Essential Utilities Inc (WTRG) 2010 Q4 法說會逐字稿

Good day and welcome to the Aqua America Incorporated fourth-quarter 2010 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.

Thank you, Janine. Good morning everyone. Thank you for joining us for Aqua America's fourth quarter and full year 2010 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 Nicholas DeBenedictis, President and Chairman of Aqua America along with David Smeltzer, the Company's Chief Financial Officer.

As a reminder some of the matters discussed during this call may include forward looking statements that involve risks, uncertainties and other factors that may cause the actual results to be materially different from any future results expressed or implied by such forward-looking statements. Please refer to our most recent 10-Q, 10-K, and other SEC filings for a description of such risks and uncertainties.

During the course of this call, reference may be made to certain non-GAAP financial measures. Reconciliation of these non-GAAP to GAAP financial measures are posted in the investor relations section of the company's website. At this time, I would like to turn the call over to Nick for his formal remarks after which we will open the call up for questions.

Thank you, Brian, and good morning, everyone. I'm pleased to report that Aqua had a solid fourth quarter which capped off one of the best financial years in the 20 years the company has been executing our growth through acquisition and capital investment strategies. Just a very rewarding year.

That's not just because we had a 19% year-over-year EPS growth and our 11th straight year of record earnings. But I say that because all systems are go. What I mean there is capital deployment, treasury, rate recovery, information systems, and management systems. Despite a slow economy we're still doing acquisitions. We did 23 as a total by the end of the year. So we start with a very strong financial and operating platform that is truly poised and ready for future growth when the economy returns.

A little bit about the fourth quarter, it was hampered by two items, cold weather, snow, that's one. And the other was a new tax law which actually cost us $0.01 because it took away the production tax credit that we were using. And both of those cost us a little over $0.01.

Having said that, the silver lining was the fact that we still made $0.21 versus $0.20 in 2009, and for the year $0.90 versus $0.77, up 19%.

The breaks were two times the normal numbers, so we absorbed those, but -- and that continued into January. They have slowed up considerably now. We've had an extremely cold December and January which is why pipes break. The good news in it, even though there were a lot of them, is the fact that none, none of them, over 300 breaks, were on any pipe that we replaced since we started our capital investment program under the surcharge and disk programs about 10 years ago, 15 years ago.

All the pipes were over 50 years old, and most of them were as small as six inches, which are the ones that are getting replaced, just not as high a priority as the big ones that are in the major streets. I think this is a tell tale thing, a long-term public policy.

This winter, I think you saw more than any huge stories about cars being iced up and city blocks being taken out. The big pipes are breaking in the cities, and this is causing major disruptions for the economy and traffic and, of course, economics. So I think I'm very happy that even though it was an extremely cold winter, and, hopefully, we won't see one like this for a while our breaks were really limited to the pipes we hadn't gotten to yet and will get to over the next ten years.

The operating statistics for Q4 and the year were superb. 170 basis points off our already industry-leading efficiency ratio. We call that the O&M to revenue ratio. We took it down to 38.6%, from 43% year over year. And our gross margins, which is a way of showing profitability, grows almost 200 basis points from 35.4% to 37.5% year end. So, a pretty good year.

I would like to go over in a little more detail why I feel so good about the 2010 results and talk a little bit about 2011 projections.

First, I'm optimistic about the future growth in 2011 with one month under our belt, and already absorbing the increased main breaks, I'm comfortable with the First Call estimates which are about $0.97. That will make our 2011 our 12th straight year of record earnings. And looking at Q1 and comparing it to Q1 2010, last year we were a little bit, a light $0.16. But that included almost $0.01 from an investment gain we made on -- a gain on investment of the stock that we owned.

This year we don't see that comparison. On the other hand our systems and organization are in place I think to carry forward with the momentum that we leave 2010 with. And I'm very comfortable with the First Call of $0.18, which would be 10% over last year's actual, a strong 10%. And if it's on the adjusted for the no investment gain this year and one last year, it's at the type of run rate you're seeing in the 10 over 9 in percentage increase. So very, very optimistic.

Why? Because in 2010, we reorganized, after a shuffle of top management, and we now have basically two operating units, the Northeast, which is run by Carl Krius, who has been with us, back to us for about seven years; former executive for American Water and then prior, city of Philadelphia. A very experienced engineer and manager. And the four states that he operates are the bigger ones, the stable with a lot of pipe replacement and a lot of our capital.

We reorganized and put all the other states, Midwest and South, which are still growing. They don't need as much infrastructure capital but they need a lot of management in order to get them up to the earnings power of the stable Northeast states that we've had for quite awhile. That's being run now by Chris Franklin, who has been with the company over 15 years, and has moved up the ranks and is very experienced and is injecting new management controls and so on. We're starting to see much more profitability coming out of those states without having to invest as much capital as we do in the more mature states.

Because of our concentration on managing regulatory lag through cost controls and rate relief, I'm confident that we can close any gap we have in any under-earning states.

The other thing that makes me very, very comfortable is our information systems are now in place to handle a multi-state operation. As you know, one of the risks going from a -- for 100 years we were a single state, single region company, and the systems were not as important. You could just walk next door and get the answers to the next office.

But now as a national company we've really redone all our information systems. We did take the position that perhaps we don't need a major ERP, and maybe we could get best of breed systems in all the areas we need them, customer information, financial information, asset tracking and so on. So I'm pleased to report as we end 2010 we're sitting with the most updated systems for financial, we use Lossin 90 for asset tracking, which is Power Plant, which is used by most of the utilities. We're in that latest version now of 2010.

We started our new CIS system. We're done with phase one with Ventex. We put in a new service link, which is an Itron system. Everything is now electronic in our field services operation, and our outside crews field service orders, you know, backlog, is down 70% since we put this system in. And we now are down to an one to two-day backlog, and I think that is excellent for customer service.

We are finishing up in 2011 all our RF meters. And to give you a result, the number one complaint most customers have is you gave me an estimated bill. Because of our RF program, we're down from 4% to 5% estimates to 0.6% last year, and we think we can improve on that. That's with less cost because the RF program allows us to have less meter readers.

We have improved all our IS infrastructure; [we have IF] phone system, we now have teleconferencing, we have a new security system and have tested with IBM our disaster recovery. So I feel very good that our systems are in place so that this company can grow.

One of the risks you'll always have when you do one of these major IS program overhauls is that it throws something out of whack, hopefully not accounting. And while Dave Smeltzer and Bob Rubin are in the room with me, I'll acknowledge the great shape our accounting system is in. We've had no SOX issues. We have never had a material weakness; and for the past two years, not a significant efficiency, which is the lower level of the test. I think that's an attribute when you're doing all the systems changeover and still can have those kind of clean books, it makes your board members feel very, very comfortable.

This year was another major year of capital spending under our chief engineer who has been with us in that position for about four years, Bill Ross. He came to us from [Royeff Weston] as a consulting engineer. We spent $327 million last year, that's a new record, to improve water quality in our distribution systems. For the first time in the company's modern history the majority of capital went towards pipe. We've always been fixing up plants and trying to get in compliance with the EPA rules and so on.

The other landmark for 2010 was the fact that we are still doing a lot of pipe work and so on, but it's no longer with an environmental gun to our head in the sense that we're now addressing all the remaining projects regarding water and waste water issues that the EPA wants done. Some are multi-year projects that are addressed by consent decrees. For 2011, we're projecting less than 10% of our over $300 million spend will be needed for these capital compliance. Therefore, more money will go into what is the disk eligible pipe programs.

And we're also turning our attention to cost-saving capital. That means capital that can be employed that actually takes operating expenses out of the business. Example, we are looking at three to four more solar operations, the one that we built in 2010, which won the Governor's award and many environmental awards. It's one megawatt which is enough to empower the entire plant at our [Ingerfill] plant. It's working better than we had performed it, and the pay back for our rate payers will be even sooner than we expected. Then we're looking at three or four more in 2011.

We're changing out our car fleet with the smaller vehicles. The Cruz's, we have some Volts on order. And we think we can cut our overall -- we drive millions of miles a year, and we think we can up our fuel efficiency, which probably won't save any money because fuel is going up so fast but at least we'll keep the costs down going forward. Replacing pumps with variable drive frequencies, so that we -- (inaudible) use electricity. We pump a lot of water up and down hills all the time, so the more efficient the pumps can be, the less electricity we buy.

We're trying to cut chemicals at our plants two ways, one, through more fiscal chemical treatment by making the water cleaner coming into the plant so we don't have to apply as many chemicals. And then less use of chlorine by putting more UV, ultraviolet light treatment, which is a technology, state of the art technology that can get to disinfection with less chlorine.

And then of course because we are cleaning up the water more before it goes into the plants we end up with what's less residuals, that's basically dirt coming out of the streams that we take water in.

Because of the investments we're making at all our residual treatment at all of our plants, when you have to take it away from the plant and bring it to a landfill, you want it as solid as possible. You don't want to be trucking too much water. We've increased the solids content of our residuals by about 30%, which is a huge savings in trucking costs, carbon footprint, and so on. All of this, obviously, makes us look greener, but we're doing it because it's the right thing to do.

The other major costs that we're attacking is employee costs. We've been able to have basically a flat line in number of employees. We have about 1600 employees. A third of them are unionized. We, I believe have one of the best, if not the best ratios in the industry, 600 customers per employee. That's pretty good. When I got here it was about 350. That's been a massive change and that's because of the technology infusion and the management systems we've put in, and the training that we're giving to our employees.

We still have legacy costs. We have competitive healthcare and we have retirement programs, but the big legacy cost being faced by most governments that you're hearing about in Wisconsin et al., Ohio, and with many large corporations, i.e., the autos and many utilities, we've been working off that the post retirement and the defined benefit plans.

We stopped any new entrants into those programs eight years ago. And the results are startling as you look where we would have been had we not done that, and where we will be in a few short years where the, as the benefits drop off, the investments pick up, we will be fully funded without any major requests of our states for rates. So we're very pleased with that.

Now that requires the cooperation of our workforce, which they have been very cooperative, including the union contracts. We had five successful contracts this year, where we addressed the remnant benefit programs, fair wages, fair job security, but we have to attack the benefit side to make -- we will still be competitive, but not have the legacy systems. In 2011, we have four major contracts up, Indiana, Ohio, Southeast PA and New York, where we are going to be negotiating mainly around the legacy issues.

Hand in hand with the large-scale investment program and the cost cutting goes to the fact that we need a rate recovery program so that our investors get a fair and timely recovery on their money. The fact that we have one of the lowest operating cost utilities in the country with less than 39% of the cents per dollar going to run the business, the efficiency ratio, most of our rate requests in the past and going into the future are going to be driven by capital investments that we're making.

In 2010 we were awarded 18 cases, and nine surcharges totaling $53 million. That's compared to $37 million of annualized awards in 2009. Obviously, the annualized awards affect revenue stream for the next 12 months. So the ones we got in 2010 are going to help us in 2011, and the ones we get in 2011 will help us in 2012 and some of the current year.

We have some major cases we have not filed yet, but we did have a successful year in 2010. And one of the non-financial successes was the fact that many of the states, North Carolina, Virginia, Texas, and Pennsylvania for waste water, allowed us to what we call consolidate rates, which makes it a lot easier for the states and us regarding accounting and legal costs when you go in for these cases. It makes the state look as one unit versus in Florida at one time we had 80 units. So you can see the efficiency of consolidated rates.

When you look at 2011, we had a busy January. We have already received three rate orders and three surcharges, totaling $6.8 million already agreed to. We have 18 pending, representing $26 million to $27 million. And we plan to file by year end some of our larger jurisdictions rate relief in Pennsylvania, New Jersey, Ohio, Illinois, and Texas.

Very proud of the efficient professional rates process that we have implemented over the last couple of years. As a multi-state company, it was made a lot difficult. The system now includes everyone from myself right down to the state controllers. But basically the chief responsible officer is the president of that state, who also is responsible to have managed the capital, therefore, regulatory lag, unless you have adequate rate recovery.

We however, have a supportive centralized rates department that injects consistency and best practices in every rate case we do. When you're doing 18, 20, 30 rate cases a year you can see how important that professionalism and the consistency is for the accounting exhibits and things of that sort.

Growth, there has not been much organic growth. Most of our 1% this year was accomplished through hustle, 23 acquisitions. We're starting to see some housing return. Housing right now nationally is about one quarter what it was at its peak and about one-third what it was just as a normalized rate of 400,000 to 500,000 versus about 1.2 million to 1.5 million. That's a normal rate.

So, there's only one way to look, and I am hoping this spring we're going to start seeing a run-off of the foreclosures and hopefully some new housing starts. We are starting to see some selective growth in the South, in Texas, where it has not slowed down as much as everywhere else. And we just announced one this week where we're going to develop a whole new town center outside one of the largest malls in the country, King of Prussia, Pennsylvania. So we're starting to see investors and banks looking at future growth again.

The other thing that is going to give us some basic, I'll call it organic growth, but it really is a new idea; in Pennsylvania we're seeing small towns, mainly in north central and northeast Pennsylvania, that have been dormant economically for 30 years, really become boomtowns because of the Marcellus Shale, which oil and gas drilling, under a new technique that goes very deep into the ground.

One of the aspects of it, however, is you need a lot of water; 3 to 4 million gallons per well to actually force the gas that's in the shale out of the formation. Unfortunately, many trucks which carry about 5,000-gallons, so you can figure out how many trucks you have lined up for one of these well drillings are going all over the place trying to find water. We decided that we probably should be a little more efficient for them to save not only the roads in the north and central and northeast Pennsylvania area, but also the environment through all the trucks and diesel fuel and everything else, let alone the traffic jams.

So we've come up with some concepts that we're initiating, which I'll call them, very, very unprofessionally, gas stations except we've given them water, and I'll explain that to you a little bit more. But basically we think it will provide organic growth for the company. This year it was about 0.10%. Next year we think it will be up to about 3 and a half -- 0.35%.

Now, nothing dramatic. This is not a brand new direction for the company, but we think we're serving everybody by doing this the right way and taking trucks out of the main parts of these small towns, and trying to put our pipes out towards the highway so they come off the highway, fill the truck, and leave.

So now whether it's to maintain our record-setting capital program or acquire new systems or pay out our dividend, which we again increased 7% this year, and still stay within our pay-out targets, we looked at how we're going to support our $300 million-plus capital. This year we were close to 90% internal generated, actually, I have the exact figure here, 98%. You can see the cash generation because of the new tax law and the bonus depreciation is supporting all our capital.

Now last fall, we were like squirrels collecting nuts for the winter, and we took advantage of some major advantages; there was an excess capacity, a tax freeze in Pennsylvania. In addition we hit the lowest rates that I think we're going to see for quite awhile, 4.7%. We borrowed and have cash on hand of $140 million that we have a couple of years to spend down. I think that's going to serve us well as we look at what is happening with some of the inflationary pressures that the economy is facing.

We also have about $20 million in unused state revolving loan funds that we will draw down as we need. And we have one borrowing anticipated for 2011. Again, it's an opportunity borrowing with the CanAm, which is a representative of an immigration policy that we applied for and we're eligible for, and we're talking about possibly borrowing $65 million at 2%, hard to turn down.

So along with our reiterated S&P A+ rating for our Pennsylvania subsidiary, and the fact that we have all this cash that we've squirreled away because we took advantage of low interest rates and the fact that we won't be paying taxes probably for two years under the new tax laws because of our heavy capital infusion through our program, we will not see any borrowing other than the one I just mentioned, or equity infusion for quite some time.

So with all this data and planning for the future, you can see why 2010 was probably one of the most rewarding I've had in my 19 years here as the CEO. I really do believe this company is positioned for the future. We talked about the cash. We have a lot of it; superior credit rating; no future dilution near term unless we have a big deal or something of that sort where we would need to get some new capital.

Our tax position is in great shape for the next couple years, none. I look at that as an interest-free loan. You will eventually pay it back, but it's cash that you can use. And for a heavy capital intensive industry, that's very, very positive.

Our management systems are in place that continue to drive a very cost-effective business model. The new systems have allowed us to really improve our customer service, where I think we had superior customer service for meter reading right round through servicing the customers and the bills.

Our books are clean. We have a great management team in place with experience, and I guess that's proven by the fact that we're still growing, a hustle-factor element. And our capital investment plans which we projected five years ago, at a huge increase, are now very predictable. They're manageable. They're consistent, and they're moved from predominantly compliance-driven to pipe and cost reduction, which is much more amenable and appealable to the regulatory officials.

Our environmental record is great, and our green -- greenness is being recognized by the state agencies, where we have continued to have excellent relationships. So as a small businessman, when I was at the head of the chamber of commerce of greater Philadelphia 20 years ago, Aqua is open and ready for business as we start our 126th year as a company in the greater Philadelphia area.

I'm sorry for the length and I'll answer any questions.

Thank you, sir. The question and answer session will be conducted electronically. (Operator Instructions).We will first hear from Tim Winter from Gabelli & Co.

Good morning, Nick. Congratulations.

Good morning, Tim.

I was wondering if you could repeat the number; you have how much cash on hand at the end of the year?

Well, of the tax freeze we borrowed, help me out, Dave, $137 million yet to be drawn. Probably another $25 million plus in state loans that we haven't drawn down on yet. We have a $60 million tax refund coming from -- $33 million tax refund from 2010. Paid taxes that now we don't have to pay because of the bonus depreciation which will come back to us as a refund, and of course no taxes paid in 2011, which helps generate new cash.

Okay. Okay. Then could you talk a little bit about how the bonus depreciation impacts the pipe replacement program in the disk, and is there any impact associated with that?

Well, we're not going to slow down. If anything we'll probably increase slightly the pipe program. The capacity limitation there, Tim, is just how many roads you can rip up at a time because you start aggravating the local officials. But with this bonus depreciation it gives us a chance to actually spend more without having to go out and borrow money or dilute. That's going to be our goal. But I don't want to mislead you into thinking we're going to double -- we're going to go from $300 million to $500 million or $600 million; probably there's a capacity limitation.

Right, but will the depreciation of the spending impact your ability to implement the quarterly rate increase?

No, I don't believe so, Dave.

Right, yes; we're very confident that the way the disk works in Pennsylvania and the other jurisdictions that that will press forward. The way it plays, Tim, you know, it's a rate-based deduct. So it could in the longer term have some effect on our ability to raise rates, but we are doing plenty of capital and we expect to be continuing to raise rates on a go-forward in relation to that capital.

The good news, the part that we wouldn't have to raise rates for is the fact that we'll pay down debt so you don't have to charge the rate payer for the extra debt because we'll use the interest-free loans to not obviously incur new debt and actually pay down some of the debt as it comes due. We won't have our revolver used as much, although that has not cost us too much over the past couple years, 75 over LIBOR because of our A+ rating. But we would manage our revolver down with all this extra cash and probably do a little bit more capital than we would have planned, which will increase rate base.

Thank you.

This is a real management. This is a bad -- I told my board our problem is how do we manage all this low-interest cash and debt? That's going to be how we earn our stripes in 2011 and 2012 by managing it properly. I think it's actually going to help rate payers. So I think in that sense the regulators will appreciate it.

At this time we have one question remaining in the queue. (Operator Instructions). We'll take our next question from Gerry Sweeney from Boenning and Scattergood Investment Company.

Good morning, congratulations on a good quarter. Quick question on the O&M front. Obviously it's tracking down nicely to I guess levels you haven't really seen since early 2000. As you get down a little further each incremental gain will probably become a little bit more difficult. But do you have a target or better yet like all things being equal, what do you think you could get this level down, the O&M ratio down to going into the future?

Good question, Gerry. Of course this year we promised 50 to 100 basis points and ended with 170, so we got a couple years out of this one. So I don't want to in any way imply that we're going to be able to continue that pace. I think at 25, 50 basis points a year from here on in would be tremendous. Because there's only so much efficiency you can squeeze out of an organization. And with what Tim just asked, with less interest, the revenue stream doesn't have to go up as fast to get the profits because you have less interest capital and so on. So that would, just by math, hurt the O&M to revenue ratio. In no way saying that it's going to go the other way. We're going to continue improving it. But I don't think if you're doing a five-year model you should figure 170 basis points a year. It would be more like 25 to 50.

Do you have specific targets internally?

Well, we manage around number of employees, because that's the 30%, 40% of our O&M, and benefits. We try to keep benefits in line, competitive, but you're going to see a lot of companies, as a matter of fact, a couple of the other water companies, the biggest rise in their O&M was the benefit side.

You'll see ours has not gone up, and everything we have is already in rates. So it's just a wash. But the targets we're looking at is the other two or three big issues in our O&M, purchase water where we're trying to build plants so we don't have to buy as much water; electric, i.e. the solar; and chemicals, i.e, the residuals and so on. After that it becomes insurance, which you can always find hopefully savings by better safety programs.

Transportation is a big issue. That is going to be difficult because of the amount of fuel and price of fuel, and we're addressing that through the meter readers are driving very, very small vehicles where they used to drive SUVs and things of that sort.

Okay, got it. No other questions.

Okay, thank you.

It appears we have no further questions at this time. I would like to turn the conference back over to you for any additional or closing remarks.

Okay, no, nothing. I thank everybody for their time.

This does conclude today's conference. Thank you so much for your participation.