Essential Utilities Inc (WTRG) 2008 Q3 法說會逐字稿

Good day, everyone, and welcome to the Aqua America third quarter 2008 earnings conference call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr.

Brian Dingerdissen, Director of Investor Relations.

Please go ahead, sir.

Good morning, everyone.

Thank you for joining us for Aqua America's third quarter 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, or call Will Meade at 610-520-6309.

There will also be a webcast of this event available on our site.

Presenting today is Nicholas DeBenedictis, Chairman and President of Aqua America, along with Dave 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.

Thanks, Brian; and welcome, everyone.

We're obviously pleased with our third quarter and also our outlook which I'll try and get into a little bit today.

I think the results verify our successful business model which we've stuck with, and been successful for over a decade, and now it's returning to its norms.

I think this quarter also validates, and I'll get into some of the credit issues that everybody is being affected by today, but I think the numbers, the balance sheet, the strength that we're showing also validates the fact that for the past decade we've been working to strengthen our balance sheet and be prudent in our use of debt.

And I think that's going to come in very handy over the next, hopefully not too long, but maybe 12 months, as the country and the world works its way out of the current credit crisis.

And I'd like to start there.

I guess the major issue I'd like to tell you is that we are still borrowing and can borrow and people want to lend us money.

And I think that puts us aside from many companies today.

Yesterday S&P just reiterated our A-plus rating, actually AA-minus on the debt, and gave us a 1-plus, which is the highest 100% recovery estimate that they put out.

We also were approved last week for a special state tax-free loan which we have to issue now through a private company, but the state backs it.

It is $80 million, we have a 60-day pricing window.

And the S&P rating yesterday reiterates this -- what they feel is an AA-minus on that to the possible buyers of this note.

We have little refinancing ahead.

We only have $7 million in '9, which is coming due.

So we should be able to turn that debt over very easily and won't have any major effect up or down on our overall embedded cost of debt, which still rides in the low [fives] for our over $1.2 billion of debt.

We have little need for new equity because of our internal cash generation, which I will get into later with some EBITDA numbers.

And basically I'm happy about that because I consider our stock depressed at this point and I would hate to sell equity into the market at a time when it won't increase shareholder value in the future.

And so we probably won't be accessing the market, short of a new acquisition or something of that sort that we would have as an opportunity.

It would have to be a large acquisition.

We can do most of them -- the meat and potato ones we do year in, year out.

We have been able to do with our internal retained earnings and our -- and debt.

So, overall I think we have plenty of room on our notes.

We have basically $100 million of unused line, short.

We have existing tax-frees that we haven't drawn down yet, of $60 million.

These were the $250 million deals we did late last year.

We're still drawing them down as we do projects.

So we have $60 million left on that.

Those notes were at 4.9% and 5.2%.

So -- and we have this new $80 million which we have not put out yet, but when we do, that would add another $80 million.

And of course the -- if you just look at net income and depreciation projections, and actually just take this year's, we're well in excess of $200 million.

And because of the Tax Reconciliation Act and the way we are actually using our capital budget to maximize the benefit of and there will be a huge amount of capital we put in service we complete in the fourth quarter and then put in service really next year, over $100 million just in that quarter, that will generate almost $35 million to $40 million worth of tax benefit, real cash, that we can use to offset those expenditures, which means that we're able to put more pipes in the ground and build new water plants without affecting rates going forward, because this is a deduction from rate-based but it's a positive thing for both our shareholders and our rate payers.

So we're taking advantage of that.

And I guess you could argue that the government talks about infrastructure and they're saying this is the magic bullet to get us out of recession, private companies like the water companies are actually spending the money, taking advantage of the government largesse, but also creating jobs and improving the environment as we're doing it.

So I'm very pleased with that.

The revenues, let's start if we go through the release -- well, let me get one other item because it's very positive.

The Board is very confident in our model.

We lived through some regulatory lag which we're still at the tail end of fixing.

But we're looking going forward at maintaining our old model which was consistent for almost 15 years.

And therefore, in August, said for the December dividend which would be effective I think November 17th, we're increasing our dividend 8%, from $0.50 to $0.54, a penny a quarter, and it will be our 10th consecutive increase above a 5% target that we usually set for ourselves, 18th increase in the last 17 years.

And we believe that this is a good way to return some of the benefits of our successful business model back to our loyal shareholders.

Let me go into revenue.

Revenue was up 7%; I'll break it down for you.

About 5% of that is from rates, which I'll drill down into as the reason why we're doing better, but it's also the reason why we relieved some of the regulatory lag from the hundreds of millions we have invested and not gotten the return yet.

That's starting to come through.

About 1.5% is from acquisitions and new growth, and -- but you take about 0.5% off that, so net 1%, because we have sold some properties, both Fort Wayne North System and the Woodhaven System, and last year we sold at the end of the year the Henrico System.

So, taking those out, the net is about 1%.

And that leaves 1% for basically increased consumption from that organic growth.

But also last year's third quarter was a very wet year, and although this year was not overly aggressive, but it was a normal year.

We were able to actually pick up about 1% based on just consumption of our existing customers.

How much of that was affected by the turn in the economy versus weather it's very hard to come down to, so I'm giving you just the gross number.

It might have been up more for weather and down more for the economy, or it might have just been pretty stable at the 1%.

But we're very happy to see any growth in that area because a lot of companies are reporting that they're going down based on consumption.

Now, that probably -- the fourth quarter will get a better read because usually the fourth quarter is not as affected by weather, it's usually the second and third.

So -- and the first quarter is usually affected by cold weather and main breaks.

So the fourth quarter is a pretty normalized quarter, so we'll be able to tell a little bit more about what the economy and what consumptions are in the fourth.

Our expenses are, I'm happy to say, I feel are back -- getting back under control.

I'll hit the O&M numbers generically because a lot of you follow that as the efficiency ratio.

Let me tick off some of the things we've mentioned in the past.

Fuel has come back down.

We're seeing fuel prices now breaking $3, which we haven't seen since last late summer of '07.

So you can see we had a rapid run-up, it very much affected Q1, Q2 and Q3.

But I think if they -- if fuel prices stay down, we'll see fuel basically matching up quarter-to-quarter where they used to be in '07.

As a matter of fact, if they stay down, we'll start seeing some positives in '8.

Now, fuel isn't the biggest part of our budget, but it has the generic influence throughout the entire economy, regarding gas prices, electric prices in deregulated states at all.

So it is a relevant indicator.

And we're starting to see it come back down on levels that we hadn't seen for almost six quarters.

The good news I guess that you can say about the run-up is it forced everybody, including us, to look at everybody in the fleet -- who has trucks, why we should downsize certain trucks.

We put GPS devices on all our trucks so we can track mileage and account some inefficiencies out of that -- excuse me.

So, the fuel economy remains very, very big with us.

Bad debt is something we're tracking very carefully because of both the conversion of our computer system which caused the initial bad debt, and now the economy in general.

I'm happy to report that year-to-date we're down to the 1% level again, which is very good for most utilities.

For us it's a little higher than we like to see, we're used to.

We like to look at the high, 0.7%, 0.8% as a great target for us.

But most utilities would be very happy with 1%.

We were running worse than that through the first six months, we were a little over 1.2%, 1.25%.

So you can see it's coming back now in the more normal utility indicators.

Not for us; we're going to try and improve it.

But the direction is the right way.

Depreciation has been -- year-to-date is only up 5%.

Remember in '07 it was up in the high single digits -- excuse me, high double digits.

We slowed down a little bit of capital, we got ready for the rate cases, brought the rate cases in.

Q3 it's up about 8%.

We think for the full year it will be in that range, maybe 7% to 8%.

Because a lot of capital is coming in in Q4, as I mentioned, almost $100 million, that will be closed usually a couple of months after its contract is [out spent] which means its depreciation starts getting calculated next year.

So I would anticipate next year, because of our capital spend this year and continuing in the next because of the surcharge programs, that you'll see depreciation return to the 10% to 15% growth levels that was witnessed in '6, '7.

Now that's good news and bad news.

Good news is more cash generation.

We get it in recovery in rates quicker where we have states that have surcharges.

But it also generates cash to support our ongoing programs, which means we have less dependence on external financing.

Interest, same thing -- interest has really been very flat this year, up a percent or two.

But as we move into this $80 million borrow and look at next year, it will be probably back into the high single digits, low double digits range, where it was in prior years.

So I'm very much more pleased with the outlook on some of the expenses which -- and bad debt -- which earlier in the year was a little bit more challenging to us.

Obviously it's still going to be challenging, but we're going to work hard, and I think we've turned the corner.

Looking at O&M revenue, which is a good way of judging the whole picture, through the first six months we had -- we were going the wrong way, about 43% in '07 up to 44.5% in '08.

So I'm happy to say we've turned that around in this quarter.

Q3 last year was 40.5%.

This year you're going to see on, if you do a quick calculation, it's in the high -- about 38%.

But I don't want to mislead you because that includes a one-time gain and some write-offs which I'll get into.

I'd say normalized, it's probably closer to 39.5%, which is about that 100 basis points that we'd like to try and get it down.

For the nine months, you can blend that -- it's basically flat at 42%.

And for the fourth quarter, we think we can look at that 100 to 150 basis points decline again, and for the full year will probably come in pretty level even -- because we were so far off in the first six months but now you're starting to see that turnaround just like in the other areas, and you're going to see a steady decline.

And then we'd like to see at least 100 going into '09.

And part of that is because of the revenues coming in now because of the rate cases.

So, I think some good news there on the efficiency side.

And obviously we're doing our '09 budgets, we're watching every position, every truck, because that's where you can increase your EBITDA and therefore use less cash for expenses, you have more for capital which is really what the regulators look for and what the investors look for.

We're returning -- we had a strong record whether you take five-year, 10-year [cagers] of pretty steady 10% EBITDA growth.

This year we're not going to see that because the first two quarters we were actually negative.

We're starting to come back very rapidly now.

I think you're going to see EBITDA growth in excess of 10% in Q4.

We are today -- Q3 was -- EBITDA was up 12%.

So we're starting to see return a little heavier now because of the immediate impact of the rate cases, but it will come back to that normal which we like to look at, which is 10%.

And I think you could model 8 to 9 with the 10% EBITDA growth and depreciation.

Talk a little bit about the rates because that's the bulk of our revenues this quarter.

This has been the most aggressive rate year we've had because we had basically three years of backlog rates that we can't do and projects were done, money was spent, environmental rules were met, and we were in 35 different cases already this year that have been completed.

It's a phenomenal workload.

By October 1 we had filed for $73 million and we had returns annualized at $60 million in those 35 cases.

That's an 81% efficiency on the rate cases which we are very pleased with because you never agree on 100% with many regulators based on what they think your return should be and what we thought, and there's always some disagreement over capital and expenses and things of that sort.

We have existing rate cases in progress.

In other words, they are already filed and won't be decided -- some could be decided late this year, most will be decided next year in the first two quarters.

Eight cases totaling $21 million in progress.

And believe it or not, we are not stopping.

We plan to file another 11 cases before the end of the year.

Mostly small cases, indexes, small wastewater cases, [6 disk quips] filing their [fuel] surcharges and indexes in some states which allow inflationary indexes.

But we plan to file those.

And looking at '09, we have currently 25 cases being prepared to be filed throughout the year.

That includes surcharge filings and some larger cases.

And those 25 cases currently represent about $70 million to $75 million worth of request that we think we're going to be filing next year on our current plans.

So you can see, they won't really affect '9 as much as they will '10, revenues.

So, very, very busy rates plan and very, very appreciative of the reaction we got from regulators, mainly in our new states where we were filing for the first time in some cases in over 10 years because the companies that we bought in those states didn't fix anything, so it's hard for them to file rate cases.

And which meant their expenses had deteriorated, their structures have deteriorated, in some cases, the way they accounted for rate base deteriorated.

And we had to fix all that in the midst of what I consider very large rate requests because of the length it was and the amount of money we had to spend on a low base.

And many of the regulators treated us fairly, and I'm very proud of the regulatory compact that, if it's fair they'll buy the [power fix], and even though it's a large rate increase, grant that to you.

An example, in Fort Wayne which we hadn't been in for years and years and we had spent huge amounts of money to fix the environmental problems, we were actually asked for and were granted a 75% rate increase.

Now that didn't ask for everything we could have, but we felt that was the fair amount.

The regulators agreed with us.

They phased it in over a nine-month period.

But that's a good example.

In Virginia we've gotten some cases in excess of 100% because of the environmental improvements we've made to some key streams that were being deteriorated by the previous owners by not putting the capital in.

In North Carolina we had a 75% award in Brookwood.

Rates are still under $25, so it's not high, high rates, but it was a high percentage increase.

And on and on.

In Illinois we had a 35% rate increase in a couple of systems.

And we were just awarded in Missouri a 41% average increase across the state.

It's a small state for us, but once again the regulators are tough but they treat you fairly if you can justify it.

Now in some of these areas, because it was the first time through, we had some rate-based adjustments, non-cash.

It basically says what was on the books didn't jive with what was on the books of the regulators, and we had to adjust our rate base to accommodate what the regulators felt.

We don't usually see these types of things in our more mature states, Pennsylvania, New Jersey, Illinois.

This is what I call the first time through problem we always have.

Sometimes it's up, sometimes it's down.

But for the third quarter it was worth about $1 million of non-cash write-offs to true-up the books.

And we also got a ruling in our Texas case after four years, of -- where we were awarded the rate return on equity that we were granted.

We were awarded the expenses that we had asked for -- all except for rate -- some of the rate case expenses, a small portion of the rate case expenses were disallowed.

And also the very unique true-up of how we -- I remember, for some of the analysts who've been following us for a while, we had deferred expenses rather than the increase in the rates, and then were supposed to true themselves up.

So, our accounting team had to predict five years in advance what the expenses would be versus what the deferral was.

And unfortunately, although the revenues are coming in, the difference in the deferred expenses, again non-cash, represented almost $1.5 million.

And that all had to be taken this quarter.

These are all pre-tax numbers.

Now, the good news is about -- we took a pre-tax gain on one of the sales of one of our systems that we sold back to the homeowners association that we were serving, of about $4 million.

So when you take the $4 million, take $1.5 million on the amortization line on Texas, $1 million off on the rate-based adjustments, which would be in O&M, you're looking at about $1.6 million tax effective.

That's about a penny.

So I would argue that if you look at our number 26 versus 22, the core is 25.

This -- all these one-timers ups and downs were about a penny.

And when you look at the 22 we are comparing last year to, I think you'll also see the fact that that was the quarter that the Florida write-off occurred and that was about a penny also when you take the ins and outs of that, so -- tax effective.

So I'd say that we're very happy because the real GAAP numbers are 26 versus 22.

If we want to put a little bit more because of the one-timers in the third quarter last year and this year, probably back to where our norm is which is like -- which is very healthy in this economy, a 25 versus 23.

And I may as well stay on that theme, looking at the fourth quarter, we're expecting operations to produce similar results, but I have to remind you that last year's fourth quarter had two one-timers in it that are in the numbers because it's GAAP.

One was the sale of securities.

We owned a fairly reasonable position in the company called Basin Water which we were able to sell after the lockup period and we actually booked over a penny gain on that.

And the other was a sale of a system where we had a one-time gain, the Henrico System in the fourth quarter.

So if you took those out, the 19 looks more like 17 non-GAAP.

But just so you have an idea if you want to try and follow what's the core business model [worries].

Capital spending, we are -- I mentioned about $100 million we're going to probably book in the fourth quarter, because we are in the process of doing a lot of pipe work around our entire system.

We have no major -- we have a plant in Maine and we have to finish up a plant here in Pennsylvania -- home of the world champion Phillies, by the way -- but we don't have any major project like a nuclear plant or something that we started that we couldn't stop on a dime.

So if you take a look at the capital spend program, we're probably in the $280 million range this year.

Next year $250 million, unless a tax act is passed, we probably will do more if we have another additional year of the Tax Reconciliation Act.

The amount of that capital that has to be spent, and I'm talking about environmental compliance, paying the builders back for their part of the pipe that they donate to us, that's an obligation, compliance-oriented, that's about 10% of our capital spend.

So we're looking at $20 million to $30 million that we just have to spend no matter -- if the world comes to an end, we're going to still spend that.

That leaves a lot of discretionary spending that we can speed up, slow down, depending on tax policies, credit markets, and so on.

It's an excellent place to be in.

Of course our model is to invest and build the system better and to make it more efficient and to use that as also a way of shareholders benefiting because of infusing equity and debt at levels that are, especially equity, that are either retained earnings and reuse of those dollars, or selling stock that is above book on the market.

So that's a number to just pick away.

10% of our capital spend going forward we see as being non-discretionary, about 90% discretionary.

Regarding our other part of our revenue, our program, which is growing customers, we -- as I mentioned, it was about a net 1% after disposition.

So you're really looking at still around 1.5% growth rate.

Organic growth has been okay, down from last year 15% to 20%.

New housing, it's no surprise to anybody, it seems to be stabilizing, and we're looking at that plus acquisitions hopefully for the rest of this year and finalizing '8, and then '9 we're looking at more of the same, of us trying to get close to the 2% growth range.

That's of course net of any dispositions we do.

That is a very healthy growth rate for most utilities in a good economy.

So I think that we're, you know, it's not the floor we like to shoot for, but it's still healthy enough to keep revenue enhancement at the top line without having just to depend on rates.

So I think it's an important part of our program and we're continuing it.

We're starting to see some opportunities in the acquisition side because of the other uses of capital municipalities may need, like pensions and things of that sort.

And actually this may open up some opportunities over the next year or two that weren't there in a better economy.

On the other hand, the poorer economy means fewer homes are being built, few new organic homes.

But that's just in my mind a backlog.

Probably it was a little bit inflated in the '5, '6 period, it's probably deflated in the '8, '9 period, and will come back to normalization, at the right number, which is probably 1.2 million housing starts.

And we're in the right part of the country that will benefit, we think, from those new housing starts when they report -- when they get back to normal.

I think I covered a lot, open it up for any questions now you may have.

(Operator Instructions).

Okay, no questions.

We'll take our first question from Michael Bloomberg with Boenning & Scattergood.

Good morning, guys.

Thanks for taking my call.

You did mention a little bit about delinquency rates and bad debt expense.

I'm wondering, in -- as we have gotten into the September, October, November, have you seen an uptick in that at all?

I know you talked about giving it to a lower number, but given that unemployment is up and there's a lot of uncertainty.

Has that affected your delinquency rates or bad debt in any meaningful way?

Michael, actually it is ironic that the bigger problem we had was the fact that we had changed over the customer service program late in '07.

Had to delay bills for a month and then we decided not to try and collect so we lost a phase of maybe a quarter of our normal collection process and we saw our bad debt jump, because people were transient in some of our areas.

And if we leave it's hard to collect.

As a matter of fact, the biggest was in the Woodhaven area, the one we sold.

That was our biggest bad debt write-off.

But we've seen it come down, even though the economy has worsened, we see it come down.

Now you're absolutely right on the foreclosure issue, which we've been fortunate our areas have not had as much impact as California, Arizona, some of the areas where there was speculative Southern Florida, parts of Florida we're in we're not seeing it as much.

I'm not saying it's not there, but it's not to the degree you're reading, at least in the areas we're seeing.

We've become more aggressive now that we have our new computer system.

It permits us to have centralized collection versus every state do their own collections and have 13 different policies.

And if you haven't paid your bill on the 10th day after the bill was mailed, you get a dinging notice sent out by computer to the field and they have to address it, which means you could get the money or shut a person off within a certain timeframe.

It's no longer an individual decision made by a collection agency in an individual local [municipal] area.

So we have not seen an uptick -- as a matter of fact, we're seeing -- we're going what I would consider the other way.

But I would say we're doing it based on the fact that we were artificially high in Q1 versus our norm.

So those two intermixed, probably it's a little worse, because as I mentioned, 0.8 is like what we'd like to see.

Run rate is now about 1.0, 1%.

But I think most people would agree that's not a bad number for a utility in this economy.

Okay, that's helpful.

And another major question --

Let me address one more area because I think Michael the other -- the new computer system allows us to bill people monthly, not quarterly.

So we're addressing these issues on a 30-day period, not a 90-day period.

And the fact of that is that our bill has been cut by a third, it's easier to pay, and it's still a third of the electric company bill.

So when we were billing quarterly, our bill and the electric company bill was about the same and people had a choice which one to pay.

Right, right.

Okay.

That is helpful.

Switching gears a little bit to the acquisition front.

A couple of questions that come to mind, particularly with what's transpired in the last 24 hours.

In general, do you think that the political shift that we're seeing across the country is going to add some stigma to the trend towards privatization of public infrastructure?

It's obviously such an important part of your business.

And in addition to that, in the Pennsylvania market which obviously is huge, how if at all does the $400 million PA water bond affect your outlook on the state?

Well, I'm on the task force that helped develop it.

So we were very supportive of it.

We are eligible for it.

It gives you low interest loans through what's called PENNVEST which means that we can borrow as low as 1.5% which we have been the number one user of PENNVEST over the past 10 years in Pennsylvania.

And I think it will provide more dollars for everybody, so I'm not worried about the fact that somebody will use it and therefore wouldn't let us -- squeeze us out or possibly not sell their system to us because they can get a low interest loan.

The backlog in Pennsylvania is about 12 billion.

So this is going to be used by those who are ready now to use it, which obviously we are, and can put people to work right away to help the economy, more than the ultimate solution by a planner to how to solve Pennsylvania's backlog of water and wastewater infrastructure commitments without having any -- having government do it all.

This is just a little nudge by government.

With the current state of the Pennsylvania budget, I don't -- fairly close with the, both the administration and legislature -- I don't see any more programs being initiated in this vein.

This was meant to give a jumpstart and to take care of the worst issues.

It will be jumpstart part, companies like ourselves and American Water and everybody else, will do the jumpstart part.

And the other part will be addressing long-term combined sewer overflows in Pittsburgh, let's say, things of that sort, where the environmental law is requiring them to do something and there's no money, so therefore they'll use some of this funding probably to do it.

So I thought it was an overall positive, not anti-competitive, not a government bailout.

It's basically a nudge.

I think it's more economic development oriented than it is entitlement oriented.

Okay.

And if you could also --

Political shifts, I'm sorry, Dave --

Sure.

I thought when you meant the last 24 hours, the Iverson trade to Detroit (inaudible).

That's just (inaudible) trade anyway.

Yes.

Having -- that's right.

Having been in government for 15 years and having run an environmental agency both at the federal and state level, I found -- and I served under four presidents, so D's and R's -- the shift of the environmental agencies will be about 5%, one way or the other depending on what the administration, conservative or non-conservative, that's in office.

I think there will be a lot more rules and regulations developed under a new administration.

Whether they enforce as much as the old administration, I hope they do, because you only have so many people in government, and if they're writing rules, they can't be enforcing.

So I'm hoping there's a balance.

And I think cities, it will all depend, if they come up with $100 billion sewer fund to help every city in the country so that they don't have to raise rates, then it will be just one more inflationary tax added to the rest of the population.

If they follow the current strategy of both the Clinton and Bush administrations, which was a cost of service model, will give you a little help, fix your system, but raise your rates to support it, return on and return of your capital.

If they do that, I think we'll finally start addressing the quarter-trillion-dollar backlog in water and quarter-trillion backlog in sewer, and people will start not getting subsidized, including big industries that get subsidized by rates that don't really pay the bill.

I think that's the biggest shift that we'll see that affects our business directly.

Now the energy is a whole new policy.

It's a lot more pizzazz.

I think you'll see a lot more innovative things there, whether they're productive or not, I can't tell you.

Whether a windmill is better than a nuclear plant, I have my own opinion as to what's better for our country, but that's not my realm of activity.

Right.

Okay, well, thank you.

It will be interesting to see how that plays out.

One last one and then I'll let somebody else hop in.

You said in the past that the long-term dividend target growth rate is about 5%.

You've obviously been growing above that for quite sometime now.

Has the thinking on that changed or are we still thinking long term that the 5% is a safe bet?

We're still under 70% payout, and I think even with that type of 8% increase, obviously 5% would be less of an impact on the payout ratio, I think it's affordable when we look at our five-year model.

I think the bigger shift would be if credit markets are such that we have to conserve more capital, which is what a lot of companies are doing, cutting dividends to make sure they have enough money to continue the program.

We don't see that at this point.

The second is if tax policies change.

Right now the dividend tax policy is such that I think our shareholders want a dividend.

If tax policies shift and it's not as a valuable a way of reward your shareholders, obviously we'll shift our policy.

Right.

Okay, thank you very much.

We'll take our next question from Debra Coy with Janney.

Yes, thanks.

Good morning, Nick; good morning, Dave.

Hi, Debra.

Question on rates.

You talked, Nick, about the success that you've had in the rate cases so far.

I think perhaps the question we get from investors more than any other is, what makes you think that water utilities can continue to put these large rate increases through in this type of an economic and political environment?

What is your answer to that as we look at your big backlog of cases that you're going to be filing going into '09?

Short of the two remaining cases that are in progress that I mentioned, which are first time through those state cases, we are now in the -- every other -- every new development that we bought with AquaSource Heater Florida Water has now been filed and gone through one set of rates, which means the books have been cleaned up.

And our second round of rates are more normalized returns, more in the high single digits, low double digits.

The risk factor on size of rate increases -- I'm not saying dollar amount because you know, the lower the rates, the higher the percentage, but that's really the political that your investors are asking about are behind this.

And that's something we learned the hard way, that we couldn't go in and get small modified rates until we fixed everything, and that meant two, three more years of no rate relief while you're building up a lot of capital.

That's all been captured in the first round.

Now, we didn't get full return like that 75% rate increase that I mentioned in the Fort Wayne area.

We didn't get full return but we got close to it.

So any future rate relief would be to make up that small difference that we didn't get this time, because our capital spend is now more in line with our return on the cash from depreciation, in those areas.

Okay.

I would argue that every utility, electric even more so than water, with the infrastructure needs that are out there, and if we have an inflationary period, are going to be in for rates.

We did this last two years of rates, a lot of cases with high amounts, in a time period where there was a void and no competition, if you want to call it competition, among with the regulator's time with the electrics and the telephone.

And I think you're going to start seeing a return of the gas, you're starting to see that already, and the electrics, where the amount of rate dollars are going to be -- make us look paltry.

Indeed.

And related to that, on ROEs, we were particularly pleased to see the 11% ROE you got in Pennsylvania a couple of months ago.

How are you seeing the environment for the allowed returns?

And how are -- how do you think regulators are viewing this in terms of relative competition for capital -- a rocky capital market?

How are your utility regulators thinking about ROEs these days?

Well, I'll give you a plug because you've been to some of the forums that we've had where we have really addressed our biggest risk, is the fact that if we don't get adequate return, investors will not provide us the money because we're not, pardon the expression, sexy industry.

We just say we prowl along.

If we do things right, we'll get fair return.

It's a lag with regulators, but they'll treat us fairly, and we'll earn our keep.

And when I saw that -- when I had a meeting one time with the chairman of GE, Immelt, and I told him that we should put 10% to 11% returns, he said, "Wow, what a lousy business."

Now, we look a little better today compared to what's happening at other companies, but it's the tortoise and the hair basically.

Basically steady and straight, but you just can't start up stop your capital program because the environmental community won't let you.

We are already the lowest and most efficient utility, I'd say, at 40% O&M to revenue, I'd argue probably in the country, not only water, among water, but probably among electric because they have the high fuels.

But the -- at this point in time, I think regulators are starting to understand more and more that if we don't have the fair returns, we won't be able to garner both the S&P ratings that we need to borrow the huge amount of money that we have, and the fact that there are regulators, that the legislators in the same states with the regulators, are now trying to pass infrastructure rehab bills and put all kinds of money on the table, says how important what we're doing is to do it on a progressive and steady basis.

I also think the electrics coming back in will raise ROEs because I don't think they could afford to maintain what they've already built over the last 50 years and all the new plants they want to build now at ROEs that we've been getting.

So I think there's a comparison factor coming on to play.

Now, Pennsylvania was -- has always been at the forefront in the sense of the water utility regulation.

They've been very fair with their electrics too.

So we're very pleased with the recognition.

I think some of the reason we got the 11, Debra, was what I can call good person points because of the fact that we are the go-to company, they ask us to pick up small troubled companies, we do it, and we've had very few service problems over the past 10 years, no -- 13 people showed up at all our hearings, around 400,000 people that we had to mail letters to and invite to complain about our rate proceeding.

So I think that played in to a little bit of it.

But I would argue that in Illinois we got 10.75.

In -- help me, David -- I think it was 10.4 in -- it's 10.7 in Florida, 12 in Texas.

So I wouldn't say -- I think probably the higher 10's is now the new range, to low 11's, I would hope.

Me too.

Great.

Thanks.

One more big picture question and then one kind of housekeeping question.

You mentioned the potential opportunities on the municipal side.

We've been hearing more discussion of that over the last, I would say, six to nine months.

It doesn't seem like much has come to fruition.

Can you give us an update of where you're seeing those kinds of conversations, what kind of municipalities, kind of what the activity level is on the potential acquisition front or public/private partnership front on the municipal level?

Well, the public/private, we never really have gotten into that in a big way.

If that's an opportunity going forward because that's the model --

No.

-- people want to follow, we'll try and look at it.

It's in most of the states that are more mature that are facing high costs for their labor, because pension is starting to come home to roost in many of these municipalities, and that means the water and wastewater plant has workers who have high legacy cost.

The fact that the EPA has now issued orders in many of these areas for combined sewer overflow on the sewer side and on the water side for unaccounted for water which is horrendous in some of these old towns, and/or the new standards for THMs, trihalomethanes, for cryptosporidium, the parasitic type things.

And all this is now meaning money to be spent, and that's when usually decisions are made.

I can't tell you, we have 10 right on the table that we're ready to announce in the next quarter, but the gestation period for these things is usually over a year.

Can you say how many you have that are kind of on your radar screen?

Not for the next quarter but for the next 12 to 18, 24 months.

Yes.

We've been talking to at least half a dozen.

Interesting.

Okay.

And my last question is on the O&M ratio.

As you mentioned earlier, there are some moving parts there relative to the -- what appears to be down, a little tad under 38%, you mentioned around 40% normalized.

We backed out some numbers and came out with closer to 41%.

How should we -- maybe this is a question for Dave, how should we look at those O&M numbers in terms of what is included or not included there from a one-time basis?

We had seven numbers that had some one-time and eight numbers that had some one-time, including goodies.

I tried to take the goodies out.

I think '08 through '07 will be flat, if you take GAAP, which should be about 42%, which is way -- well above what we'd like to be.

The numbers are not coming down as rapidly in the south as I had hoped, but that's because we didn't get the rate increases as rapidly as I had hoped.

So they'll come down next year with cases in two of our southern states, and with more normalized accounting, I'll call it, in Texas, because now we don't have all these deferrals anymore and amortizations, it's going to be straight revenues with less expenses, a lot easier to gauge.

I think the fact that we were up almost 200 basis points through six months, and now we're going to end the year flat, gives you an indication that we're back on that track, and I would project that '9 versus '8, you're going to see at least 100 basis points off.

Okay.

Thanks, I appreciate it.

Good.

Our next question comes from Jim Lykins with Hilliard Lyons.

Good morning, everyone.

Hi, Jim.

First of all, I was wondering if you could go into a little bit more detail with your rate cases, the eight that are filed right now for the $21 million, if you could give us an idea when you expect those two start to come in.

And then also in '09, I know you said there's 25 being prepared, but maybe if you could just hit on a few of the bigger ones and when you anticipate making those filings?

Sure.

The -- of the eight, I think -- see -- one, two, three -- four will be decided by the end of the year, but they're the smallest amount, less than a million.

The two big ones are North Carolina and Florida.

And I think they will be decided sometime in Q1 or Q2 of next year.

Okay.

For the '9 filings, the biggest group in those would be Pennsylvania, late in '09 to be filed; New Jersey, late in '09 to be filed; New York, early in '09 to be filed; and then a number of small cases in Illinois.

Price indexes in Florida, six cases in Virginia to catch up, and a major case in Maine, small cases in Indiana, and three cases for three divisions in Ohio.

Okay.

And I can't remember if this is in the press release or not, but did you disclose or, if you didn't, could you tell us what you think you might be filing for in PA, New Jersey and New York in '09?

Well, we're finalizing it, and I'm giving you nine months in advance.

I can give you rough numbers --

Yes, that would be great.

-- Dave could call you on that.

Okay.

We'll get with our rates person and have you talk to him about all the specifics.

Okay.

By the way, one other thing I didn't mention was short-term interest.

We have a bar of almost $100 million almost all the time, short, and then we turn it into long after the projects are done.

LIBOR came down again yesterday.

It is now lower than it was before all these prices occurred, and actually lower than it was last year.

Yesterday's LIBOR was 2.18.

We borrow in ranges of 30 to 50 above LIBOR.

So you can see our short-term money is back down to the 2.5 range again.

And at this point we have a lot of -- about $100 million still on our lines to borrow if we have to.

I think LIBOR was the number one issue that at least bothered us three weeks ago when it was as high as 4.5.

Less than a month ago it was double what it is today.

And we've just seen a steady drop over the last two weeks.

I think that's very, very good news for overall credit markets.

Sorry.

And one last thing I wanted to ask you, you mentioned housing stabilizing, but maybe if you could just give us a better feel for how you see that trending into '09, maybe the first half versus the second half.

Yes.

I think with this new administration, it may occur even before that if Congress gets involved, I think there's going to be some squeeze on the banks to halt foreclosures.

And when that occurs, it will be -- we'll all pay for it, let's not kid ourselves.

It will be principal reductions and don't pay interest for a couple of months.

This is me speaking.

I'm not obviously in anybody's administration.

But I think once the crisis stopped dropping, you're going to see people who have waited in their apartments a little longer than they would have normally because they want to make sure they hit the ultimate bottom of the market.

And at that point I think you'll start seeing the returns to the normalized -- right now I think we're, our housing starts are 0.7 -- 700,000, something like that, maybe even less.

And I've talked to some of the bigger builders and they said, "The money is out there" -- I mean, we're still talking 6.5% mortgages.

When I got my first mortgage it was 14%.

So I mean, young kids can afford 6.5%, young families.

But I think nobody wants to buy a house unless they think they're getting the absolute lowest price.

There might be another 5% in the market, I don't know, in certain areas, where there wasn't rapid speculation.

I'm not talking about Nevada, Las Vegas and Southern California and Southern Florida.

But, you know, North Carolina would be a good example, slowed down drastically.

What -- we were at 4% growth, almost 3.5%, 4% growth just a year ago, slowed down to less than 1%.

I think that's because people -- the builders are telling me, once they -- people think that the housing prices have bottomed, they're expecting an upturn because the financing is there, it's more affordable, obviously, than what they were getting before.

Now they won't have this idea where they put a house up for sale and four bidders come in and they outbid each other and go over the asking price which was occurring in the summer of '05, but it will be more normalized like it was 10 years ago, you have a house on the market for a month or two and you have to bargain a little bit, you ask 5% more than you think you're going to get, and you actually put some money down on the house -- all those kinds of things.

So I think you're looking at another quarter or two of stale sales.

You got the winter coming up in most of the northern states anyhow.

Nobody buys a house around Christmas.

But I think probably by second quarter next year you're going to start seeing the housing bottom.

And I think you have to to stabilize the banking, accounting.

That's me speaking, so that's what we're projecting a year at this time.

Okay.

Well, that's helpful.

Thanks, Nick.

Our next question comes from [Richard Verde] with [Sterdida and Company].

Good morning.

Thank you for taking my call.

Nice quarter.

Thank you.

Nick, I wanted to back up to the rate case activity.

I'm looking at a slide here from a presentation on your website and you even -- you went through it on your call here about rates approved in 2008 were about $60 million, and I believe you mentioned that 81% of them have been approved so far?

No, Richard, what I said was that that represented 81% of what we asked.

Okay.

So that's -- I think a lot of times analysts say, "Well, if you asked x in x, y, z state, you usually get 50% or 60% of what you asked."

Yes.

Eighty is probably at the high end of the range.

And I think the reason for that was we basically modified our requests, actually in some cases took less than what probably would have been the rule, normal rule on the ROE, in order to capture all the capital and get some earnings on it, and knowing that we probably have to go back in a year or two get the rest.

But we felt that the number was just too high to ask for at one shot.

Okay.

So you're saying you've got about 50% of this so far?

No, no.

Of the -- of what we got, 80% of what we asked for is in the bank, is annualized, but it's in the bank.

The last one went into effect October 1.

Okay.

That will affect us positively for the next 12 months.

So you could argue a 60% delta to current run rate revenues over the next 12 months.

Okay, perfect.

And I had another question here.

Most of my other questions have been answered.

On the acquisition front, with American Waterworks back in the arena in the competitive environment, are they showing up at the table on acquisitions here?

And if so, how is that affecting your process?

In some states they really were there even when they were private.

Okay.

Because RWE wanted them to grow too.

I'd say no more, no less than in the past.

I think at this point, probably the less competition from people we had never heard of before who had money but no normal water experience, that's gone; we're not seeing any of those type of investors coming into bids.

Okay.

All right, that's it for me.

Thank you very much, and great quarter again.

Thanks, Richard.

Our next question comes from Jonathan Reader with Wachovia.

Hey, good afternoon I guess it is now, guys.

Hi, Jonathan.

Congrats on the Phillies, first of all.

I know that was at the forefront of you all the time.

But --

That's right.

Didn't see Tampa Bay going down quite that easy, but I guess it speaks to the Phillies' strength.

How about my 207-yard drive [put]?

Exactly, Nick.

Exactly.

But, yes, pretty detailed call so far, just a couple of quick clarifications, if you don't mind.

In Pennsylvania, in 2009 you guys are planning on filing a full-blown rate case, is that correct?

Yes.

Okay, and then at that point --

We will have a number of [disk] filings through the end of '09, and then a filing for all the [non-disk] capital and expenses incurred over the past two years.

Okay.

And then after that point, Nick, do you think you -- is that when you might be able to get on to kind of the three-year rate case cycle and kind of avoid the, I guess, the debacle with the electrics coming in?

Is that sort of the plan?

That's our strategy, contingent on a return to growth in '9 from a standpoint of normalized consumption, normalized organic growth.

If you don't have any growth, that deters your revenue stream.

But I'm pretty confident that's going to return.

And then the second piece is inflation.

We don't calculate anything -- I think we're looking at, what, 4%, which is -- right now inflation looks like it's going down.

But I don't know how we can keep putting all this money out and keep inflation down.

And if inflation pops up again in '10 and stays for '10, '11, something like that, then I think you're going to see all utilities going in more normally.

But without that and with reasonable growth and with the cash flow we're going to be providing, we're not going to be going to the markets that much more to borrow, I think we could probably extend this from two to three years.

Okay.

And any update on going to that 7.5% limit on the [disk]?

No, but the -- my understanding of -- we've had the lawyers working over, we're getting ready to file it -- the -- that becomes -- when that becomes effective -- you don't have to, before you spend a penny, have it approved.

In other words, if we're at -- under the old rules, which are 5%, and we get it approved anytime in the next year, whatever, to 7.5%, then we're eligible for that 7.5%.

It's not like you have to start over.

Right.

But it sounds like, I guess, for you guys, if you're planning on filing a late 2009 rate case, I guess the timing of getting that increase isn't as imperative in the near term, it's more for post 2009?

Yes.

And actually if you file a case in '9, you don't get it for -- until mid to late '10.

That extra 5% to 7.5% could have a positive impact in Q1, Q2 of '10.

Okay.

So that's where -- that's -- as soon as I get off this call, as a matter of fact, we're going to start our meeting on the filing.

Okay.

Probably going to be running a little late based on how long the call is going.

Yes, right.

Okay, quickly on the CapEx, if I understand you correctly, your plan is 250 in 2009, and unless you see, I guess, drastic changes in credit markets, you're going forward with that, no need to reduce that like some of the electrics have been doing?

No.

At this point the 250 could actually grow if the Tax Reconciliation Act of 2008 is extended for a year, because that makes sense.

This year we're up $30-some million because of the cash generated from the spend.

And -- or we could lower it somewhat or drastically if we have to.

As I mentioned, we're sitting with probably a line plus the $80 million plus what's left on the others.

We have about a year of spending already booked basically, you could say, without having to worry about it.

Right.

So I mean, as long as we don't see a deterioration further from this point, you don't see any issues?

No.

Okay.

And then last, just touching on the organic growth plus the acquisition, you're saying you're targeting now 2% or so for '08 and '09.

What do you see kind of beyond that?

When can we get back maybe to the 4% range?

Is that reasonable or do you think longer-term it might be more in the 3% range?

I think -- I'm still comfortable -- for Texas, North Carolina, Florida, we're growing at that without any acquisitions.

And we're now -- now that we have our rates, at least have our regulatory relationships and our rates, and start -- and understand the rules a little better, we're starting to see some acquisition possibilities.

So I'm still - I mean, I -- we have not changed our model, although we did not hit it last year or that we won't hit it this year.

Last year I think we're mid-threes or something, three.

But we had all that digestion, Jonathan, from growing to 20% in two years.

I mean, they were all small systems.

So, unfortunately, I'd love to say we could levelize it off exactly for each year, but when you look at it over a five-year period, comfortable with it.

Right.

So the ratcheting down, I mean, that's just near term given the economic pressures?

Yes.

Okay.

It's -- nobody -- everybody just froze for a couple of months, unfortunately.

Okay, fair enough.

I appreciate the time.

Okay.

Our next question comes from Tim Winter with Jesup & Lamont.

Good morning, Nick, I'll be quick.

The North Carolina and Florida properties, if you were to separate given what you spent, adding to the system and what you purchased it for, what is roughly the current rate base and what is the return on equity earning there, and how long do you think it'll take to get up to the normalized 10.5%, 11% range?

Sure.

I'll have to get back to you on the exact rate basis.

In Florida we look at it two ways -- Sarasota which regulates itself and we've had two rate cases and we're closing in on full earning there.

And I don't know how much the rate base is in Sarasota.

Dave might have that.

But on the Florida properties, the Florida Water properties and so on that we purchased, we have not ever -- we have not made any money on them up until now.

And that's even without the write-off last year.

So at this point our return on equity is zero.

Let me give you the rate base in -- and we did ask for what the state's formula is on rate base -- I'm sorry, on return on equity in this rate case.

And we're hopeful that that's not going to be an issue.

See, what is the --

Well, the Florida rate base is about $57 million.

Without Sarasota?

All in.

All in.

I'm going to say Sarasota is about third of it.

So it's probably 40 and 20.

And on the 20, we're probably earning a reasonable return on equity at the 50% level.

And on the other, we're earning nothing.

That's why this rate case was so important last year, I think more important this year.

In North Carolina, about 90 in rate base?

And we are earning, I'm going to say -- we -- this year was a bad year because there was a drought in North Carolina, so the -- 120.

And we feel that's a pretty good then.

120 in North Carolina.

Yes.

And I'm going to guess on -- see, it's not consolidated yet.

We bought from four different companies properties.

Hydraulics is where we started, we've bought the [Eidur] properties, we've bought the ASI properties, and then the AquaSource.

So we're trying to get them all into one rate base now.

Now, the only separate rate case was Brookwood, LaGrange which I'm going to say is about $10 million of the $120 million.

And there we're earning our full keep because we had our rate case.

That was the one I mentioned had a 70% rate increase.

But the rest of North Carolina, we're trying to put all these disparate units together into one company, get the rules so that we're following all the accounting rules and the booking rules of the North Carolina.

Very thorough state, very professional state.

And we're in the rate proceeding now where we're asking for full return on it.

Is that about right, $120, about $10 million is Brookwood?

$11 million.

That's not bad.

We can give you much more detail after the call.

Okay, will follow up afterwards.

Thanks, guys.

Okay.

Our next question comes from Sam Robbins with Robbins Planning.

Hello.

I'm a newcomer to the company.

Welcome.

And my questions are basically long-term oriented.

One question that goes through my head is, it would seem to me that over time it would be harder percentage-wise to grow the company as fast as you have in the past simply because your base is larger.

In other words, is there a possibility over the next five years that maybe your growth would be increasing at a decreasing rate?

Is there a possibility that you would have to use more equity to acquire companies because you probably have as much debt as you want to handle?

And so, does that mean the possibility looking out, you know, looking from Mt.

Olympus down on all us little people running around, looking long term, does that mean you might end up being a growth company but not a growth stock?

Pardon the embarrassing questions.

No, no, it's fine.

First of all, with the internal cash generation growing and the EBITDA growth of 10% a year, the need for equity becomes diminished, not increased, even with acquisitions.

The second question you asked was really the IBM issue, probably you could ask that same question of IBM 30 years ago, 20 years ago, 10 years ago.

The answer is, yes, as we get bigger, we have to grow faster to continue the same growth rate.

Yes.

State the obvious.

On the other hand, there's 50,000 individual water companies and we haven't even touched the surface of our model of being able to address them all.

So if you believe that there shouldn't be that disparate an organizational structure, the way the industry has grown, there will be a couple of -- many large cities, 500 or so large cities who will always be probably municipal, which is why the Europeans go after that for maintenance, operational maintenance contract.

And then there will be a number of other ones with the 8 or 10 big companies that are private being I think in a way the consolidators of all these small either municipal or private companies who have gotten into the water business and now don't have an exit strategy.

So, I mean, my job and I guess why you would buy the stock and why I own the stock is because I'm confident in the future that we can continue to grow.

Now if we grow earnings from the current pace and double them, let's say, in x years, at some point your stock value is going to increase just because of the current earnings.

Even before you get to how much can you grow next year -- but I realize that's always what the investors are looking at.

I think over the next year or so though, a stock that can grow even in a bad market, has a steady track record, pays a nice dividend, may be considered a good defensive play after the shakeout of the market over the past year.

Another question I'd like to ask is, you alluded to this a minute ago, a while ago, we all know that there's a deflation evolving in the economy, we know that there's a recession, probably becoming a depression and so on.

But eventually, with all the money that they are printing and bailing out various institutions, I think we all realize there's going to be a hefty rate of inflation in due course.

How will, if we get, I don't want to say runaway inflation, God forbid, but if we get a rapid run in inflation, will you be able to -- or how will you be able to cope with that?

Because you'll have inflation in costs without being able to readily raise your rate.

Right.

Well, I referred to that, Mr.

Robbins, earlier, and we did go through that.

This company is 107 years old.

We did go through that in the late '70s all the way through up until the early '90s.

And what happened was more money was spent on operations than on capital infusion.

Rate cases were every 10 months.

And it was just a constant going in getting relief, because that's the rules of the regulators.

We're hopeful, for the country's sake, that doesn't return.

Basically we're zero-sum game as much as any industry, so other than the lag, which means you have to go in more often for rates rather than stay out for three, four years -- and I mentioned earlier some of these properties we bought in the South hadn't been in for rates since the mid-'90s, and that's when inflation had slowed down.

That would have been impossible had inflation been higher than 2%, 3% that's been over the last 10 years.

Yes.

Finally, what's the risk of acquiring a company -- many companies must be 100 years old, and there must be a -- there could be all kinds of piping time bombs that nobody knows about.

How do you account for that risk when you're appraising a company?

Well, we value the company based on its inherent value of its book.

We try and pay book or less.

We feel very confident that we can fix anything because we've been around 100 years and we know what it looks like.

Some of our pipe was 100 years old.

We've been replacing it for the last 10 years.

And we have our own engineering department, our own environmental compliance department, our own legal department.

And we basically don't have to rely on other people's opinions, we can do it ourselves.

So we feel pretty comfortable.

The pipe work is usually not the issue as much as it is -- I mean, it's a waste, it's inefficient and eventually has to be fixed.

But it's not as immediate as a wastewater plant that's in violation of a stream standard where the EPA wants it fixed yesterday.

In cases like that, we work with the EPA before we buy the system.

Get what's called a consent decree so that we're held harmless as long as we fulfill our obligations.

And we've been able to do those flawlessly a number of times over the past 10 years.

Okay.

Thank you.

Thank you for your interest.

We'll get to meet you someday.

Yes, we'll get there.

Thank you.

Okay.

(Operator Instructions).

And with no questions in the queue, we'll turn it back over to Mr.

DeBenedictis for any additional or closing remarks.

No, just thank everybody for the time.

Sorry it ran so long, but the questions were good and I wanted to thoroughly answer them.

Thank you.

That does conclude our conference for today.

Thank you for your participation.

And have a wonderful day.