on with private equity and maybe some of our sister companies that would want to buy a big one to have to pay-up for it, for a base.

You know, as you know, we're considered frugal, that's why we walk away from a lot of deals, that's why we got that $1.5 million a year ago and ended up with two good properties at like 1.2 times rate base versus 2 to 2.5 times rate base.

So we, we won't be competing in that arena, but we think the sweet spot is really these 10,000, 12,000-person, you know, municipalities, small cities, townships, where, that's where we're concentrating our effort.

Okay.

Great.

Well, I had two or three questions on acquisitions but you pretty much covered them, Nick.

Thanks a lot.

Thank you.

We'll take our next question from Jim Lykins with Hilliard Lyons.

Good morning, everyone.

Hi, Jim.

I know you guys have kind of talked about your opportunities on the north, but I'm just wondering if you're making the Sea Cliff acquisition, if that's maybe just kind of indicative of what we might be able to see in Long Island?

If maybe you could just give us a better sense on what you, what opportunities you think are there?

Well, unlike some companies who say they don't like to do business in New York, we're finding New York tough to bear, and we know what the rules are and as long as you can follow them you make a good profit for your investors while also keeping rates reasonable.

So they're throwing things at us that we're looking at every day, some are small privates, they don't, aren't doing their job now, and they'd like us to look at them.

We have to get our consolidated rate base up there so that we're not running, you know, 15 companies but one company, and that'll help with that, just like we do in Pennsylvania, so you can pick-up some of the small ones.

But, yes, I think there's plenty of opportunities.

There's not growth opportunities in New York.

It is the second largest State in the country, and there's a lot of people in New York.

And, therefore, I would consider it a premium annuity, is the way I'd look at it, if you run it right and you invest correctly, you should be able to pretty much guarantee your investors a fair return, and that's what we're looking at.

So I think they respect us because we go in, we do what we say, we fix it, and we don't ask for rates until it's fixed and we make our investment, and that costs you a little money in carrying costs, more when interest rates, short-term interest rates are high, but it gets you long-term credibility with the regulators.

Okay.

And the 25 to 30 acquisition target that you guys have, do you still feel pretty comfortable with those numbers?

Yes, I couldn't understand that, Jim, you said 20?

You guys have kind of thought you'd be around 25, 30 acquisitions for the year, do you still feel pretty comfortable with that range?

Yes, but I, I would concentrate more on the percentage growth, if we only did 20 and grew 6%, that's better than doing 30 and only growing 4%.

But whatever it takes, we're going to do it, and we have plenty in the channel.

So, yes, I think you'll see us in the 20s.

Okay.

And one last thing, can we just get the CapEx number for the quarter?

Sure.

Capex, do we have that?

It probably slowed down and it was probably good in January and it slowed down after the cold weather hits it.

Our, our goal this year is 240, it'll probably run a little higher than that, but if we do -- and this, the first quarter was 60, so right around target then.

And you came down about $10 million this quarter; right, for your projection?

Weren't you at about -- you're at 240 now?

Yes, 240 for the year is what our budget is.

You always have a new EPA rule that comes in that you just have to do.

So I'd say 240 to 250 is a good range.

Okay.

That's down from actually money spent last year.

I think our K went out with 270 last year, so you can see it -- but that's difference of $20 to $30 million was almost exclusively the south fix-up that now comes off the south.

Okay.

250 is a good -- yes, so last year was 270.

All right.

Thank you very much.

Thank you.

Thank you.

We'll take our next question from [Jonathan Raider] with A.G.

Edwards.

Good morning, Nick.

I have one question, just to clarify, I may have missed it but the onetime expenses that you had in the quarter last year, were they related to your pursuit of Acquarion?

I'm not allowed to tell you that.

But it was a large acquisition we were looking at, and in order to step aside we were, [inaudible] the contract, and they awarded $1.5 million cash, which we then used, I guess I'll give you why we would take it off expenses versus -- because we theoretically got it to relieve us as incurred expenses?

Well, I mean we don't have a line on our income statement that would be very precise for an item like that, and since it was relatively immaterial in relation to our income statement the best place to put it was as a negative O&M [inaudible].

Okay.

So that SKU's numbers, especially Q1 numbers.

It wouldn't have looked bad if we had a warm winter because we wouldn't have had all those overtime expenses and it would have been washed out, but it really did make a difference.

Right.

So if I remember correctly, we had a special item related to the, the potential large acquisition, as well, in Q4 of, I think '05 it was?

Right.

That's when we sold the [Geneva,] and it was, again, a reduction in expenses rather than a gain on the sale or something because that's the way the accounting rule said you had to do it.

Yes, that's right, you're exactly right.

Q4 '05 versus Q4 -- '04 versus Q4 '05 was that comparison.

The same exact way.

So what we'll do is in each of the quarters we'll remind and then try an rationalize it so you can get the core business.

Okay.

And I was wondering if you'd give an update as far as what you see as a targeted consolidated run rate for your efficiency ratio now.

I mean we used to look at, I guess, the core Mid-Atlantic operations, but it's clear that the Company has expanded much further beyond there.

What do you think you can get, overall utility business down and then even I guess the consolidated with the non-regular operations?

Well, Dave is looking at our long-term plan.

You're looking really for future projections; right?

Or just the year?

Yes, I'm saying maybe five, ten years out, whatever the, the goal is?

I know you guys shoot to trim 50 to 100 basis points off per year.

What knocked us off that was, of course, healthcare, which we've now gotten under control, this year it was only up 6%, and that's because we have our employees paying 20% of their premium and we've changed the plans, and we're starting to see healthcare costs at least moderating below 10%, so we've done pretty well, but we're going to, we are doing that Companywide and we're continuing.

And on the pension side, the fact that we -- because that was a big bump for a couple of years when you had to start putting your new [summations] in versus getting credits out of your pension.

And, of course, the market is going up, but more importantly, all new employees are no longer in the pension, they're in the 401(k) which makes it predictable and we get that back in rates.

And I would say probably less than 50% of our employees are now still in the [defined] benefit plan.

And we, we have the biggest chunk in Pennsylvania, are in rate, so we shouldn't see a jump.

Now, you did see a jump -- that's a -- I'm glad you brought it up.

Q1, Q2 you're going to see a huge increase in expenses, in labor, because the run rate of $8 million, I think we started in July when we got the rates last year, and a year ago, so it's being charged at a run rate of $8 million in Q1, Q2, whereas last year it was probably 6.5?

6.

6, so it's a $2 million difference just in Pennsylvania, which that variable goes away Q3, so that should help O&M revenue, but it's a wash.

You're getting it right back in the revenue side, but handed out on the pension side.

But we -- I really feel, now our next step is to look at an all out freeze, which is a drastic measure but a lot of companies are looking at that, and we have not taken that off the table, but we want to make sure we don't hurt our, our, our competitiveness in attracting the people to the Company, too, because that's what makes the Company work.

I think most of our O&M to revenue ratio [inaudible], other than those two anomalies I just mentioned, pension and healthcare, are going to come from complement control which we are very tight on.

We've expanded our customer service because we had to go from 38 customer systems to one, which is now almost complete.

As a matter of fact, the last transmittal [to states is happening as we speak,] and that meant we had to add people in computer, IS, and in the cost centers, but it's, it's stabilized now and that'll be flat.

Most of the northern and Midwest and Pennsylvania states, there isn't complement expansion, and every time we get a rate case because of, of capital additions, not because of expenses, O&M expenses, i.e., pensions, healthcare, labor, that helps the O&M to revenue ratio.

And we'll give you separate projections going out for that, like the northern states, New Jersey, Pennsylvania.

New York has a lot of room to grow in that, and we have union contracts that we have to negotiate and so on, so I don't want to overpromise but there's -- it's a very high O&M to revenue ratio in New York.

Dave, maybe you can help me with that?

It's over 50, I think?

Oh, yes.

That's pretty high for a 50,000, 60,000-customer state.

The south until we get the rates we really don't know what the run rate is, but we're still 70, 75% in Florida and even North Carolina is still in the 60s.

Texas, because we got our rates in place, it's down into the 50s and we think we can prove in all that, and that's going to be [Chris Franklin,] our new President's challenge.

That's going to be in his objectives that, to fine-tune his labor needs with, with, after he gets his rates, a September 1 priority.

And I think you'll see those numbers come down for two reasons: rate cases, but also because he's making a more efficient use of the people we have.

We'll give you a much more -- that's, that's an overview, but Dave and Bob can actually give you some firm numbers, Jonathan.

Okay.

And I mean do, do they have the numbers now, or --

I don't --

I had another point.

We'll have to look at our five-year plan and give you an idea, because you're really looking at, can we get them down that 50 to 100 basis points a year?

Yes, I mean like in Pennsylvania, I know you guys had gotten it down to 35% or so, and I didn't know if, you know, 40% is now the, you know, the firm wide utility target, or, or if that is, you know?

I think we're going to go below 40.

Yes, we, we have goals, Jonathan, but, you know, a lot of it is going to depend on the kinds of [inaudible] that come to the table; right?

When we look at, just looking at 2007, for example, there's probably 100 basis point difference in our O&M ratio just extracting some of the new growth, that we brought to the table, that is less efficient than the existing company.

So the efficiency of that growth, i.e., there are a lot of customers in a tuck-in and suburban Philadelphia versus a new standalone system in North Carolina.

There's a tremendous difference in efficiency.

So I expect the Pennsylvania Division and some of the northern Divisions to continue to trim away at the O&M ratio as they have fairly consistently in the past.

You know, again, depending on where the growth is we may get some push-back on that in, in some of the southern Divisions to alleviate that trim to some extent.

I expect it will still come down, but perhaps not at a rate as it has in the past.

Yes, you're too young, Jonathan, but that old guy, [Tim Leonard] will remember.

When we were just Pennsylvania, we said we thought we'd get down to the -- we said it would probably reach [inaudible] level at around 35, 36.

Why don't we just pick out Pennsylvania.

I thought you were 33 in Pennsylvania right now?

Yes, I think we've gone below that.

Yes, so I think it's doable even in the older states, as long as you have a lot of capital and you don't let your expenses go up, but nobody expected pensions to go crazy and nobody expected healthcare to go crazy.

That blip is over, and I think we're back on track.

But I think because our revenues we can dissect by, by region, we'll do that for you in the O&M.

You probably can gauge it yourself, and you'll see, it's New York that has the most potential for trimming and it's, it's the south, all across the board.

Okay.

And you mentioned, Nick, that I guess, you know, some of the expense comps will get easier in Q3, do you believe that assuming you get normal weather for the, for the last two months of the second quarter that we could see a resumption of EPS growth next quarter?

Yes, I do, yes.

Okay.

Then a last question, just touching on the private equity and, you know, your sister companies in the M&A competitive landscape environment, and I was wondering if you are seeing the opportunity for some larger deals right now, and if you do see larger deals do you even believe that it's possible for a company such as yourself with your price discipline to acquire anything of size or, you know, if just the competition that's out there is going to kind of bid you out?

Well, depending on what the discipline is on the private equity side, the only big ones out there would be the publicly traded ones.

I mean there are some that are 30,000, 20,000 which are nice sized systems for us and they're still privately owned.

And we're, we're actively talking to some of those, but if you're talking about the 200,000 plus type systems, which would be 20% growth for us, those probably would be in the range of the private equity.

And that's not saying we wouldn't pay a fair amount for it and maybe be the winner, but it has to have some strategic [inaudible].

We're not just going to grow for growth's sake, because I think we have a -- we can grow earnings, solid amounts, just on the base we have now, just investing and getting a more efficient machine now and getting our rates in place and so on.

And there's normal small, you know, that, that small stuff that I mentioned, there's plenty of that around, and nobody wants that.

Maybe American when they get back into the swing of things would look for it in the north, along with us, but in the south, very few companies who have people on the ground like we do that are really looking at it.

Okay.

I appreciate the time, gentlemen.

Thank you.

[OPERATOR INSTRUCTIONS.]

And we'll go next to Selman Akyol with Stifel Nicolaus.

Thanks.

All of my questions have been answered.

Appreciate it.

Okay.

Thank you.

And at this time it appears there are no further questions.

Okay.

Well, thank you, everyone for your time.

That does conclude today's conference.

You may disconnect your lines at any time.