Essential Utilities Inc (WTRG) 2008 Q1 法說會逐字稿

Good day, and welcome to the Aqua America First Quarter 2008 Earnings Conference Call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to your moderator for today, Mr.

Kevin Brophy, Director of Investor Relations.

Please go ahead, sir.

Thank you, Anthony.

Good morning, everyone, and welcome to Aqua America's first 2008 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.

There's also a live webcast of this event available on the site.

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

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

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

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

Reconciliation of these non-GAAP to GAAP financial measures are posted in the Investor Relations section of the company's website.

At this time, I 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.

Aqua's first quarter '08 results were characterized chiefly by a slowing in revenue growth to only 1.4%, rising from $137 million to $139 million.

And that adversely affected net income generation which was $14.3 million versus $16.9 million in '07.

Our revenues were affected by reduced consumption somewhat due to a wet March but chiefly due to the national economy and regulatory lag, which I'll explain in much more detail as we go ahead.

Regulatory lag, for those of you who are not following the industry for a while, it's a technical term that we use that says the need to carry major capital investments and rising costs while you're waiting for rate relief from the state regulatory bodies.

That's a big part of our issue right now.

Although normally utility results are somewhat resistant to economic slowdowns, when you think of the three areas that are significantly affecting U.S.

economy today and is on the TV every night, reduced housing starts, high fuel costs and foreclosures.

Those are three areas of an economy that all have a direct negative effect on utilities and, unfortunately, had a negative effect on our first quarter '08 versus '07 comparisons.

We also witnessed the larger reduction usage in 1Q in the industrial and commercial segments, which I think probably lends credence to the fact that there is an overall economic slowdown in the U.S.

To put that in perspective, industrial and commercial is about 18% of our revenue stream.

And although oil consumption was down, the commercial/industrial was down to a factor of maybe 5%, 6%, whereas most consumption was down overall of 1.5%, blended about 1.7%.

So let me put some numbers around the -- how we did get to the 1.4% increase.

First of all, reduced housing starts hurt us in our revenue growth and customer growth.

Housing starts have now slowed below 1% from the more recent normal trend of 1.5% to 2%.

Peak year '05, we were growing in excess of 2% just from natural growth.

That dropped a little over 1.5% then a little over 1.1%, 1.2% last year.

And this year, it's running slightly below 1%.

Now, the only way we can make that up in our growth patterns is through acquisitions.

And we did announce an acquisition in Florida yesterday and we have about 20 -- 15 to 20 prospects in '08 in the pipeline.

And if successful, I think we could grow that to 2% to 3% on acquisition side, and hopefully have a housing turnaround which will get us close to our normal goal.

We're looking at more larger ones this year than really just used to do 25 to 30, but a lot of them were small.

We're really concentrating now much more on the larger ones.

The other factors that I mentioned, fuel costs -- they're up 50% year-over-year.

And I'm sure I don't have to tell anybody, they know that from their own gas pump.

And the only difference between your usage and ours is we drive 23 million miles a year.

So you can see that's a significant inflationary factor in a core estimate of 2.5% growth in O&M that we work off of.

So -- and housing foreclosures have an interesting impact on us.

It's not the foreclosure that costs us money, but as soon as somebody leaves the house, it creates the risk that you may not be able to collect the final utility bill.

And of course if the house stays vacant for a while, you won't be selling water to that home.

So it's a dual effect.

I don't want to overstate this because foreclosures in most of our states -- excuse me -- are still well below 1%, but it is an issue that made us increase our bad debt reserve.

Now, we may still collect the money, but to be cautious, we increased our bad debt reserve up to 1% of revenue which we're going to project for this year.

And that's up from about 0.8%.

Now, most utilities wouldn't be upset about a 1% bad debt reserve, but we've always enjoyed in the 0.6%, 0.7%, 0.8% range.

So that did hit O&M this year, this first quarter, and hopefully we'll get it corrected towards the -- as we proceed through the year.

To dissect the revenues and say how we came up with the aggregate 1.44%, so it's somewhere between 1.4% and 1.5% growth, rates and surcharges awarded over the past 12 months were roughly 1.5%.

Revenue growth over the past 12 months was in excess of -- excuse me, from acquisitions, and organic was well over 2%.

But then we had to adjust for the loss of revenues from some facilities we've been disposing of, the key one in the first quarter being Fort Wayne.

And that has basically made the year-over-year growth about 1.5%.

And therefore, consumption decreased, from the slowing economy and weather, about 1.5%.

That's how we netted out at the 1.45%.

Now while we wait for the economy to turn around, quarter-to-quarter revenue comparisons will be under pressure until late awards are achieved in Q3 and Q4.

And coincidentally, Q3, Q4 of '07 was when we really saw the dramatic drop in housing starts.

And that's also when we started to see an increase in bad debt reserves that we're starting to take.

So I think the comparisons as we get later this year on the expense side and on the growth side will be more palatable, but the economy was still humming in the first two quarters of '07.

So this quarter, you're going to have rough comparisons.

The loss of Fort Wayne customers will also affect us all year long, of course, until they wash out of the -- in the '09 numbers.

And that's somewhere between 1% -- 0.5% and 1% for your projections.

However, the transition is going smoothly.

We've cut costs, we've reduced workforce.

And it has not affected the rate proceeding which again I'll get into later, which is for the 2/3 of the system that we retained.

We retained the key wastewater facilities that we owned and which -- and in the faster-growing section of the suburbs at Fort Wayne, but we were condemned in the area of -- in the City of Fort Wayne.

And we did, as I mentioned in the release, as we mentioned in our Q, we were paid for it, obviously, but we don't think we were paid enough, and we are challenging it in court.

And that won't be decided for a while.

We also expect, as part of our pruning policy that we announced last quarter, voluntary sale of at least one other franchise in our northern division for about $10 million.

And that will occur later this year, either Q3 or Q4.

Now, Aqua has 17 current rate cases, $65 million of requests now in various stages of the regulatory process.

However, I don't -- I can't predict when the awards will be made, but we believe most will be made late in the third quarter or possibly in the fourth quarter.

So, logically then, these awards should positively affect revenue comparisons for the next 12 months.

And therefore, when we get the awards, there'll be a positive comparison revenue-wise over the next 12 months of that rate cycle.

The most significant cases are Pennsylvania, $42 million, to be decided we believe in August.

New Jersey, $7 million, to be decided in September.

Illinois, five cases -- excuse me -- $4.1 million, to be decided in December.

You can see most of these are late.

Missouri, $1.2 million in September.

Florida -- Sarasota, Florida, separate division in Florida, $2.2 million in October.

Ohio, $3.2 million, we'll hopefully get it this summer.

New York, we have five small cases that we're merging as one.

We have a consolidated rate and that's $0.3 million.

And Indiana, the two cases, one Hendrix, one in the rest of Fort Wayne -- $5.6 million.

And that probably won't be decided until January of '09.

Now, over the next month, we'll be filing comprehensive state-wide cases in Florida and North Carolina.

And this will mark the end of an era.

During 2003-2004, we made three separate purchases from electric utilities who were exiting the order space after a failed attempt.

And we purchased over 150 systems from these companies and we paid $265 million which was clearly a good investment for us because it was at rate base.

We did not pay any premium on these properties.

And that's the secret of buying it in the water or any utility business.

Now, if you look at our normal growth pattern of 3%, 4% a year, sometimes 5%, depending on the housing growth and so on, if you look at '03, '04 those two years, we bought -- we grew 40%.

And I'd say that's almost five times the normal growth rate.

So there was some digestion period which we said when we bought these.

However, I don't think we predicted, no one predicted, how long it would take to get these facilities managed, fixed and so on.

So over the past five years, we have completely rebuilt the management structure.

So we paid -- management structure -- we've invested over $230 million to fix environmental issues and provide capacity at the wastewater and water treatment plants so we can provide for future growth.

And we've invested millions of dollars in accounting and customer information systems to bring these operations to our expected standards.

So we basically have invested over the past five years as much as we paid.

So the good news is it's done.

The second good piece of good news is that it's all at rate base, so there shouldn't be a challenge on earning on that rate base.

The negative is that it took us five years to get to the position where we could file, because you had to fix the customer systems, you had to fix the management, you had to fix the capital and environmental before you could ask regulators to approve any kind of rate increase.

And the fact of the matter is the original investment of $265 million, that wasn't earning its fair return at the time.

So obviously, this means you have catch-up on the original, a huge amount, almost doubling of the rate base over the time period that you're now asking for your first rate case.

And that's been part of our dilemma, the rate case requests have been very, very large, sometimes in excess of 100%.

The regulators have been very fair.

And a good example would be Monticello where -- in Virginia, where we invested $10 million and got over 100% rate relief.

In Brookwood, LaGrange which earlier this year in February we were awarded a 70% increase.

So these are very large increases.

And the good news is now that we get on a more normal cycle of the one -- of two to three-year rate relief cycle, these rate requests, depending on how much capital we have to put in and how much inflation hits us, should be in much more reasonable ranges that we're used to in the more mature areas where we file in the Pennsylvania, mid-Atlantic and the north.

So the filing of the North Carolina and Florida cases over the next couple of months will represent the next step in this process.

And now we're going to request fair returns on all these investments because of the improved customer service that we've absolutely provided.

So if we can get this initial process behind us, assimilate at all the AquaSource and southern properties, and creating -- and that's basically this doubling of rate base, has really created the bulk of the regulatory lag which has hurt our revenue stream and our net income over this past year.

Expense growth -- this is one area that was of concern, but it was -- it's now back to normal levels.

We for a number of years had very significant O&M, local tax, depreciation and interest cost increases, and those were all due to basically a 60% growth in our customer base over a five-year period, and so almost three times the normal growth rate, and the fact that we did start to experience some inflationary pressures on the commodities during that time period.

So, very happy to see that our O&M is back to more normalized levels.

Last year, if you recall, it was up in the double digits, 15%, 16%.

So I'd like to take two seconds and analyze our O&M which is up 6.6%.

But if you take -- if you dissect that over half of this increase is due to some non-cash accounting adjustments required when we went for a rate case, the regulators sometimes have things adjusted.

It's not cash but you have to adjust the rate base and so on.

Dave can explain where they were.

And the other is the fact that when you have new growth of 2.6% last year, you need to have some O&M increase to cover the new growth.

When you look at that, that's about half of the 6.6%, actually a little more than half.

The remaining 3.2% was adversely affected both by the bad debt reserve increase, which we discussed earlier, and of course the fuel costs.

If you take those biases out, run rate was about 2.5%, which we're very happy with.

Depreciation is another factor which is really, again, non-cash expense component of the regulatory lag.

But it has really risen very rapidly over the past three years because of both our acquisition increases and also the fact that we're putting so much new capital into the systems.

And a lot of that new capital wasn't the hundred year long-lived assets we usually install.

A lot of it was meters and computer systems which have very short lives, i.e.

increasing the depreciation rate.

So the -- we are now at a run rate of $250 billion a year in investment -- excuse me, $250 million a year.

And that's almost double what we were spending before the '02.

And the depreciation this quarter dropped to around 7%, almost half of what it's been on an average over the past three years, 15%.

We anticipate that will rise in the second half of this year only because a lot of our closings for rate cases occur in June.

And that will add to depreciation when you close the asset.

On the other hand, we don't anticipate year-over-year being much more than 10%.

So therefore, it's about 2/3 of where our run rate has been.

And we think it'll stay in that range going forward based on how much capital we're investing over our existing rate base.

So we'll continue to invest at a very healthy pace, depreciation and therefore cash generation will grow at a very healthy pace.

And by getting it in rates more rapidly, not waiting five years, we should avoid any negative effect on earnings.

The other major issue that we experienced over the last couple of years, again, due to the run-up in the vast expansion of our assets and also with the rapid growth we incurred, was interest.

This year you'll see interest expense quarter-to-quarter is only up about 4%, between 3% and 4%, versus -- excuse me -- 14% all of '07.

Now, this is real good news because the result is that we're borrowing less as our internal cash generation is increased.

And we've also been able to lower our borrowing cost, which I've noted in the press release.

We continually refinance, we continue borrow at lower rates than our embedded cost to debt.

And I think our treasury department deserves a lot of credit on that.

So we've lowered our embedded cost to debt of long-term debt to 5.6%.

And that -- most of that is long term, 20, 30 years.

So we're in great shape long term, if you think 5.6% is a good carrying cost.

And this year, it looks like we'll be borrowing much less than last year, maybe $100 million approximately, and we'll refinance about another $5 million in old debt at rates that are 9.5%.

So clearly we're going to show some gain on that.

And we anticipate increases in our interest expenses to probably remain in the 5% range or a little less going forward.

So that has stabilized now also.

As I noted, our first quarter run rate was about $60 million in capital spend.

We anticipate exceeding probably the $250 million in capital investment that we talked about on an annual basis due to the tax implications, which I'll talk to you about.

But we think the $250 million in capital is very sustainable, once we get these current rate cases decided and we start seeing the resulting increase in EBITDA.

And the EBITDA has been growing, about 10% change over the last five years.

So that's been a very healthy part of our story over this growth and the investment period.

And the key is getting the new investment into rates, collecting on your depreciation, collecting on your investment return, and getting surcharges which absolutely help, so that you don't have the same regulatory lag we had with the major investments we made in the south over the past five years.

So I guess the good news is that our future capital is absolutely proactive versus reactive, which it had been over the past couple of years.

We were under the consent decrees of environmental agencies and the commissions were very concerned at AquaSource and some of the other companies had not done what they should have done for customer service and, i.e.

meters, computer systems, and also environmental.

And we believe we've now addressed all the major current environmental requirements that face the entire company.

And to put that in perspective, for the past five years, we spent almost $0.5 billion to make sure we meet all the current and what we are projecting as future environmental requirements.

So we have flexibility now to make sure capital is timed around regulatory -- planned regulatory actions, so we don't have the "build it first before you're even allowed to go in" for rate relief.

We also have some room in what we're doing now so that we can take advantage of the tax benefits of the new Economic Stimulus Act of 2008, and we can talk a little bit about that.

We think we might be able to generate as much as $20 million to $30 million in increased cash that we can use obviously for our program, rather than borrowing or floating new stock in order to support our capital program under this new tax law.

The other issues, we don't see the need right now for any levels of new equity infusion that we've experienced in the past.

Not just long ago, probably three, four years ago, we were issuing almost 5% additional stock annually.

That dropped to 2% to 3% range over the last year or two.

And we're projecting 1% dilution range, which happened in the first quarter, to be our new run rate going forward.

So that's good news for our existing shareholders and -- that we're not diluting them as much in order to support all this new growth.

So I think looking back, yes, I wish we could have done better and gotten it in sooner in the sense of rates and didn't have some missteps like we had with a couple of state regulatory agencies.

But I think we're now in a good position.

Hopefully we're successful in these rate cases.

We will time our capital going forward.

We have a great financial foundation and cash generation potential to support our future needs in this business.

It's still a good business; it's still a secure business.

And we're comfortable that the economy will return.

At that point, we'll start seeing a little bit more in total growth, and that will help with our customer growth strategy going forward.

But I think five years from now, we're going to look back and say, the fact that all this investment, almost $0.5 billion, is at rate base, and that -- those properties will probably be growing faster than our existing properties, therefore giving more support to the company.

We'll probably say that was a good investment, even though we've had to live through these couple of years.

And, as you know, in the utility business, it's really a long-term business.

So the company a hundred years from now with the most earning asset wins in the long run.

And that's what we've been trying to do by our growth strategy.

So I'll open it up for questions.

(OPERATOR INSTRUCTIONS).

We're ready to accept questions.

We'll take our first question from Heike Doerr at Janney Montgomery Scott.

Good morning, everyone.

Hi, Heike.

I wanted to follow up on the efficiency ratio.

Nick, could you just speak historically on how many basis points of improvement you expected to see in a given year?

We've now reached on a rolling average about 42.5%.

I realize that some of this is revenue weakness.

But can you talk to maybe when you think we'll see this come back down?

I know we used to talk in reference of being below 40%.

Well, part of the concern this quarter, the reason it went to 42%, was this almost half of the expenses that were charged, I would call -- Dave, can I -- am I allowed to call them one-time?

You know, regulatory true-ups and things of that sort.

The other is the fact that the regulatory lag, if you take a look at a reasonable percentage of that $65 million and put that into your base, I think you'll see that O&M, the revenue ratio come down pretty rapidly.

So, yes, I'm disappointed, Heike, I wish it was lower.

But it's something we're -- we're still tracking, so I hope you still track it.

But I think if you correct for those two, were probably flat year-over-year.

And as we look at the efficiency ratio comparison of the north versus the south and the catch-up at the south, that the south has seen since you've gotten some of these efficiencies taken care of and the operating structures a little better.

Can you maybe talk about what we've seen there in the south?

No, the south is -- the whole reason our ratio is up, Pennsylvania keeps -- and New Jersey keep getting better.

The north is pretty stable -- no, the south, and rather than going down in efficiency, it's gone up, for two reasons.

We basically had to put new people all over the place to get the thing running and it's now stabilized and our new president there, Chris Franklin, is -- has got all kinds of statistics and benchmarking and so on.

And -- but -- I mean, to be very honest with you AquaSource had $12 an hour people.

They weren't getting the job done.

They were reading meters from their car; therefore, the meter readings weren't right.

And we just had to redo everything in the whole company.

That's done now.

We have professionals in place, trained operators at the plants, things of that sort.

And that was a cost.

The fact that we've had five years, in some cases, of inflation plus the new cost we've added without getting any return, i.e.

regulatory lag, has actually the O&M, the revenue ratio in the south has actually deteriorated over the five years, not increased.

That will turn around now that we've stabilized the operations.

We now have RF in in most of the states, so we'll have better collection practices.

And also, the fact that most of these rate increases, the huge percentage increases at least, are coming in the south.

So I think we'll start seeing a steady trend down now in the south.

But that's what's hurt us.

We can divide out and we'll get back to you as to what the O&M, the revenue ratio is in each of the states.

You'll get a feel for that.

Okay, great.

And as we look at Florida, I know that we've had some hiccups there.

The regulatory environment has really changed with the new two commissioners, it's a little more pro-consumer than it had been.

We haven't seen any new rates.

Can you maybe talk about the synergies you see and the logic behind the acquisition that got announced yesterday?

Sure, sure.

Look, five years from now, 10 years from now, when you look around, we're going to be in eight of the ten biggest states, and two of those are Florida and Texas, and North Carolina.

Although they are not performing financially the way we'd like them now and we have huge rate increase requests and everything before them, we will be the largest water utility in each of those three states.

And I think it's a wise investment.

So we're not abandoning Florida.

We think it's a good state.

And I think we had -- yes, you're being kind, the hiccup, last year where we had to refund the interim increase and so on.

We've now completed all the requirements of that case.

We're holding our last set of hearings.

We're going around the state, have public meetings.

Some of the commissioners attend those.

They've been very productive.

We've learned a lot.

I think it's a lot better when you have a meeting without a rate case in front of people, they tell you what they would like to see in service and selling and things of that sort.

And I think we're ready now for an approach towards a consolidated case with Florida so that we can grown in that state effectively.

And I think the regulators want a strong company because there's a lot of systems in Florida that are, I wouldn't call them orphans, but they're -- a lot of very small homeowner association systems, things of that sort that are between the big cities that are usually municipal.

Okay.

And as a final question, you mentioned previously that instead of this 25 to 30 small tuck-in acquisitions that you've been looking at larger systems.

And as we look at the growth available in the south but the quicker recovery in the north, can you maybe talk about where you're seeing these larger acquisitions coming from?

We're starting to see cities much more willing to talk about -- whereas three years ago they weren't possible acquisitions, other than just, "Would you run our system?" you know, concession like [Peoria] does.

We had a bid -- now, these are much tougher to public.

You don't sit behind a closed door as you do with a private company and then nobody knows about, then you go out and announce that these are very open, so there's a lot of bidding and things of that sort.

But we have a couple that we've been involved with.

One, we were the high bidder and it looked like it was on its way.

But they decided to postpone and of course there's an election coming up in November.

There's always an election.

And so probably they'll get reinstituted after that.

So you can't time them as well.

But we decided, rather than worry about timing as -- whether it's 4% over three years or 4-4-4, I don't think it really matters in the regulatory process because it's a pretty long-lived business, and also the fact that the regulatory cycle, break cycle, is probably two to three years anyhow.

So we made a clear direction when we had our internal management retreat, that we should spend more time on larger systems than a lot of small ones.

And probably we'll drop the numbers from telling you that we're going to do 25 to 30, probably get in the 15, maybe 20 range, but spend more time.

That means you might not get them all and you might -- if you only have 15 and one falls -- probably has a bigger impact on the number.

But we still think that's the right way to go going forward.

And for a city, do you need -- does that get on a public referendum or do you need the public approval or how does that work?

For a city, oftentimes they ask, but very seldom do they do an actual voting or referendum.

Probably they do it in California.

But most of the time, it's a vote of the city council or the authority council, which means it's publicly-noted and it's very, very public.

Okay.

So we'll see them before anything gets finalized then, right?

Sure, sure.

Okay.

Thanks.

I'll stop monopolizing your time now and hop back in the queue.

Thank you.

(OPERATOR INSTRUCTIONS) We'll go next to Ryan Connors at Boenning & Scattergood.

Good morning.

Good morning, Ryan.

Nick, I kind of wanted to step out of the trees and have a look at the forest here.

I kind of have a big-picture-type question for you.

I just kind of wanted to take a moment here to frame it.

One of the big major aspects of the investment case for water utilities has always been that although you, and your peers for that matter, may not grow as rapidly as other sectors of the economy, the growth that you do generate historically has been very, very consistent.

And so, that consistency, that relatively low risk profile, if you will, in my view, has always been a big part of what draws investors to the sector and what draws them to Aqua America in particular, kind of the Bellwether in the space.

And I think that's a big part of why -- a big driver behind the premium valuations that you've traded at the last few years.

So, right now, given that we're -- with these Q1 results, we're sort of in year three of flat or -- and/or declining earnings.

I think the evidence suggests to many people that that assumption of consistent earnings growth may not be accurate after all.

And I think the market is struggling right now a little bit with what the risk profile of the business really is in terms of the volatility of earnings growth.

So I'm just --

Let me take a shot at that.

I'd love to get your reaction to that, and just what you would say to an investor who says, "Hey, you know what, at that level of risk, I can get better growth elsewhere, but the growth isn't going to be consistent."

Right.

Well, first of all, the "premium valuation" has been lessened over the past two years.

So the reaction to the market has been exactly what you're saying versus what it was two years ago when the rapid growth in the -- all these three or four acquisitions, the 200 or so systems we bought in a very rapid time period.

If I had my druthers, I would have liked to stretch them out over five years.

It would been, seeing exactly what you're asking for.

The problem was AquaSource was for sale, it was a good deal.

We bought it at a good value.

And we couldn't just buy a fifth at a time; we had to buy it all at once.

Same thing with Florida Water, the same thing with Heater.

So I guess if you want to look at consistent growth over a long time period, I think we'll still be able to deliver it, like -- as we did until we got into this rapid run-up of 60% over about three or four years, with so many small systems.

But -- so I'm still confident the investor model is there, especially with the fact that we've been able to strengthen our financials, if you look at the amount of cash generation we're doing now and a lot of our expenses.

A lot of our EPS has gone to depreciation.

It's not the end of the world -- I mean, if you look at it on an EBITDA basis.

I mean -- I think another reason people buy a couple of these is for dividend and cash and no surprises, although we're very disappointed that we aren't growing like we used to and we had this temporary hiatus.

I think it is important to note that very seldom do we -- we don't have the -- what I'll the credit crunch issue in the sense that we're having any trouble borrowing money or continuing with our model.

The second is you don't see a quarter, at least in the regulated business, where there's a huge write off.

It's cheaper cuts as you're going through it.

So I think that risk factor is not there.

And the third is I think there's plenty of cash for the continued increasing in dividends which I think is the other thing that people buy these for.

So, I mean, you can time utility investments and obviously it would have been great to time the water utilities in general three years ago.

But I think that part of it has been assimilated, the rapid run-up in inflation hurt us all.

The -- our case, the rapid growth hurt us.

In some other companies' cases, it would be change in ownership hurt them and so on.

And that caused their instability.

So I think we're looking at an era now where it's going to be a little bit more like it used to be.

Okay.

And just as a follow-up to that.

I mean, I think one of the things that's particularly troubling is that, generally speaking, you are seen as a defensive investment and to be -- right now it's a little bit disconcerting.

So I wondered, is it just sort of the perfect storm you mentioned that the foreclosures and the housing starts --?

I think so.

I mean, when I looked at and I said, "Jeez, what's happening?" Well, I looked at where the consumption was down.

And it was down in the industrial -- and I can -- you can think of the -- you're from this area, but think of the big manufacturers, the Roman houses and so on, they use less water in the first quarter.

So obviously they had some kind of change in their process or there's been some kind of slowdown in that manufacturing process.

And the commercial, and that's directly related to the economy.

The actual consumption of the homeowners wasn't down as much, but it was down.

I attribute some of that to weather.

I saw the California companies had bad first quarters because of weather also.

But we don't have as much usage.

If you look at how much people use water in our area, it's in the 150 gallons a day, which is not as much like if you looked at some of the other water utilities, especially in warmer areas, they sometimes use 300 gallons a day -- huge difference.

So if people really start conserving like we are doing in North Carolina right now because there's a restrict -- that's way down because of the drought restrictions the governor put on.

There's a long way to drop.

Now the -- that's the bad news.

The other news, as you go back in and you're allowed to true it up in your next rate case, but it causes you lag.

So these are the things that normally we don't see but we're starting to see a little bit of conservation.

I think there was some consumption difference because of the economy.

But the two factors that I would say are your comment, the perfect storm, would be, in my lifetime, I don't ever remember every night on TV hearing about foreclosures.

And that was the bad debt.

And the other is fuel prices running up so rapidly.

Now let's hope for our economy, that they're going to stabilize soon, at which point we'll stabilize because it will be, unfortunately, increased cost in our rates, but we'll get it back.

But those two factors, we drive 23 million miles a year, we can't bump [the trend].

Sure.

Well, I appreciate your perspective on that.

Thanks, Nick.

Okay.

(OPERATOR INSTRUCTIONS).

We'll go next to Francesca McCann at Stanford Financial.

Hello there.

Hi, Francesca.

A couple of quick questions.

The first is, on the acquisition landscape, either for kind of small to medium or medium and larger-sized acquisitions, just what you are seeing in terms of the competitive landscape on what that might mean for premiums or for prices.

In the states where we are one of like four or five utilities like New Jersey, Pennsylvania, there'll be competition, although in some cases if it's in your -- clearly in your area, it doesn't make sense for somebody else to bid on it because they can't produce the product as efficiently.

But in a general singular franchise, yes, there will be competition.

Less so in the states where there's only one company.

For example, Florida, North Carolina, Texas somewhat, not as much competition.

There's always somebody at municipal authority who might want to compete with you and so on.

So what we -- the reason we don't do more is we know when to fold them.

I mean, either -- know when to hold them, know when to fold them.

There's only so much [season] of work and you're not going to make it up on volumes.

So I mean, basically you have to pay what you think it's worth and what your cost to capital is to make sure it's accretive.

And that's our screen.

So that's why we decided it's better to focus on bigger ones and spend more time on those, and hope that we are successful versus a lot of small ones, since nobody else is looking at it.

Okay.

Thank you.

And then --

You faded out, Francesca.

Ms.

McCann, your line is still open.

Please go ahead.

And we'll check on that line.

We'll go next to Tim Winter at Smith Moore.

Good morning, Nick.

Can you hear me?

Yes, Tim.

How are you doing?

Good, good.

I have a couple of questions, one is on the acquisition front.

You're talking about bigger acquisitions.

Can you give me an example of what you're kind of referring to?

Are you talking about --?

I'm not talking about cities.

I'm talking about towns, municipalities, municipal authorities that are nice-sized.

A nice size for us is 500.

Manteno last year was 4,300.

That's an excellent one.

A couple of those a year is really what you need.

So, bigger is more of a 20,000 --

Yes, that would be --

-- customer system as opposed --

I'm not talking about trying to buy the City of Chicago or --

Right.

I do understand Providence, Rhode Island is for sale or at least that's what the media reports.

I mean, does that fall into your category of bigger?

There are so few that self-initiate that everyone that self-initiates, we call, just to see if it works.

That would be a very big one for us.

We're not in Rhode Island, but there's no numbers on it yet, there's no real clarity yet.

But, yes, we are at least talking to them.

Okay.

And then as far as some of the numbers you were giving regarding rate base in Florida and North Carolina, I believe if I heard you correctly, you spent -- you bought them for $260 million rate base.

And that's just the Florida and North Carolina properties --

That's the -- yes.

It's Heater -- there were three purchases -- AquaSource which were six, seven states; Heather which was in one state, North Carolina; and Florida Water which was in Florida.

And those three combined, we bought over '03 and '04, 2003-2004.

And that's the ones we spent I think $265 million.

So, rate base is roughly $500 million for the systems?

Dave, is that right?

$460 million today.

$460 million as we speak.

Okay.

And then if you could ballpark -- if you have an exact number, great, but if not, if you could ballpark what kind of return or income level you're earning on that $460 million today.

And when you go to file, will you be filing for the whole system as uniform rates in North Carolina and Florida, or is it going to be a little more complex than that?

Well, other than these counties in Florida which self-regulate, Sarasota being one of them, Citrus another.

It is our intent to look at a consolidated case in both those states.

There is no self-regulation in North Carolina, but we did agree to move on [Fayetteville], Brookwood-LaGrange systems separately.

So, other than that exception, we would look for a consolidated rate.

The second is what we're earning on that $450 million to $460 million.

I'm going to guess, Dave, less than 5%.

Yes.

But we can get you exact numbers.

Okay, that's less than 5% on the whole rate base?

Yes, because none of the $260 million or the little of the $235 million of additional -- like the depreciation basically -- we got the cash, that's not in any rates yet on all that capital, right, because you didn't get them in rates yet.

Second would be the carrying cost on that.

A lot of it is with debt.

We've been carrying that cost for now three, four, five years in some cases.

And that's deteriorated the earnings potential.

Plus, Tim, I would argue that some of the original -- what was the original investment -- $265 million, wasn't earning its keep.

Was doing better in North Carolina than they were in Florida.

Heater was a pretty well-run company, going in for rates on a routine basis, but it wasn't earning its keep at that point.

And that's going down mainly because of the -- all the capital we've added.

Okay.

And if you had to guesstimate those properties, are they roughly 20% of total rate base?

Yes, I can you give that exact.

David.

We can -- we'll give you that exact.

I think you're close, about 20% of our customer base.

So I'd imagine it's about --

Up 20%.

And is that the only area of size that's under-earning materially?

The north, we're in for rate cases in Indiana and we're in for rate cases in Illinois.

Ohio is earning -- pretty much earning its keep.

New Jersey is only earning 6% as we speak because of all the capital we've had to put in.

New Jersey passed a "radium" monitoring bill which has forced most municipalities and all the private companies in the state huge amounts of treatment processes on -- to treat the radium, it's in very, very low levels, which we have already done.

We're meeting the standards.

Now, that's in lag and that's forced the ROE in New Jersey down.

Now with a $7 million case, that will pop it back up.

Pennsylvania, they -- I mean, until we get the rate case, you're in -- when you're spending $150 million to $200 million, Tim, in one state, even if it's surcharges and everything else, towards the end of that two-year rate cycle, it starts deteriorating then it pops back.

That's the traditional utility model.

And we're at the end of that recycle in Pennsylvania.

So I mean, this -- I guess it was Ryan who was saying the perfect storm on the economy and the defensive nature of our stocks.

This would be almost, as a regulatory model, this would be the perfect storm that we're facing.

Even our strongest players are at the end of the regulatory cycle and ready to be rejuvenated.

So that's why we're very hopeful that we'd do pretty well in the third and fourth quarter, so we can start seeing that those ROEs come up.

Okay.

Final question, are you able to make any kind of adjustments to your funding request to incorporate what the economy has done, the slowdown?

And --

Hopefully, yes.

The only thing you can do is if you're in a rate case and they're projecting growth rates at -- normal growth rates at a 1%, 1.5%, and you can show them that the growth rate is nowhere near that anymore, that would increase your revenue requirement and they might accept that.

But that would be the -- that would be the issue.

Some states are starting to give you some allowance, they call it a reconciliation clause, for when usage drops precipitously and you go in each year at each other, I think California is looking at that.

Europe does it now.

And that will be helpful in states where consumption is much higher than norm.

It won't be as needed in our states, but if you have somebody using 300 gallons a day or 400 gallons a day of water versus the 100, 150, and the drop become normal and go to 100, 150, you can see what that does to your revenue requirement.

Okay.

Thanks, Nick.

Okay.

And we'll go back to Francesca McCann from Stanford.

Hi there.

Hi, we couldn't hear you for a while.

I think my line got cut off there.

So if these questions have already been asked, my apologies.

One is you'd mentioned kind of North Carolina and seeing decrease in usage there due to conservation efforts, I'm guessing over the next several years, however many, we may see that in other states.

Are you seeing anywhere on the regulatory front anything in place similar to the California revenue adjustment mechanism or some kind of similar proposition out there that could help buffer the impact of conservation efforts.

Yes.

First of all, in North Carolina, I wouldn't call it conservation as much as a forced regulatory scheme.

The cities aren't regulated.

They're allowed to have free watering and people are watering their lawns again.

It's the regulated companies that are being told that we have to put restrictions.

So, most of the decrease in usage in North Carolina, which I'm going to say is in the 5% range, has been because we are forcing watering bans and things of that sort.

So I think it will return because the usage in North Carolina isn't exceptionally heavy.

And probably the percentage is your difference.

On the other hand, yes, New York is doing -- already has something similar to California.

And I'm sure, all the states, if there is a precipitous drop, we'll look at it.

I'm not sure we're going to see it everywhere though.

I think in many cases, and I think some of the more mature states that we operate in and American operates in, the -- there's always going to be pressure on usage as pricing goes up and also as conservation and environmental ethic continues.

But I don't think it's going to be as precipitous as where somebody is using 10,000 gallons a month versus 4,000 gallons.

Okay.

Does that answer your question?

Sure -- yes.

And then on your kind of pruning plan, you had mentioned one system that you're kind of planning on putting in Q3, I believe.

Anything beyond that, kind of the outlook not just this year but perhaps in '09, over -- in the next couple of years?

Yes.

Yes, we're going to be doing one or two a year.

I think we have half a dozen or so.

You know, you can't just rush out, sell something because you don't want to look -- basically they're all okay, it's just that they don't fit in to our plans and we think they may be more valuable to maybe a local government or another company.

So there's a number of them we've been discussing, but the one that we're working on now is one that we had a willing buyer.

We think we struck a very fair deal for both sides.

It's at the regulatory commission now.

There's another one that we're looking at in Illinois where there's a local municipal authority who has some interest in one of our sewer plans, expansion capacity.

So I would argue maybe one, sometimes two a year for the next couple of years.

Okay.

Perfect.

Thank you.

That's all.

We'll go next to Jonathan Reader at Wachovia.

Good morning, Nick.

I apologize, I missed some of the call.

So if you already addressed this, I can just go over the transcript.

But, what do you think, after we get through this kind of backlog of regulatory issues, is it reasonable growth rate going forward?

Are you guys still going to target your 10% annual EPS or is that kind of scaled back a little on a going forward basis?

I hate to predict because if the economy doesn't start growing, I have to admit that we're not -- we're going to have a hard time, because you need some organic growth.

And I was just explaining earlier back in '05, if you take out the apparition of all the rapid run-ups that we had with buying the 150, 200 systems in the last three, four years, out of it, and just do a normalized 3%, 4% growth, you need some organic growth, because that's -- that adds customers right away, no risk, and it's already on a system that works, you don't have to put a lot of capital into it, so on.

So that would be one of the constraints which would make me not want to predict what we see the economy coming back a little bit with the new housing.

But we're back to normal on interest rates again and growth in our cost of borrowing.

Cash generation is good, which means that we won't have to borrow as much both dividends and for ongoing increases in capital.

We have a lot more flexibility now because most of the capital spend going forward is not mandated, it's the right thing to do.

It's infrastructure replacements, capacity increases, and so on.

It's not like we have a consent order from an environmental agency saying, "You have to build it like we had."

Let me give you an example.

In Texas when we [acquired] AquaSource we had 121 items that were under consent decree.

I mean, you don't have a choice.

Whether you have the money or not, you have to fix them.

They're all fixed.

That's the kind of pressure we're under when we inherited that asset.

But it's not like we didn't know about it.

We knew about it and we knew we had to take it on.

But we knew it was all coverable, just that we'd like to have recovered it sooner rather than later.

So I'm going to be -- hedge a little bit.

I'd love to say that we can hit that 4% year in, year out of profitable growth, and that of course triggers the rest.

And I think there's a question earlier about when are we going to get back to the efficiency ratio.

That's something we concentrate on, but that's how you accelerate your revenue growth into EPS growth.

And of course, when interest rate is down and depreciation somewhat reasonably levelized, helps too.

Right.

Going to the O&M side, in the southern properties, you were talking about it kind of leveling out.

How fast, once you start getting the rates in, could we see the efficiency ratio and the southern properties start dropping?

I know there's the continuity issue which kind of puts an inherently higher operating structure in place there.

But I mean, given the, I guess, the critical mass you have established at this point, I mean what would be I guess optimistic or maximum kind of efficiency ratio you could foresee in the south?

Yes.

Well, I'll get back to you with more exacting numbers, Jonathan because I want Chris Franklin to give me his next model.

But realistically, I think where the Pennsylvania type companies are always in the lower to mid 30s.

The smaller but concentrated mature franchises are probably in the high 30s to low 40s, the New Jerseys, companies like that.

Probably, realistically, the south in total will settle somewhere between 45 and 55.

But the bigger states, Ohio and Texas, particularly North Carolina and Texas where we have a lot more critical mass than let's say Virginia, we only have 25,000 customers in Florida where we are growing but only have that 35,000 I guess to 40,000, it'll be a little tougher there.

They get the higher end of the range, but we're nowhere near those ranges right now.

Where are we right now?

Well, I think -- well, Florida, probably zero.

North Carolina, let's say about 50-some-percent now, 55%.

All of them have room.

Now the first jump will be when we get rates, because that will add to the denominator.

But the numerator has grown, not decreased, because we -- I don't know if you were on earlier, but I explained all the systems we had to put in.

And basically you have to have a professional company if you're going to go in for rates.

And that's not what we bought.

We bought a fixer upper.

We fixed it up.

But now we've stabilized expenses, we're watching everything over time.

We have our trained certificated operators, things of that sort.

So I think our expenses are a lot more predictable as we go forward.

We don't have the pension problems like we have in the north where that could, any one year, go out of whack, depending on the stock market, things of that sort.

So it's a lot more predictable.

So I'll get you projections.

Okay.

And then with the disc in Pennsylvania, can you just give an update what's going on as far as getting an increase from 5%.

I think it was -- you're going to 7.5% like American Water did.

American Water requested and was approved to get -- move it from 5% to 7.5%.

We anticipate we'll have to do the same.

It won't just be given to all the states -- I'm sorry, all the companies.

And you have to have a timing to do it.

We're not done on our first disc yet, we're in a middle of a rate case.

But I would anticipate sometime in the near future we'll be looking at that.

And I don't have any reason to believe they would treat us any differently than they treated American, especially since we're actually doing probably more pipe work than anybody.

So, would it follow the resolution of the current rate case?

And how long I guess is the approval process?

The approval process probably would be six months, but it would take us well in excess of that after this rate case to get to even the 5%.

Usually it takes us almost two years to get to the 5% level.

So we have plenty of time after this rate case to decide to apply.

And if we do apply, win approval of it.

Obviously it's not a slam dunk.

You have to show that what you're going to use it for, that there's a need, and so on.

But I think we've shown from our record that we've had a consistent steady program where we really have made a difference in the infrastructure.

Okay.

So you don't apply in advance, you apply as you're getting close to breaking through the 5% threshold?

Anytime, but you have the luxury of continuing up to the 5%.

And if you get approved in the interim, then you keep going.

Okay.

And then last question, just with the Fort Wayne condemnation and the $16.9 million.

I think you mentioned this before, but could you remind us what the -- I guess how the $16.9 million compares to the book value or the rate base of the system?

Well, it is in excess of the rate base and book value, but nowhere near what we think is the fair value.

Okay.

Thank you.

All right.

And with no further questions in the queue, I'd like to turn the conference back over to Mr.

DeBenedictis.

Thank you -- thank you very much for all your time.

And if you have any further questions, feel free to call myself or -- there's one more question.

One more question.

We'll go to Richard Alderman at Merrill Lynch.

Good morning.

I was just wondering whether you could comment on the trends that you talked about with regard to revenues for industrial and commercial and domestic customers in Q1.

Has it carried over so far as you can -- as far as you can see in into Q2?

And if that's the case, given what you said about the delay on rate cases into the back end of this year, should we expect the consensus earnings to be coming down by a reasonably material amount?

Maybe 6% to 10%, that sort of number?

We don't give guidance but I'll just give you a general answer, Richard.

Yes, we're not seeing -- we only have April in, so I don't want to predict the whole quarter.

But there's -- April's numbers were actually, at least in our biggest subsidiary, were pretty on budget.

So either people watered their lawns a lot more because of the planting season, because it was dry in April, and that [masked] the industrial.

But I can't give you an answer because I haven't studied it.

But I -- and then I'll call you back on it, I promise to do that.

I only anticipate it went up because we didn't really see the drop in economic activity until the third quarter last year.

So I would imagine quarter-to-quarter comparisons probably are going to be not positive on the industrial commercial side.

I don't want to put a number on it though, whether it's 2%, 1% or 5%.

I can't -- looked at April's numbers and they were pretty good for our biggest subsidiaries.

Overall -- so that could have messed the industrial.

The second question you had was earnings consensus.

All I can comment on is that none of these rate cases which are really the story -- I think our interest rate, our depreciation rate factor, our backend line, and they'll stay consistent, we're hopeful O&M that there's no surprise write offs in this regulatory process that might be non-cash write offs which would affect earnings but not cash.

And our borrowings are not going to be excessive in the second quarter that would -- that in any way raise our interest cost.

Really it's about revenues.

And I don't see much in the way of a big -- a big acceleration of revenues year-over-year resulting from the fact that Fort Wayne is out, that was in last year, out this year.

The fact that housing has not turned around on the dime in April, so I would imagine that will stay consistent.

In Q2 last year, housing wasn't that bad.

It dropped off the map Q3, Q4.

So there's a lot of quarter-to-quarter comparisons and I don't want to be to micro-managed because this is a utility, it's longer term.

But I think Q2 is going to be -- last year's Q2 was okay in the sense of housing starts and send-out.

If we can match that, then we'll be fine.

But if not -- but there's no big revenue stream coming in from rates that I know of.

Dave, is there any cases coming in the Q2?

No.

Okay.

So it's going to all be backend-loaded.

Okay.

All right, thank you very much.

Okay.

And gentlemen, we have no further questions in the queue.

Okay.

Thank you, everyone.

Thank you.

This does conclude today's presentation.

We thank everyone for their participation.

You may disconnect your lines at any time.