Essential Utilities Inc (WTRG) 2007 Q2 法說會逐字稿

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

Today's call is being recorded.

At this time for opening remarks and introductions I'd like to turn the call over to Mr.

Kevin Brophy.

Please go ahead, sir.

Thank you very much.

Good morning, everyone; thank you for joining us for Aqua America's second-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 call Will [Mead] at 610-520-6309.

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

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

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

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

A 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 would like to turn the call over to Nick for his formal remarks after which we will open up the call for questions.

Thank you, Kevin, and good morning, everyone, and my apologies for the contractor, Premier Global's technical difficulties, that's why we're starting a little late.

I'd like to start by welcoming Kevin Brophy as our new Investor Relations head here at Aqua.

Kevin has been with the Company for a decade and has worked in both operations and also in one of our states as a corporate development head.

But his degree is in finance and he's also been with the IR department on two different stints during that decade and with C.J.

[Pertel] who was for a short time our IR Director for the last six months.

He just left and went to one of the investment houses.

We wish him well; Kevin has come back from Texas and is now going to be our new IR Director.

Welcome, Kevin.

I'll start by -- hopefully everyone got the release; if not the phone number is on the -- was given as to who you can call to get it.

But it was a solid quarter, we had strong revenue growth.

The weather was erratic; it was a bad April, bad May and then a great June which rounded out to be a solid quarter.

We had solid performance out of our new acquisitions, New York Water, Sea Cliff, and we had two other issues during the quarter that don't show up in the press release that are a part of doing business and that is personnel changes that, in addition to Kevin, we also lost one of our senior vice presidents.

We also lost a number of other people based on retirements and we've been able to do some reorganization.

And we're very excited about the new people that we're bringing in in the water quality area and in the production area.

And also a new treasurer which was announced two weeks ago, Steve Anzaldo who has experience in the utility field and also a new head of regulatory affairs, Kimberly Joyce, who wait got from the Pennsylvania Public Utility Commission and with that we've decided to decentralize our rate function to the states.

We've always been a centralized company because we were one state one company for 100 years and then we started branching out.

And now with the Aqua Source we're in 13 states and we're just decided with the volume of rate cases that it would much more efficient to put resources in those states and then centralize the overall management and overall policy orientation in the central office but the work will be done in the states.

That all happened in this last quarter and we're very, very optimistic as to what it'll do for future operations and results of the Company.

The other thing we did this quarter, no easy task, usually you don't hear me talking about major bias IS and customer service systems on these kinds of calls, but for a company whose job is customer service and whose job is to make sure bills are right and calls are answered it is a huge task.

We, after the accumulation of all of these properties over the past decade, we were running 27 different call centers on eight different computer platforms.

We've had a two-year program, extensive program to merge that all into three regional call centers -- Midwest, South and Mid-Atlantic -- and one platform for the coordination with accounting.

And I'm happy to say that although -- and anyone who tells you they do a system changeover like this there's no growing pains, there have been growing pains.

But we think the worst is over.

We've put the resources in place and this was the trying quarter and we basically survived it and it can only go up from here.

So getting back to the solid quarter -- revenue up 14%, expenses also up 14% but a lot of that was the new expenses that we absorbed with the New York Water and Sea Cliff and also the fact that the septage business has a higher expense to revenue ratio than our normal business which is in the 40 to 45% range depending on what region of the country you're in.

If you subtract those '07 additions that weren't in the '06 numbers, revenues were up about 8% and expenses were up about -- revenues were up overall 8%.

And Dave, help me with the expenses, 5.6?

Yes, here it is.

So you can see the expenses to revenue ratio stayed steady.

The other issue that was -- probably jumps out at you when you look at the numbers is property taxes.

Property taxes were up a huge amount mainly because most of the New York regulated water companies have huge property taxes collected through the water bill and that's why the jump.

If you take that out the property tax increase across the board was more normalized.

Interest up again, but two reasons.

One is as we continue to implement our major rebuilding program capital structure you have to borrow money to capitalize it.

So our short-term borrowings were up until we get into rate proceedings at which point we turn those into equity and long-term plus the carrying cost for New York Water and Sea Cliff were not in last year's and that was they were both significant acquisitions for us.

Good news on the interest front, this will be the first quarter in almost three years going forward that our LIBOR spread rate of about 5.3 will be equal to or less than what it was the prior year.

Every quarter we've been working off of almost a 100 basis point increase year-over-year because of the rapid rise the Fed did from a low of 2.5% up to over 5.5%.

We're now right in the range, assuming the Fed does not raise short-term rates, and if they actually go down they will go the right way for us (inaudible) year-over-year.

So that's the good news on the interest and the other big jump, you'll see another 18% jump or so in the depreciation.

I guess that's good news/bad news.

The good news is the fact that that means we're going to generate more internal cash, the bad news is that it affects P&L in a non-cash way on earnings until it's all absorbed into the revenue stream and that doesn't happen until every one of those dollars are in rates.

One way of ameliorating that are the surcharge programs that we've had initiated in five states where you can recover within three months and not have to wait sometimes two years to get your money back while you're accumulating depreciation on that capital spend.

And the good news there is that Pennsylvania last week ruled that they would raise their -- for one company, American, because they applies and obviously we're going to also apply -- raise the surcharge allowable in between rate cases from 5% to 7.5%.

That's very significant, a lot of states are above the 5% now; Pennsylvania was first with that ruling.

But Connecticut just last month passed something that's I think well over the 5%, I think it's closer to 8%.

Illinois is -- I'm sorry, Delaware is over the 5% and also Ohio allows you to go up as high as 9% I think.

So you can see, I think that 5 to 10% range is the new benchmark for the states that need infrastructure improvement.

And I think after the tragedy in Minnesota more and more people will see that they need incentives to get the private sector to invest the kind of capital that's needed to build -- rebuild our country's infrastructure.

And I'll push that onto not only the private sector but the public sector, the cities are going to have to step up to be plate also.

The [pipe] is just not getting any younger.

I'd like to go through very quickly our major goals and give use some -- a little background on the numbers you're seeing.

First of all, growth, which is always a key part of our story.

Last year we had a tremendous growth year, 7.2%.

Now coming off that it's always tough to continue with your normalized trend which we think is 4% and that 4% is probably double if not more than most utilities' budgets.

So we are trying to grow much faster than the average utility.

And at the new base load of customers in the 900 to 950 range, it means needing about 35,000 to 40,000 customers a year to hit that range of the 3.5 to 4.5%, 4%.

We always look at organic being maybe a quarter of that and then new acquisitions being three quarters of it.

The good news is we're right on pace.

If you look at our first six months our growth is just about 2% so it's right on pace.

A lot of that has come from acquisitions, we had a very good quarter with Sea Cliff and Mantino, which is -- Sea Cliff was the acquiring property in New York on Long Island which is a great complement to our New York water service purchase of last year.

The Mantino is a fast-growing municipality in Illinois right in our Kankakee division area.

They needed better water as they continue to grow and it's right near where the third airport is planned someday in Illinois to relieve O'Hare.

So it's a great growth area now and into the future.

And we also had a good acquisition in Texas, two in Florida and a couple other small ones in Pennsylvania and other states.

So the acquisition pipeline is still moving and full and we're very pleased with the results in the first months and have some visibility out to the next six months.

The organic growth has been very interesting.

If you look at housing starts, they were historic in '05 and '06, they started slowing in late '05 and they actually peaked out around I'd say about 2.25 million -- 2.2 million to 2.3 million housing permits issues.

That doesn't mean a house is always built because you have a permit, but that was the (technical difficulty) max.

It then just fell off the wall, almost straight down over the next year, to hit the below 1.5, we're around 1.4 to 1.5 now and it seems to have bottomed out and they're forecasting it to get back to the 1.5 into the 1.6 range next year.

As that inventory is worked out though, I mean we live off the inventory of the permit after the house is (technical difficulty) we hook it up.

We really have not seen, up until this last quarter, much diminution in our pace of adding new organic customers which, as I mentioned, is only 25% of that (technical difficulty).

We are starting to see a little bit in the North and the Mid-Atlantic states where we're seeing actual hook-ups off the 20 to 25% range which is not abnormal when you look at the building permits (inaudible) they're down.

The South continues strong, we're hopeful that it can continue to be that way.

We're starting to see a little bit of pressure in Texas where the pace of new hookups per month is how we measure them there because it's a healthy area, has slowed down slightly.

As I mentioned, this is a piece of the smallest piece of our growth strategy and I guess the silver lining is if growth does slow organically the acquisition front may pick up because it takes one of the reasons why people aren't ready to sell, I think we're growing too fast to sell this (technical difficulty) and therefore want more money for the acquisition.

Some of that philosophy in the negotiations may come off.

Regarding our other piece of our what I'll call growth strategy, and that's the capital spending part, I really feel very good about this.

We've spent a lot of money over the last couple years.

In the five year period since we bought Consumer, that was the '97 through '02 period, and with the increase in the infrastructure rebuilding in our core state of Pennsylvania we really went from -- we doubled our capital spend from the mid 60s up to the 125 to 135 range.

So that's a doubling in that five-year period.

Then we bought AquaSource, continued to invest in our Midwest and Mid-Atlantic states, and the '02 through '07 we jumped from that 130 base up to about 260.

And I think -- I would not predict short of a major acquisition or major new EPA rules or something of that sort that we're going to double again in the next five years, but I do feel like we're going to have to maintain this very, very heavy pace of capital spending over the next five years in the $250 million to $300 million range.

And that's to stay on top of the infrastructure rebuild, the new EPA rules and so on.

The good news is in the South we've spent a huge amount of money fixing systems that basically had in my mind been neglected for years, pre AquaSource purchase and then after AquaSource purchase.

And the one thing that, as a former environmental secretary in the 100 year reputation of this company, we spent the money, we didn't worry about the getting recovery.

We said let's fix things and that's what we did.

So I really feel we're very much ahead of the curve on the AquaSource states now.

We're getting ahead of the curb on much of the pipe work that has to be done in the North and (technical difficulty) Midwest and we're ahead of the curb on the EPA rules that are coming out now on arsenic, disinfectant byproducts, trihalomethanes -- all these new rules which are really going to play havoc with the finances of many of our municipal governments.

We have rebuilt probably over two-thirds of our plants over the last three years and we'll get the rest done over the next couple of years so that we're in great shape there.

So I feel very good about our pace of our capital spending, I'd love to tell you it's going to go down but it's not.

There's a lot of pipe out there, we've got a lot of work to do and the EPA rules are not going to get any less stringent.

On the other hand, I think this may also, once again, mean that municipalities especially are going to be faced with huge expenditures.

They haven't been doing it as rapidly as many of the private companies and it will be at least one reason for them to consider privatization.

Now the good news in all of this is the fact that we are generating a lot more of our cash internally to support this $250 million to $300 million spending level.

And if you look at the numbers and you can figure this out yourself, but (technical difficulty) EBITDA up about 11% over the year-over-year over the first six months and we feel comfortable with that kind of projection.

Last year we generated about $280 million internally.

I think you're going to see that move up from that same type of increasing range.

So that's the good news.

As we generate more cash and get more of these needed rate cases in the regulatory climate to get the needed depreciation factor in rates, right now we're absorbing that and that's the regulatory lag we're feeling.

And as interest rates stabilize that's all we're really needing.

I really feel comfortable going forward now much more than I could have said a year ago.

Another thing we decided to do, which I think is important for those of you who have followed us for a long time -- as you know, I've always said the business of a utility from a shareholder standpoint is asset accumulations and then earning on those assets.

The assumption of course is the assets are good which we have always had.

We've moved up over the past five years $1 billion in assets, $2 to $3 billion, phenomenal growth.

And I'd like to say every asset is perfect but I can't.

And we don't like to sell, we like to maximize our return on every asset and we try to do that.

We basically feel it's unfair when some states reward us more or less than other states so therefore we have to invest in the states who are giving you a fair return so it's fair to all of your customers.

Because we have one standard and that is the best standard environmentally in the way we build things because we're going to be around, we hope, for another 100 years.

We don't do things on a cash starve basis; we build them right so they'll last.

But that means it's only fair to get return.

Some areas -- there are some small systems that just are not going to make it and we've decided to, just as you would in your garden with a tree or a tomato plant, prune some of the branches that are hurting the whole plant, the whole tree, we decided we're going to do some of that.

We actually started that earlier this year.

Here's a good example -- there was a small facility that AquaSource had purchased in Southern Indiana that made us have a base in Southern Indiana for very few customers.

We sold that asset which was actually losing money every month and had huge capital needs going forward with very little customer growth.

That's not what you buy a utility for.

They had a lot of water which is great news and we were able to sell that facility called Water 1 and Wastewater 1, sold Water 1 to the state of Indiana because they are looking at where do you want to be in 100 years and needing water in Southern Indiana and there's a lot of water on that property.

The problem is I don't think our shareholders want to wait 100 years for a fair return on their investment.

So it became a win-win.

We actually are now making money on Water 1 because we now run the system for the state of Indiana and they're happy because they now have control of the major water supply in that area.

We're looking at one in Virginia, one of the 60 or 70 systems we have in Virginia actually had a -- losing money.

It was in a county that wanted to take over the system.

We've been able to negotiate with them with a very fair price (technical difficulty) and we will be exiting that division which will actually put some dollars in equity on our balance sheet because we're selling it, but also take a P&L loss off the sheet, not big, but these are both examples we're looking at a couple in Illinois right now and of course in the Q you'll see Fort Wayne, there was a significant development in Fort Wayne.

The Supreme Court ruled three to two that our challenge that the city even had the right to try and condemn the property was incorrect and the Supreme Court ruled three to two that Fort Wayne can proceed with the condemnation but did not order a condemnation nor a set of values.

So we're back now in discussions with the city as to what fair value they'd be willing to offer us for a piece of our Fort Wayne franchise that they're interested in.

And I would say we're looking at probably when you add all these up together over the next two years (technical difficulty) probably happen quickly, some may happen this year, probably some next year, we're looking in the range of about $25 million of assets (technical difficulty).

And obviously we're not going to sell any of these if it's not positive for the P&L and for the shareholders.

With the internal generation of cash and with some of these asset sales we're very comfortable that we're in pretty good shape in the way of needing -- in the need of not having to access the market for major new shares.

We did that about a year ago now at about 2260, we sold stock in a forward which we still are holding 3.5 million shares on the books because we haven't needed them.

We'd have to go through those first before -- because they've already been sold -- before we'd have to access the market again.

In looking at a long-term trend, back in the early part of this decade '02-'03, we were increasing our share count diluting earnings by about a 5% pace a year, then lowered down to 3%, then to 2%, then a little over 2% and a little under 2% for these last two years and would stay there until we (technical difficulty) 3.5 million shares in the forward and then it will drop to 1% or below based on the fact that we always have option exercises that we get a couple million shares a year on dividend reinvestment, a lot of our investors reinvest all their dividends.

And that should suffice for us in our most recent five-year plan so that we'll not have to access the market short of a major acquisition, a major shift in EPA requirements, things of that sort, but absent those we feel very comfortable that our share -- outstanding share level will stay pretty constant.

Now the key to all this capital build up is to make sure that it's in the rate structure and we are behind and have been behind, I've mentioned this in the last couple conference calls, mainly in the AquaSource states for very practical reasons.

When the EPA says you have to fix something you can't say I'll fix it on a time frame that gets us into the regulatory climate on the PUC schedule.

So therefore you have to fix it first, that means you're depreciating these capital investments, you're paying short-term debt or long-term debt on the coverage.

You have to float enough equity to keep S&P happy.

So it throws the whole thing out of whack.

And unlike when we were a one state, one company issue we could time rate cases so there was very little regulatory lag.

As we continue to increase capital spending well above -- when we were doing 60 million it was a lot easier to time things than when you're spending at the quarter billion pace.

And the fact that we couldn't go in until everything was fixed in some of these Southern states has been part of the reason why we have had some regulatory lag.

That coupled with inflationary pressures on power and chemicals.

The other thing we're trying to achieve at the same time, along with recovery of rates, and many of these areas haven't had rates for 10 years so you're starting with very low numbers.

So the percentage increases are very high based on where we are used to and we're looking at 50 to 100% rate increases.

And we're also trying to get more consolidation so we don't spend a lot of money on administrative costs, lawyers, cost of service studies, all those things that -- and Florida is a good example.

We have 80 individual cases we had to file and we're trying to merge them on a county-by-county basis which would lower the number to 13 which is much more manageable for the accountants, for the professionals at the commissions and so on, but all these things are happening all at one time so this has been a very demanding period on our rates group.

But as I mentioned, we've beefed it up, we have a new head of it and we're up to the task.

You'll see in the Q we felt it was important to mention the Florida case because, unlike Virginia and Texas and the other states where we did have large rate requests based on the huge amounts of capital we put in we were able to achieve very significant increases that were fair for both sides in places like Monticello, Virginia and Missouri and other states.

In Florida this is a very complex case because of the fact that there were 80 different cases that had to be filed, a lot of accounting, new management in Florida, we're spending a lot of money to get into environmental compliance with the EPA there and there has been a very, very I'd say abnormal, but in most states we have not had the public reaction we did in Florida and that has caused concern because of the consumer advocates and so on doing their job in trying to protect the public interest.

But we think -- we want to be in Florida long-term and the only way we can be in Florida long-term is to make the necessary investment, have a reasonable timely return on that investment and to understand that these rates have been the same since the early '90s, therefore with all the improvements and all the new rules there's no way you could still (technical difficulty).

So we're working on that.

Our senior management has been addressing it and we're going to be in Florida as a matter-of-fact this week talking directly to regulators.

So just as a summary on rates because it's such a big part of our current story, it will be more normalized as we do forward in '08, '09 and so on.

This year we've already filed in eight different jurisdictions a number of actions and we already have an annual run rate of $14 million granted since the beginning of the year.

There are 14 new cases now already filed in various states which, if all our requested or granted would be another $10 million; some will happen this year, some won't because some may stretch into next year.

And we're going to be very busy between now and the end of the year, we're going to file 11 more cases, significant cases in Pennsylvania, New Jersey, North Carolina and Indiana and Fort Wayne that I mentioned earlier and they could total as much as $60 million on request.

So as you can see, it's going to be a busy rate year -- has already been a busy rate year and will continue.

And the other thing I'd just like to mention is the -- normally when we -- well, the expense side, the O&M is back on track with the change in the presidency in the South our new person down there, an MBA, is really looking at metrics and tracking expenses and we're already starting to see an issue there.

The positive there would be in the South in some cases is way higher than we're used to in the North, in the big concentrated states we're in the mid to high 30s, in the smaller states we're in the 40 to 45 range, but in the South overall we're well in excess of 50, some cases going as high as 60, 65% and we just have to improve on that.

We have shown some improvement.

If you take a look at the numbers, O&M to revenue, which is what we call our deficiency ratio, it does show an improvement between '06 and '07, but the '07 number is masked by the fact that we've added so much O&M with the septage hauling business which is not a regulated business and therefore has a higher O&M to revenue ratio and the New York water.

And if we take a look at taking those out because they weren't in last year's numbers, it looks like about a 70 to 80 basis point improvement range.

So I think you can see we're back on that track of we like to say we're trying to improve on a same-store sales basis between 50 and 100 basis points a year over the next couple years.

So I'm comfortable we're back looking at that, and part of that of course has to do with inflation, power prices and chemical prices.

And last but not least, our Board does not meet until tomorrow.

We usually use tomorrow as our five-year planning process.

So therefore we usually at this point in time discuss the dividend.

As you can see, our pattern has always been to look at the third and fourth quarter for an adjustment in the dividend, so that will be probably discussed at tomorrow's Board meeting and if there's any change we'll put a release out immediately.

Sorry for the length, but I felt there was a lot happening that you'd like to know about.

Answer any questions.

(OPERATOR INSTRUCTIONS).

Jim Lykins, Hilliard Lyons.

Good morning, everyone.

You mentioned that last week in PA you were granted an increase in your surcharge from 5 to 7.5%.

Is that effective immediately and is that for all of PA?

No, I'm sorry if I misspoke.

Pennsylvania American about six months ago requested this, went through hearings and it was ruled on last week that Pennsylvania American would be eligible going forward to go up to 7.5% for their surcharge.

We are still at 5% until we file a similar request which we obviously plan to do very quickly which would affect our pattern over '08-'09 because we're already in the rate cycle now to go in for rates at the end of this year.

But I think it's a huge positive for anybody who does business in Pennsylvania.

It's a huge positive for the environment because more pipe work will get done and it's needed in the older states.

And it's also a huge positive for the customers because the disk is much more efficient, less rate cases, less money spent on lawyers and accounting programs and more chance to bid projects out of size so that you can get better pricing from the contractors.

Okay.

And in the press release you also mentioned recovery mechanisms.

I'm wondering if there are some other states where you're looking at some disk or [quips] like mechanisms?

Good question.

Actually what we're looking at right now because of the rapid rise in purchased water cost -- municipalities that you buy water from raise the prices, also wastewater services.

And then also power which we're starting to see return as a major part of our -- increasing parts of our balance sheet.

We were able to in Texas, a law was passed that allows us to pass through power and Texas is one of the highest priced electric states, so it really does affect us there.

So we'll be submitting a request as soon as the regulations are written.

Pass-throughs for water purchase have been allowed in New Jersey for waste and in North Carolina for purchased water.

And we are still proceeding and hoping that one of our key states, New Jersey, continues to look at the surcharge mechanism, it's one of the few states in the entire Northeast Midwest now that does not have a surcharge and that would be very positive for the private companies who do work there and the regulators are open to discussing it, but obviously it's a big move.

So that will be one of the areas, Jim, I guess if you had asked me which is the next state we're really going to concentrate on it would be there.

The South really doesn't have a pipe problem yet, it's 50 years younger than the North and better weather.

Okay.

And you also said I think you're going to make 11 more filings this year.

I'm just wondering if you can give us any idea regarding the timing and maybe if there's anything you can say in regards to the amounts you plan to file for as well?

I gave you the ones that are already in progress and we'll give you those later.

But these will all be within the next four or five months.

Pennsylvania is the biggest; Indiana which is the, we call it utility center, but it's the two different operations around Fort Wayne, some in the city, some out of the city and the one in the city is the one that's subject to condemnation.

To put it in perspective, the condemnation would be about 25% of the entire system so it's not the entire system.

New Jersey a major case; North Carolina a major consolidated case where we're bringing all the small systems we purchased over the last couple years into one rate system.

A couple small ones in Virginia, a couple small ones in Florida.

And two fairly significant water and wastewater cases, so that's four if you want to count them, two times two, in Illinois where we are starting to see some good returns now on the investments and that's one of the states we're doing some pruning and getting rid of facilities that just were purchased years ago that just never made sense, but we tried to work with them but they aren't working so there will also be some equity infusion for that in Illinois.

Okay.

And one last thing, can you break out the revenue mix between what was rates and what was acquisitions?

Bob, can you help me with that?

Is that 70-30 this quarter?

We'll get you that and get back to you.

I think it's predominantly rates.

I'll tell you went though, New York -- if you go from 8 to 14, 6% of it had to be acquisitions.

It was a run rate of 8 on same-store sales, so you had some small acquisitions that -- I think in New York Water which I would call acquisition and the [Perno] which is our septic business.

One more time, 8% or?

About half and half.

What was the 8% again?

That would be the run rate on a same-store sales basis, it's rough but - not a cap number, but basically the 14% revenue increase, if you took just two of our acquisitions out it represents 6% of that 14.

And then Bob is reminding we have some other smaller acquisitions, Sea Cliff and other, so about half and half.

Okay.

All right, that's all I've got for now.

Thanks, Nick.

Ryan Connors, Boening & Scattergood.

Nick, you mentioned the issue of infrastructure and obviously the upgrades having to take place and so forth and the states stepping up their roll along with the private sector, but it seems like we're once again seeing this issue where nonwater infrastructure is more visible and therefore it gets more attention.

In this case the latest thing is this bridge collapse in Minnesota and that's generating all this political momentum behind all sorts of spending going towards transportation infrastructure.

I just wanted to get your thoughts on how you think about the issue of the more visible infrastructure categories crowding out investment in water and whether you think that's a risk.

And if so how do you and the rest of the industry kind of fight back against that?

I'm going to speak as a former environmental director and as a personal -- just my own personal opinion as an engineer and someone cares about public policy.

I think probably when you look at the -- and also someone who's been in politics.

First of all, there is no -- absolutely no comparison between the clout of the transportation lobby versus the clout of the municipal or water company lobby.

It's just like putting a heavyweight in against a welterweight.

As to if there's a dollar there who's going to get the bulk of that dollar it will be transportation.

The second issue is there's no user fee on most of our bridges and on most of our highways.

You're starting to see rapid talk about selling turnpikes, raising tolls on turnpikes to fund mass transit and other things in lieu of raising gas taxes (technical difficulty) politics.

But you need a steady source of funds to continue to build new roads, which is 85% federal, and to fix the road you have, which are basically state responsibility.

Very little local responsibility for roads other than township roads which need a little repaving here and there but no heavy truck traffic going over bridges on a township road.

Regarding the water and wastewater, I think what has frozen a lot of the investment in the companies who make pipe and others, and I think that's where you're leading, the private companies with these disk surcharges and so on have stepped up to the plate and will continue to, even though it means higher rates.

As I've told you, Ryan, there's been very little negative reaction because people see the streets being fixed, they see the pipes being done, they know they're paying more for a bottle of bottled water than they pay for a whole days worth of all the water they want.

So we have not seen the negative over these surcharge increases which come to about, in reality, less than a nickel every two years on a day.

So I think what's going to happen is there will be a revival of we have to do more for bridges because that's what happened.

And thank goodness -- a pipe break causes a lot of concern and reliability problems but nobody dies.

So I think what will happen is short of riding the coat tales of the bridge type issue or the water resource type issue, i.e.

Katrina, dams, levies which are cataclysmic when they break, I think there finally may be a recognition of look, here are the rules, if you raise your rates 3-4% a year every major city over the next 20 years can meet them and we better get cost of service in for water.

And once that realization is done and there's not this chance that the federal government is going to bail out our middle size and large cities I think people will get on with it because it's not that painful politically as long as there's a game plan.

Look at Atlanta and look and Washington D.C.

where after they had tragedies -- they had lead in the water, a problem with the contracting out and so on and pipes breaking in Atlanta.

The mayors there took the bull by the horn and they basically said we're going to have a multiyear rate increase but we're going to do things with it, and I have not seen any negative political reaction to Mayor Franklin or the Washington mayor.

So I always look for the silver lining and I think, A, it's maybe going to get this malaise off the dime that there will be some federal bailout.

Okay.

That's very, very helpful to get your perspective on that, Nick.

The other issue is just with regard to New York and the regulatory environment there.

I wondered if you could just comment on now that you've been involved there for a little while, talk about what you like and don't like about that regulatory environment and how it compares with your other states?

Professional which requires a lot of work because they demand a lot from the paperwork side, the legal side which is expensive but you're dealing with professionals.

I think that's important on the other side, it's not arbitrary and capricious, it's -- they know what they want, you have to give it to them or they're not going to move your order.

And they're experienced and understand the process and that's one of the reasons we ended up with Sea Cliff in an odd way.

Because they had clear rules for the other purchases that weren't going to be allowed.

The other thing that they do is they give a true-up mechanism so that they sort of cut the chances that you could make a lot of money off, but they also cut the chances that you could go in a hole if it was a bad weather year or if property taxes go up too much.

And I mention property taxes is the fastest rising and largest section of the expense category in New York because the local governments like to collect high property taxes on the utilities.

And I guess that's a poison pill against condemnation in one way because they couldn't afford to condemn you because they wouldn't get all those property taxes.

On the other hand, it does bias your accounting planning when you're looking at a five-year plan because you have to recover it and they have given some mechanisms for that, it's called a -- I don't know what it stands for but it's called a RAC, (multiple speakers), revenue adjustment clause.

And we're filing one as we speak in New York now and it's going through the process.

So I would say professional, fair and they keep your returns to a tight range.

But it is very predictable.

Okay, that's very helpful.

Thanks for all the thorough answers.

(OPERATOR INSTRUCTIONS).

Heike Doerr, Janney Montgomery Scott.

I wanted to ask a quick question to follow-up on Jim Lykins' question.

Can we maybe pin down how much of the 60 million you expect to file throughout the rest of this year is attributed to Pennsylvania and when you expect those rates would take affect?

Is that a July 1, '08 expectation?

The answer is over half and with a settlement clearly by July 1, without a settlement probably August, mid-August.

So if they get a little bit behind they wouldn't do something that would be a retroactive effective back to July 1?

No, Pennsylvania is a very clear you get your answer within nine months.

So depending on when you file you could take it to the bank, nine months from then you'll get a decision.

On the other hand, if the case is a resolvable case, settleable without full litigation it could happen sooner.

So let's just take an example, mid-November we file, that would be mid-August that you would get a ruling, but the case may be less controversial, easily resolved and sometime in June or July you could theoretically give a commission ruling with all the parties agreeing to it which is what happened in a lot of the PECO cases recently and get it sooner.

Okay.

And Dave, can you maybe explain why we're seeing accounts receivable up about $16 million comparing to first quarter?

Yes.

I think most of that is that fact -- I mentioned earlier we did the Meritage -- we call it Meritage -- but it's our customer service switchover that I talked about earlier in the conversation.

Because of that we delayed bills so that they were perfect for about a month which made accounts receivable go up in two states.

And Bob, I think probably if you look at it it's probably Ohio and Illinois that --.

Correct.

Which are the two states or the last two states that go in.

So those bills are out now, but obviously we didn't bill them so we couldn't ask them to pay them.

So we would expect that to go down in the third quarter then?

Yes, yes.

And what we're watching very closely of course is the bad debt.

We want to make sure that because people had longer to pay that were -- and a lot of them obviously had to float on that money for a couple of months but we're not going to be -- we're going to be just as diligent on our collections.

Okay.

And one last thing, on depreciation, I understand that it's going to be in this 15 to 20% increase range for the rest of 2007.

Nick, where do you see that going in 2008?

What would you think is a normalized depreciation year-over-year growth rate seeing as the CapEx budget is going to stay about what we're seeing right now?

I think it will get back into the -- there are two factors there.

One is that it's growing at 18 to 20%, but it also is a much larger percentage of our revenue dollar which is the significant piece because that means it's not in rates yet.

So I think the two key things that we'll get back to you will be how much it will grow.

We're doing our five-year plan as I mentioned.

How much it will grow, it has to slow down unless we keep doubling capital which, I mentioned earlier in the call, we're going to increase capital, we just can't keep growing at 100% every five years.

But the other piece of that is how quickly do the revenues catch up to it, therefore what percentage of the revenues does it represent which is really the keep.

It used to be at the old Philadelphia Suburban, Dave, I think we were around 12% and that was steady as a rock, interest kept dropping because we kept putting more of our own money in the business and that used to be in the 7-8 range.

But everything changed when we bought Consumers which had a higher leverage factor and a lot more capital per current depreciation needed and AquaSource was off the map as to low depreciation because they had low, low rates and high capital needs because they hadn't fixed the systems in 10 years.

And that's the assimilation we've been doing over the last couple years and until we get it in the rates it's going to be hard to bring that lag down and also get the depreciation as a factor of revenue.

But that's a very astute question and that's something we'll drill down on and get to you.

Okay, thanks for the clarification, guys.

Ajay Jain, UBS.

Good morning.

Nick, just two questions.

First, how do you feel about the weather comparison this quarter?

I think for the corresponding period last year you cited whether as a drag on earnings.

So with that behind you do you feel like the consumption trends are going to be materially better based on what you're seeing for the first five, five or six weeks into the quarter?

Are you talking about third quarter of last year?

Yes.

Last year's third quarter was not a great quarter.

We didn't have a great July, we were off 1.5% weren't we?

In Pennsylvania, but overall.

But some of that may have been the billing issue, Ajay, because we can't book it until we get it.

And so far it's been better than last year.

Now we don't have the favorable comparison in the third quarter that we did with Pennsylvania in the first -- the rate case occurred last year I think in June -- late June or early July.

So we won't get that kick from just increased pricing in our biggest state, but we do expect a little better consumption so that will help out.

Okay, great.

And a also, just a follow-up with a real high-level question.

I know that last year you cited some regulatory lag with what AquaSource, based on some remedial investments that you were making there and I was just wondering more conceptually how do you feel about the overall benefits from geographic expansion?

You've been expanding into the Southeast and Midwest for a number of years now and more recently into Long Island.

Do you think the diversification benefits from -- both from a regulatory whether standpoint are attractive enough to offset the increased earnings volatility and execution risks and just the overall increased complexity of operating in a lot of different states?

I guess if you think our investors are looking for a somewhat defensive play, steady Eddy, every quarter you can anticipate -- other than the weather and maybe a rate decision here or there you can predict what you're getting and the whole issue is asset accumulation and managing those assets properly.

Then the diversification takes that one risk away of having too good or too bad a quarter and gives you that consistency.

A good example was Texas had a terrible consumption in June/July.

They've had record rains so obviously our usage is way down, yet North Carolina has been up.

And that's both in the south so that's bifurcation just in one region.

The Midwest has been good this year, but believe it or not New Jersey and Pennsylvania are off from last year because it's rained just enough that people haven't watered their lawns.

The only thing I have slight concern over is you keep raising prices, which you have to do as you put the capital in, is will people use less?

But I think we've already seen a lot of that diminution of average usage occurred and as long as you are in for rates over a certain period of time, it eventually becomes (inaudible), there's only so much water, you have to have a certain amount of water you use and we're down in Pennsylvania to less than I think it's 4500 gallons, in some areas even less which is really a minimal use of water.

So I think these mechanisms like they're doing in New York you're going to see a lot more which actually that's this revenue -- adjustment clause.

It's a reconciliation of revenue so it takes that risk out of the business, actually it would make our earnings even more consistent.

Now as far as the South and the diversification, had we not purchased the assets and gotten our base at such a good price I would be second-guessing myself a little bit because, I have to admit, I didn't anticipate the length it would take to get the regulatory approvals to fix these systems and then to get them fixed.

I can't say I'm disappointed one iota in the growth, the growth has been phenomenal 5-6%, and that's without kicking in Florida because we felt we had to fix things first in Florida win the credibility and the support of the regulators consolidate the rates, then we will be a premier company in Florida 10 years, 20 years from now if the regulators allow us to do that.

But the part that surprised me was -- and I guess I should have been a little bit more predictive, was the size of these rate increases that were going to be needed after we put the capital in.

And the reason is nobody had been watching the store for the last 10 to 15 years.

And although we bought the assets cheap, they had not raised rates where they should have been because small properties.

They figure why take all this aggravation for small property, we'll go after the bigger ones.

That was Florida water situation and the situation in North Carolina was we're buying stuff because the state wants us to buy it, now we have to get it in rates and the have been very, very predictive and fair with us in North Carolina, it's just getting the cases filed.

So it took us a little longer.

The philosophy that our former head of rates had which was to be to centralize all rate-making had its merits and every one state company, but I think we're on the right track now by decentralizing which puts the regulator in closer touch with the people in the state as to accounting and regulations.

Okay, great.

And in North Carolina you feel like all the necessary adjustments have been made?

Well, we're in right now -- here again, cases hadn't been filed for over 12 years, we had to put radium treatment in and the rate request is for over 100%.

Now having said that, it goes from $14 to $28 a month, still less than $1 a day for reliable water and it's now treated to the EPA standard which it was not being treated to prior and it's still less than a pint of bottled water a day if you're going to drink to avoid the radium in the water.

Now we're going too treat it, fix it the right way forever but it's going to need a huge rate increase percentagewise, but when a look at the average cost of water around the country, $28 a month, it's probably right in line.

But that's a good case study on the dilemma.

Now once we get the $28 rate, then it's going to be a routine put some pipe in, fix this, going for a 5 to 10% rate increase every other year assuming there's no growth.

If there's growth in the system in the South, if there's a lot of growth you may be able to stay out of rate a lot longer.

Great, thank you.

(OPERATOR INSTRUCTIONS).

Mr.

DeBenedictis, we have no other questions in the queue at this time so I'd like to turn the call back to you for any closing comments, sir.

I appreciate it.

We're right on target; I appreciate everybody's time and hopefully we answered your questions.

Obviously if we did not answer all your specifics call Dave Smeltzer or myself and we'd be glad to give you some more meat on the bones.

Thanks.

Thank you.

That does conclude our call.

We do appreciate your participation at this time.

You may disconnect.

Thank you.