Essential Utilities Inc (WTRG) 2009 Q2 法說會逐字稿

Good day and welcome to the Aqua America Inc.

second-quarter 2009 earnings conference call.

Today's conference is being recorded.

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

Brian Dingerdissen.

Please go ahead, sir.

Thank you.

Good morning, everyone.

Thank you for joining us for Aqua America's second-quarter 2009 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 aquaamerica.com or call Fred Martino at 610-645-1196.

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

Presenting today is Nick 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 the call up for questions.

Thank you, Brian.

Good morning, everyone.

Despite some strong headwinds from the economy and particularly the slowdown in home building, which affects our organic growth element of our model and some very wet weather in the quarter, especially in June which is normally a strong month for us that affects the usage patterns, despite that Aqua had a very strong quarter, which I think validates our growth model and highlights the fact that we remain among the most financially sound and one of the most efficient utilities in the country.

I think that execution has helped us show some good numbers despite the economy and the weather.

Revenue was up 11% in the quarter, net income up 15% in the quarter, and we were able to raise the dividend yesterday at our board meeting.

We have a once a year strategic session.

It looks into the future five-year planning, and we came out confident in our business model and the future earnings power of the Company, and the Company increased its dividend 7.4% from $0.54 to $0.58 effective at the December 1 payment.

I don't want to pass over that too lightly.

That is the 19th increase in 18 years.

It is 11 straight years above our stated five-year goal, and I think it makes us one of the strongest and most consistent dividend paying companies in the country.

And we are very proud of that record because we continue to have a lot of retail investors who look at the dividend as an important part of their total value in the Company.

The rates I think were the story in this corner.

We are starting now to get a rate relief that was required by all of the capital we put in through the '05, '06, '07 time period that we were not regaining, and the regulatory lag hit us in '08.

We are starting to see the benefits now of the treatment we're getting, fair treatment by the regulators, and after sometimes a year of litigation in some of these cases.

Approved to date in '07 -- excuse me, in '09 is $27.2 million.

We have $9.2 million pending cases filed that are in the process now, the hearing process, and we anticipate filing an additional $50 million in rates before the end of the year, two key cases being Pennsylvania and New Jersey.

So, as you can see, the rate discipline is very important in order to recover the major amounts of capital we are investing in infrastructure and for water quality purposes throughout the 13 states.

Now regarding capital spending, we are looking at this year's spending up to $315 million, which is even higher than what I told you at the last call.

The reason being is that we were recently approved for a new DSIC in Pennsylvania, which will allow us to invest more in Pennsylvania, fixing pipes that in some cases are 100-years-old.

So we are very pleased with the foresight of the commission in Pennsylvania.

Also, we are taking advantage of the accelerated depreciation allowance under the Economic Stimulus Act of 2008 that was extended by the Obama administration in '09, and that is bringing about $40 million more in cash into the system, which we are putting right back into infrastructure repair, which I think was the whole purpose of the stimulus.

So we are actually doing, I think, what the law's intent was derived to be.

The spending is if I can characterize the $300 million plus in spending.

Less than 10% now is what I call compliance spending.

And that will actually go down as we go through the next five years.

As our spending stays steady or goes up on the total capital, the amount absolutely needed to appease the EPAs and the DEPs of the world.

The state regulatory environmental agencies is actually lessening because we have finished most of those projects.

Which means we can put more of the money into what we will call discretionary spending absolutely needed for enhancement of aesthetics, better treatment, but more importantly, pipe, tanks, pressure, fire hydrants for fire companies and so on.

That is a lot easier to manage than deadlines on environmental issues, which are much more difficult and the timing of getting them in rate cases is much more difficult.

Also, the other general trend in our major capital was for putting dollars in the states that have allowed the surcharge since it is discretionary.

Since it is mainly for pipe, clearly the states who have recognized the field pipe is a major investment and have passed these various issues that are called -- in one state it is called SIC, in another state it is called a QIPS, another state is called a DSIC, and another state I think it's called a [RAP].

But whatever it is it is called by each of those states, the intent is clear, and that is to avoid the necessary regulatory lag that you have by putting pipe in when you have -- it is in service so quickly, and it starts eating itself up with depreciation and non-earning.

These mechanisms allow us to earn when the pipe goes in after auditing, and I think it's a great public policy advantage for the states, and also it is something that we are adhering to, and that is where most of our capital will be going.

The other side benefit of that, of course, is the fact that we had to put a lot of money for compliance reasons in the '04 through '07 time period in some of the newer states that we got into.

That spending now has decreased.

They don't have as much pipe problems, although there's other enhancements they would like to see, which we will obviously do if the regulators want us to.

But the bottom line is now those states can be allowed to get closer to their full earnings potential through needed rate cases while we put the capital in states where the recovery is much more secure and is a fairer -- I think a more fair contract with both the shareholders and the regulators.

So we are starting to see that now much clearer in our five-year plan.

And really you're seeing that kick in in '09 with the fact that we were able to post reasonably good numbers even without the growth that comes from new home building and the usage patterns that are relevant if you don't have bad weather.

The other issue that is very important is we watch our costs.

I think this is something regulators are expecting us to do.

We expect it.

Our shareholders expect it.

And I think when you look at our record over the years, we are delivering on it.

The O&M, the revenue ratio, which is what we track, has done very well.

We are down about 150 basis points over the trailing 12 months, and we think we can hold that through the year and get close to low 40%, between 40% and 40.5% in that range for the year, which would be considerably lower than what we ended '08 with, which was almost 42%, 41.8%.

Sometimes there is noise in those numbers as to how you treat certain write-offs, things of that sort in rate cases.

But the bottom line is, if you look at it over a five-, six-year period, you'll see we're getting back to the efficiency model we were at before we bought the AquaSource Companies, and we are starting to see some real positive trends in the Southern states where the O&M, the revenue ratios are getting much closer to where they should be from a standpoint of getting the rates in place, getting some new growth and basically utilizing the infrastructure -- personnel infrastructure we had to put in place in order to be a major water company in those states.

The pension, which I know some of the companies have had some problems with, we have pensions for about 45% of our employees.

55% have defined contribution versus defined benefit.

No one else gets into the defined benefit plan.

Certain states allow it to be booked as a regulatory asset.

So it is trued up in every rate case, and I would say probably of the number of people on the pension, probably well over 75% are in that category.

So our risk factor in between rate cases is about 25% of the 40% of the people who are still in the pension.

That, as you can imagine, every company with a pension plan from General Motors through water companies were affected by the market going down and benefits going up and the discount rate coming down, which makes the liability that you have to book even higher.

Total impact for us is about $0.005.

So it is something we watch.

It is one of the major issues we are looking at, but it's not a major factor in this year's earnings or going forward.

The strong point when you're spending $300 million a year and your revenue is less than $700 million or in that range, you say, how can a company spend that kind of capital with that revenue base?

The answer is internally generated cash and access to the credit markets.

Our EBITDA is up 15% over the trailing 12 -- 6/30/08 to 6/30/09.

If you look at a 10-year record, you will see our EBITDA is in the 10% plus CAGR.

It continually goes up.

Our EBITDA will well exceed our capital.

We will look at probably 350 for the trailing 12 months.

But more importantly, if we put interest in there because you obviously have to pay your interest and look at your operating cash flows, we are still -- even after paying interest, 80% of our enhanced and increasing capital budget is being paid for internally.

Which means we have less need to access the external markets but for new debt and equity.

Now having said that, and since most of our spending is occurring in the mid-Atlantic states, because of the DSIC programs and the pipe work that we are doing, we have been able to access the market.

Our credit rating was reaffirmed at an A+ for Aqua Pennsylvania, and we have been doing a lot of borrowing in the Pennsylvania arena.

We just issued -- it was oversubscribed, a $58 million tax-free issue at 5% effective when you figure all the fees in and the discount became the 5.2%.

Still very healthy for a 30-year bond.

And that is non-AMT.

So I think the purchasers of the bonds got an extra benefit.

We have a 1 plus recovery rating, which means that we are very likely to pay our money back.

We have never failed yet, but that is a very high rating on a scale of 1 to 10.

And we are also looking and just got approval from the Commerce Department in Pennsylvania for another allocation this year for another $75 million tax-free, which we anticipate yielding -- doing by the end of the year.

We honestly believe that we have three years to spend the money and draw it down, and we honestly believe that this is the time to be borrowing money.

We think interest rates are an excellent time to go out with interest rates in this range.

And when you look at our embedded cost of debt at 5.5%, we are actually allowing us to lower our embedded cost of debt with these kind of issues.

We are also maximizing the use of the -- I told you earlier about the accelerated depreciation using that cash to do some of the capital.

But we are also using state revolving loan funds and economic stimulus money.

We access the New Jersey EIT it is called, and that is for about $2.3 million for some major water quality projects.

That money will come in somewhere around 2.5%.

In Maine we received $4.6 million at 0% interest.

I don't know how they can do it in Maine, but they do it.

So we're building a project with our equity of about $3 million and their 0% interest loan, which, of course, helps rates.

And in Pennsylvania we have already received -- we are drawing down on $7.5 million of PENNVEST loans.

We have $10.2 million already approved.

That gets you up to $17 million in cash that we will have to do some of these projects, and we have $27 million of applications in for their October meeting.

These have all been enhanced by the infrastructure part of the $780 billion economic stimulus package passed late last year, early this year.

So you can see we are accessing the market.

We have no problem getting purchases of our paper, and the larger states that we are spending our money in and we need to borrow in have had the vehicles ready for us to use.

The corporate development, we are seeing an uptick.

We had a couple of announcements I think it was yesterday and last week.

We have done about -- we will have done about 11 by the end of this week.

A lot of small ones.

But last year we did nine for the whole year.

So you can see there is some activity picking up in that arena.

We still think that with the current financial situation and not everyone being fortunate enough to have an A+ rating and access to markets as we do, we are going to see more opportunities driven by the finances for some of these water companies that are facing major capital just as we are.

The organic growth has slowed to less than 1%.

We usually look at 1% to 2% organic and then 2% to 3% acquisition.

We are probably seeing -- predicting less than 1% organic, maybe 1% acquisition, short of some bigger acquisition coming along later in the second half.

So that part of our formula is not as vibrant as it has been in the past, but is being made up by the efficiencies and the borrowings and the capitalization we have been doing.

I would like to remind people that the third quarter will probably be somewhat affected by weather.

July has not been -- it has been better than June but not much better.

Just to give you an idea of how wet the second quarter was, at least in our areas, the South was not affected.

But Maine was the wettest in history in June, and then the mid-Atlantic and Northern states, using just one criteria, it usually is 30 days out of the 90 you get rain.

We had it 45 days out of 90.

So it is 50% more days of rain, and that is really what affects usage for lawn watering and car washing and things of that sort.

July was a little better than June, but still nowhere near what it was in '08.

And also in Q3, last year we sold a system which we don't anticipate having a system sale in the third quarter this year, and that was the Woodhaven system last year, which I think if you look at last year's $0.26, probably close to $0.02 of that was regarding the sale of the Woodhaven system.

And that would show still a nice trend between '07 and '08 in third quarter, but probably a $0.04 jump between the third quarter of last year and the third quarter of '07, which probably half of that was because of the Woodhaven system.

So if you're using last year as a base, it was a normal weather year, and this year we are going to have to fight back in August and September to get back to normal.

But, of course, we have rates and more people on our system this year than last year.

So that will help ameliorate the weather.

I think the only other issue I will mention is depreciation.

Depreciation is up 21%.

That hurts earnings but helps cash, and that is the reason that we are showing that 80% of our needs are filled internally with cash, even for that program of capital that just five years ago was $200 million.

So we're basically up almost 50% in just five years on the capital spending with the other shift being that it's mostly discretionary now, whereas it was almost all compliance-oriented five years ago.

I think I will open it up for questions.

(Operator Instructions).

[Michael Romberg], Boenning & Scattergood.

I just had a quick question on the acquisition front.

The recent Texas and Indiana acquisitions that you guys announced within the last couple of weeks, are these bolt-on acquisitions to existing platforms in those regions, or do they provide you with a sort of springboard into acquiring other adjacent communities?

They are not bolt-ons.

I call it bolt-on when you already have a pipe and you just extend that pipe and pick up that customer, new customers or new town.

Most of that happens in the more dense areas around Philadelphia and so on.

But these are stand-alone systems but in a general area where we are already operating.

LCRA, which is the lower Colorado regional authority, we bought two of their systems in the Austin, Texas area.

They are the highlands right outside of Austin.

In the other one, the air industry is an industrial park with residential, and that is not very far from one of our other operations in Hendricks County.

We will manage it exactly the same as we do our other operations in that area.

But it is a separate stand-alone system.

But do these assets provide an entry point into acquiring other adjacent systems that might be appealing?

Absolutely, because it puts you in a new town, a new area that is adjacent to the other area, but you're on the ground now in a new area.

So every one is a leapfrog to the next one.

Okay.

And then you did allude to this a bit in your remarks regarding the cash flow generation which you guys are becoming more and more successful at than ever before.

The flipside of that or probably a result of it is that you are accessing debt at incredibly cheap levels relative to the rest of the power holders out there.

At some point your cash flow may not be too far into the future will exceed your CapEx needs.

And I'm just curious, particularly in light of your board meeting that you had and the review that you conducted yesterday or recently, do you think about at a certain point of accelerating the dividend growth rate?

I know you guys have stood said in the past that you target 5%, but given the cash made to exceed your investment needs, how do you think about that issue?

A major discussion at our board meeting yesterday because there are some who feel keep going with the dividend; others who feel you keep it and you build your equity in the Company since we have so many good places to put it, which have a good return.

So we think that the 5% goal beats most companies.

I don't know many companies who can say almost 20 years in a row they have raised the dividend -- and meaningful raises, not just $0.0025 or something of that sort.

And we have beaten our 5% target goal 11 straight years.

You are right about accessing the market at pretty cheap rates, but we don't want to use that to pay a dividend.

The dividend really should be looking upon as a mixed year equity, too.

And I will give you another astonishing number.

We are about $180 million of our $235 million line is being utilized.

And on the majority of that, we are borrowing at less than 1%.

That is on short-term money.

So our thinking now is to use every bit of access to the market to do this kind of capitalization, lock in very low rates -- at the 30-year rates obviously -- and use our retained earnings to help support that debt so that S&P keeps our A+ rating intact.

I will give you an astonishing number.

Less than 8% I think it is of the companies in the United States have an A or above rating.

So we are in an elite class.

I don't want to jinx ourselves, and we want to make sure we keep that.

And part of that is keeping your equity levels to a reasonable level.

Okay.

Do you have a, now that we are in the second half of '09, have a dollar figure for an early read on 2010 CapEx?

Yes, we can give you that.

I think it is -- you have the sheet there, we will share the forecast.

It is going to be over 300.

I don't know if it is 310 or 312.

I will get you that.

(multiple speakers) If you want to call us afterwards, I can give you the numbers we were looking at.

$1.5 billion I can tell you over the next five years, but I will get you the exact numbers if you want to call us.

Jim Lykins, Hilliard Lyons.

Congratulations on your award.

Thank you very much.

First, I wanted to see if you could break the $27 million in new rates, at least along the bigger states if you could break that out?

And then also I was wondering if you could make some general comments about what you're seeing out there right now with the rate cases?

I'm wondering if just the environment that we are in, if customers that would normally complain about rate increases, if all of a sudden they are having much louder voices, and if you still feel that the rate of words are fair, and how that is impacting the allowed ROEs?

Well, I will start with the latter part of your question first.

Generally in almost every one of the rates that we have done and we are probably in 30 different cases because we are not consolidated in all our states yet, I think we have been treated fairly by regulators.

There has not been undue -- we expect people to show up at a hearing and want to know why their rates are going up.

But most of the complaints are usually based around water quality, which we have been able to attack through all the money we have been spending.

I think that is the number one issue that scares me when you're in for a rate case and you have not fixed everything yet.

That was our problem in the Southern states early on.

That is probably why we did not succeed in our first case in Florida whereas we did in the second is because we have not fixed things yet to the level they should have been fixed before we went in, even though we deserved a rate increase because we basically had put a lot of money in.

It just was not all done.

The rate increases are a dilemma for water companies whether they be municipal or public, or publicly traded, because our water rates are always low.

So, therefore, the percentage increase looks high.

In other words, if you have a $100 bill and you get 10%, it is $10.

If you have a $30 bill and you need that same (multiple speakers) it is almost 33%.

And people look at it as a percent, not as total dollars.

And that is what had to happen.

The worst example, of course, was Florida where they had not gone in for a rate increase since 1994.

You can imagine the size of the rate increases, although the average person in Florida is a paying more than they pay me.

So it is just a matter of your communication, but it is most important to make sure your services is up to snuff.

And we've had some very high rate increases.

I will give you one example.

A small facility we bought.

They had no fire protection.

They wanted a tank.

We put all that in.

They had very, very low rates.

They now have average rates, but the rate increase was 112%.

And the commissioners gave us that, and the people are not rioting in the streets.

I mean a couple of people came in, wanted to know why and we explained it, and so far, so good.

That was a small one in Indiana.

Overall you asked for the $27 million.

Of course, part of it is the surcharge annualized, but the bigger ones out of there are Pennsylvania.

We had a consolidated case of all our small wastewater that we have been buying in the Northeast Poconos area.

That is now all consolidated into one company.

We had the three in Indiana -- Darlington, the one I just mentioned to you, and then utility center, a 25% step increase.

That is the Ft.

Wayne area.

Lake County, which is our mentor facility in our Ohio, went up about $0.5 million.

Our Struthers facility in Ohio went up about $400,000.

These were about -- one was about a 4% rate increase, the other was about 6%.

And in Florida and North Carolina and South Carolina, we have got our first ever consolidated cases.

They were the big ones.

North Carolina went up about 25%, and it is now consolidated.

So it will look like Pennsylvania and New Jersey and so on in the sense that when you go in for a rate case, every customer is covered, and it's much more efficient for both the regulators and for the rate payers and ourselves obviously.

In Florida the increase was higher in the 60% range, but that is the one I mentioned that had not been in for 20 years.

That was worth about $5.5 million, and the other one is worth about $8 million.

So you can see the two big ones are Florida and North Carolina, and the major story there is they now have a much more workable way of applying for rates.

We don't have AD systems anymore in Florida.

We are down to eight.

And in North Carolina we are down to one water and one sewer rate structure.

Okay.

And then the pending, we have cases for $9 million.

We just filed a statewide case in Missouri.

We have a case in Maine, another small one, a pretty heavy increase in Wildwood Shores in Indiana, and then we have the major consolidating of all the rates in Virginia.

That will allow us to have if we are successful all the South will now have rate structure looking like the North, which was one of our major goals.

Okay.

I also wanted to ask about O&M.

I'm wondering what some of your assumptions might be.

You have talked about 150 basis points of improvement, and if we look back at, say, last year, it is pretty easy -- with fuel costs being much higher last year, that is going to be one easy way to improve your margin, but healthcare costs, on the other hand, are going up for everyone.

So maybe if we could just talk about what the assumptions are -- and I'm wondering if there might be some things in there that could even be a reason to think there could be some further margin expansion than what you have talked about on the call.

Right.

Well, first of all, bad debt.

That was a big issue, and that is coming down.

I think that is probably counterintuitive to what you would think for utilities.

We have had a lot of success I think, one, because our rates are lower than the electric and gas rates, and second, because we have a more -- we have put everybody on metering so that they don't get estimates anymore.

The estimate rate is below 1% now.

They get an actual bill every month, and we are very disciplined in collections.

And so we have dropped to below 1% where it was well above 1%.

I think you'll find that is very good in today's world for any utility.

We think there is further contraction available there.

Regarding fuel I don't think fuel prices are going down anymore.

As a matter of fact, as you know, they have started to go up.

But we have started to change over our fleet to smaller and more fuel efficient cars.

We are obviously not doing it overnight.

But we are doing it over a time period, and everybody wants a four-wheel drive truck, right?

Every man and we're getting people in smaller cars and not always trucks and not always four-wheel drives, those of us on the road.

We drive millions of miles a year, so it is significant if you can save one or two miles per gallon.

The pension we have attacked I think as well as any utility.

I know a lot of private industry has just wiped it out completely.

You cannot just wipe it out completely under Orissa.

But by shutting the door for new entrants coming in years ago, it is amazing how much your liability drops over a three, four, five-year period.

It does not happen right away, but we are starting to see the benefit of that.

And we are looking at pension and healthcare, particularly as two areas that we are concentrating on, whereas companies used only look at complement as the only way of controlling cost.

We're looking at different plan type systems, one statewide -- sorry, one countrywide plan that we can save money on and so on, and we are working on that as we speak.

But you're absolutely right.

Healthcare costs look like another 10% increase again this year.

So it is tough to grow at 3%, 4% O&M when one of your key elements is 10%.

So we have to attack that.

We are also looking at water production costs.

Chemicals have been stubbornly high and have not come down.

They are starting to now.

High prices are finally coming down.

Salvage value was way up, but the commodities of scrap steel a year ago with the Chinese buying up all of our scrap steel, that started to come down.

Chemical costs are starting to moderate and actually come down.

That should help.

We are looking at any place where we buy water to see if we can efficiently put capital in and make our own water.

I mean we always took the easiest path in the past because we did not always have enough capital to spend.

Now maybe we can develop our own water resource and not buy from a nearby town.

Because what is happening is some of these towns are using it as a funding source for their own budgets.

Now our purchased water is very low compared to most water companies.

We are not like the California companies, and I think probably American has a little higher purchased water than we do.

But I think our purchased water is less -- well less than 10% of our total water sold.

So it's not a major issue, but it is an area we can pick up 1% or 2%.

We are also going to continue pruning.

Pruning is our word for if the system does not have future potential and somebody else wants it more than we want it, we will sell it for the right price.

We did one of those in the last quarter, Orange, Texas near Beaumont.

It was the right thing to do, and it was about $1 million, and we sold it for a little plus of $1 million.

But the cost saving by not having one of those helps your O&M.

Because they are usually not -- they are usually not in the same ratio of 40% of costs O&M to revenue.

They are usually much higher cost to run them.

I would say they are the major issues, and you have hit the nail on the head.

With acquisitions of about 1%, if you take that off, the 5.2 goes down to 4%.

So I would not say we are overly nervous about a 4% growth in O&M.

I think if you look at some of the other companies, you're going to see it a little higher mainly because of pensions where we have cut hours under control.

The first quarter was only 2.8, so blended it is probably still less than 4%.

But we think we can even do better going forward, and that is what part of our five-year model is showing.

All right.

And speaking of acquisitions, that is one other thing I wanted to ask you.

Did I hear you right in that you said there is going to be a bigger acquisition in the second half?

No, I would love to tell you we have it, but there is one in New Jersey, which is about 2500 customers, which is a nice size, that should happen in the third quarter.

But no, what I was saying is if we were to get a bigger one, it would change the whole complexion.

But you can only get them when they are for sale.

And I'm still optimistic that the financial situation on some of these communities is going to eventually come to roost, and some people will be selling operations.

With our cash availability and our access to the capital markets, we would be ready to do any size deal.

Debra Coy, Janney Montgomery Scott.

First, a quick follow-up on the rate case discussion.

You mentioned $50 million in rate case filings.

You are anticipating that seemed like it might be a little low to us considering that your last Pennsylvania filing was $41 million alone.

Can you just give a sense as best you can at this preliminary stage of how you are thinking of the makeup of that?

Well, of course, that 50 is after the 27 I mentioned earlier, plus the 9 that we are active in now.

So we are well over the 70 that I predicted last year.

The Pennsylvania case is less than the last time because we have a 7.5 DSIC this time.

So if you put 2.5% more on there and then multiply that by the capital needs that that makes up, I think that will come out about the same.

I don't know if I mentioned earlier the DSIC in Pennsylvania, and I don't want to preempt -- the commission did put a release out, but it is not official yet because the [peel] period has not run.

But we did get a unanimous vote from the five commissioners to allow us to go from 5% to 7.5%.

We also got the recommendation of the PUC staff, the office trial staff, and the administrative law judge.

So there was only one party who believed that was opposing it, and they still have the appeal rights.

But I think the fact that we have never had a problem after 13 years in any of our audits that we have done what I think they wanted to do in the DSIC allowed us to have a reasonable airing that we are very happy with, and it was approved in late July.

That will allow us to use the pipe that we are planning, and that is one of the reasons we went from $300 million to $315 million this year.

It has all gone into Pennsylvania.

And that will probably get us up to the 7.5% a little faster than we would have thought.

And in the last case, we were capped at 5%.

So I think you will see that is about the difference between the $40-some million we asked for last time and the $35 million or $40 million we will be asking for this time.

Okay, that is helpful.

And on that CapEx and cash flow discussion, Dave, just first a couple of quick housekeeping questions, and then I have a broader question.

Can you tell us what CapEx in the quarter was and what operating cash flow in the quarter was?

Yes.

We had the draft Q here, so we will just pull those numbers right off the --

I knew you had them, even though we --

Well, I have year-to-date numbers.

The cash flow is only year-to-date.

So for 2009 CapEx year-to-date is $117 million, and cash flow from operating activities is $107 million.

Okay.

So that suggests we should have an acceleration on both of those things in the second half of the year.

So Nick, you mentioned earlier that you expected to cover on the range of $80 million of your CapEx plan internally, which implies about $250 million in operating cash flow this year.

(multiple speakers)

Right.

You said $80 million, but 80% is the --

I meant 80%.

Yes.

So about $250 million --

Yes.

-- which is up a lot from $200 million last year, and then that brings me back to my depreciation question.

As you mentioned earlier in your remarks, depreciation has accelerated this year.

Can you talk through how much of that is related to accelerated depreciation allowed under the Recovery & Reinvestment Act and sort of how we should think about depreciation levels going forward throughout this year?

And then what happens after that?

Is it a one-year thing under the ARRA Act that ends at the end of '09, or how should we be thinking about depreciation for the remainder of this year and then going into 2010?

Well, the depreciation that is related to the tax act that really does not show up on the financial statements with the exception of the impact on deferred taxes.

So it is only on the tax line.

So all this accelerated depreciation is just simply higher CapEx levels?

Yes, it is really a combination of two things.

It is a combination -- certainly you are right of the higher CapEx levels, but it is also reflective of higher depreciation rates acknowledged in the Pennsylvania case which became effective last August.

So that portion of the increase in depreciation will annualize out as in the third quarter and won't be reflective of growing depreciation in the future.

And if you can just take a very brief two minutes and talk about how that works, because that is interesting in terms of a policy change.

How is it that Pennsylvania moved to allowing higher depreciation levels?

Are they speeding up the depreciation schedules, or what has been kind of the thought process there that that has come through this way?

In each rate case, we look at the depreciation rates, but then every five or 10 years we do a full depreciation study and evaluate what the appropriate depreciation rate is for the property.

Remember that the compact we have with the regulators is that we recover all of our costs of the utility plan.

So to the extent that retirements are occurring faster or slower than contemplated, the depreciation rates need to get adjusted every once in a while.

I do know, however, think that the largest component of the adjustment in Pennsylvania was related to what is called negative net salvage, which is the difference between cost of removal and salvage.

Because that is the cost that we accumulate on our books and we amortize through the depreciation line on a five-year amortization.

And so significant changes in that category accompanied by a five-year amortization tend to move the needle on the depreciation.

And so that was the largest component of the rate-oriented increase that does go away this August, the anniversary of the PA rate increase.

I think depreciation levels next year realizing the rate cycle we're in and everything else will probably levelize back down to the high single digits, 10% range overall for the Company.

This time around don't forget we just had the Florida case, which put in the new capital.

A lot of the new cases, all the new capital was coming in 9 over 8, and that is why you're seeing such a high jump.

If you go back to 7 -- 8 over 7, I think we are in the 10% range, too.

But still healthy.

I mean it is still almost $15 million, $20 million of more depreciation, which obviously is cash.

It hurts earnings, but it helps cash.

Well, and it is I think increasingly important to think about it that way.

My final question has to do with your capital structure.

Your debt equity ratio has crept up to the mid-50s now.

You talked about continuing to access the debt markets.

Are you comfortable at this I think it is about 56% is where you are now.

Is that --?

Yes, we are probably -- because -- when I said last year at this time we did not see any need for major equities, I mean we do 1 million shares a year off the DRIP.

People reinvest their dividends and buy stock directly from the service.

But that was when we were talking $250 million to $275 million in capital.

And the fact that the accelerated depreciation in our model we are not showing going forward in 2010, we assume they are not going to extend it.

If they do that is a different story.

Dave, I think $40 million a year from accelerated depreciation at this spend level.

So if we don't have that, then we have to come up with $40 million somewhere else.

Both the A+ rating that you have, obviously the rating agencies and the regulators are comfortable with you showing at least from what we can see on a consolidated shareholders equity basis this 55%, 56% range?

Yes, because what we do is adjust it.

As we get into a rate case, we will float more equity, and we might have to float some equity in 2010.

Alright.

That is helpful.

Thanks.

Tim Winter, Gabelli & Co.

I had a couple of questions.

Can you go over real quickly the DSIC states, the states that have disks, and which are likely to get it in the near future?

Right.

I think the two states we are not in that have it, although it's a level different in Connecticut and Delaware -- the states that we are that have it are Missouri, Indiana, Illinois, Ohio, Pennsylvania and New York.

And we are hopeful that they are considering it now in a preceding in New Jersey which will allow us to put a lot more capital in New Jersey because we are ready to do pipe work in New Jersey now.

Okay.

And then on the topic of internally covering capital expenditures, that 80% number that you spoke of earlier, does that include the dividend or not, the common dividend?

No, that does not.

That does not include the common dividend?

And when you do your CapEx budget, your forecast going out I know it gets fuzzier in the outer years, but does that number increase, that percent that is internally generated?

Is that trending up -- continuing to trend upward?

Well, one of the qualifications I have to say is we don't know what the future of the tax policy is because that would help it.

But it is -- I think you can project the EBITDA number at a good CAGR of 10%, and you can back into it.

Because our interest is actually down this year over last year.

Which is very rare when you put out this much debt and your interest rate goes down.

It is because we are refinancing at lower rates, and that is good for the customers, too.

But I think that is the variation on the internal generated cash flow.

But if we don't get the accelerated depreciation, that will hurt because that means we have to come up with some other means of funding that capital.

The capital -- the plan is for it pretty steady in be 300 to 325 range going forward, and I don't have it right here.

But we will give you all that as to what our future plans are.

I think the key, though, is that where the money is going, and it's going into the states.

I mean every state will get as much money as they need to fix anything that has to be fixed.

But when you're looking at 2.5 times depreciation, which is a pretty heavy spend, you will see that it is in some states it's 1.4 or 1.5 times depreciation, and in others, it is close to 3.

And that is because they are the states with the surcharge.

(Operator Instructions).

[Jonathan Rieder], Wells Fargo.

I just wanted to know if the PA rate cycle has now changed at all given the increase in the DSIC or just to step up I guess in your capital reinvestment and to keep you on the two-year cycle?

The fact that we have increased our capital mainly in Pennsylvania keeps us on the two-year cycle.

I mean if we had not increased the capital in Pennsylvania, then we would have probably stretched it out a little bit.

But there is so much pipe that has to be replaced, and our rationale is with interest rates and carrying costs below 1% and then when you can capitalize it, you can capitalize it with your debt portion at 5%, a little over 5%, now is the time to be investing.

Plus, we are seeing our contractors working for us at probably 15% to 20% less than they were a year ago.

So we are getting 15% to 20% more pipe done for the same dollar.

So from a public policy standpoint, I don't think anybody could disagree with what we are doing.

Right.

It makes sense.

And the other question I have just along your usage trends, you are talking about organic customer growth.

I think pretty much being expect to be flat to maybe modestly positive this year.

Are the usage trends lower than the normal I think 60 basis points is what you normally said the annual decline is?

Yes, we are starting to see it in the South especially, and that is because I think the rates reveal the fact that water is not free.

It is still not expensive, but it was to the point where people did not even recognize it when you had $10, $12 water bill.

I think what has happened is people are looking at their use.

Now looking at the patterns, the bulk of our customers are in the North.

It's like 15% in the South and 20% in the South.

The Northern customers are already at levels which we think have recognized usage patterns, and that is in the low 4000 range.

4000, that's less than 150 gallons a day, and that is not a lot of water.

I think if you look at your California companies, you are going to see probably in the 7000, 8000 range a month versus 4000.

And that is why the conservation is kicking in in California, and that is why they put in the balancing rack.

In the South we were seeing I'm going to say in the 68, 65 range, 6500.

So you can see 40%, 50% higher usage.

Now it is sandier soil; it is hotter.

So there are some reasons for it to be a little bit more, probably not that much.

And we are starting to see some definite usage patterns coming down.

Which means that in our second and third round of cases, which we are going to have to do to get our ROEs up in the South, some of it will be for usage drops.

In that sense that is why the timing is right, and for us now that we have put a lot of capital in the South, to not put extra capital in because the next set of rate structures is going to be to recover some of the cost and usage patterns.

Okay.

That kind of leads me to my next question then.

I guess do you still believe that you don't need to pursue decoupling mechanisms, or you are fine just addressing the new usage patterns through the rate case cycle?

Well, because those states don't have it, we would be starting from scratch, whereas California took five, six, seven years to do it.

We do have it in New York, and obviously we use it there.

But we have decided that by more routines -- we are not going to wait 17 years for our next rate filing in Florida like the last company did prior to us taking it over.

So I think timely rate actions, although it is torturous for both the regulators and for the companies, are another way of getting to the usage pattern changes.

And as long as they don't happen overnight like they are trying to force in California and you're starting to see, I think you have -- if you are in every year, year and a half, two years, you can pick it up over a five-year period where it will get to the asymptotic level that you would expect it to get to just from normal usage.

Okay.

That is all I had.

I appreciate the additional insight.

That concludes the question-and-answer portion.

I would like to turn the conference back over to Nick DeBenedictis for closing remarks.

Okay.

Thank you, everyone, for all your time this morning.

If you have any follow-up questions, Dave, myself, Brian are available.

Thank you.

And that concludes today's teleconference.

Thank you for your participation.