Essential Utilities Inc (WTRG) 2012 Q2 法說會逐字稿

Good day, and welcome to the Aqua America second quarter 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, Alyssa.

Good morning, everyone.

Thank you for join is us for Aqua America's second quarter 2012 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 website.

Presenting today is Nicholas DeBenedictis, President and Chairman 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 risk, 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 non-GAAP measures.

Reconciliation of these non-GAAP to GAAP financial measures are posted in the investors relation secretary of the Company's website.

At this time, I would like to turn the call to Nick for his formal remarks, after which we will open the call up for questions.

Thank you, Brian.

Good morning, everyone.

Pleased to report a solid growth, with GAAP up 11% at $0.30 versus $0.27 last year.

We experienced strong revenue growth of 11% in this quarter.

Broken down, 5% of that is from rates, 4% from acquisitions -- the fact that the Ohio purchase and the Texas purchase last year were up against less robust results from the other states that we used to have, and also 7 new smaller acquisitions -- and the remaining 2% from better than expected weather, chiefly in the Midwest.

But the main story of this solid financial performance in the quarter, I believe, is execution, execution, execution.

Things were just clicking.

Our operating expenses from continuing ops and interest expenses were both flat, and that allowed the GAAP earnings on a continuing basis to actually go up even faster, $0.30 versus $0.26, or a 15% increase in EPS.

On the interest front -- financing -- we held on to our coveted A-plus rating in Pennsylvania, which makes us one of the higher ranked utilities S&P.

And that is allowing to borrow at unprecedented low rates.

We did $50 million in May, a 15 year note for 3.57%.

We have about 55% of our $300 million revolver used, so we still have quite a bit of space on it, and we're averaging 1% a year on that borrowing, and we have -- we all ready took out this year a $5 million issue at 9% -- Who can remember 9% money?

That was 30 years ago, I guess -- And $25 million at 6%.

And we have over $100 million in tax-frees ranging from 4.5% to 5.5% that we plan to recall in the second half at their 10 year time period.

If we just stay with the same length of maturity, which would be a 20 year maturity, we think we might be able to do as well as 75 to 100 bip savings on that $100 million.

You see we continue to do financial engineering, but in a very positive way because of the financial foundations of the Company and it's strong S&P rating.

And timing is everything, and some of these notes are coming due or callable, and we're taking advantage of today's historic low interest rates.

On the O&M front, for the trailing 12 months ending June 30, 2012, we posted and O&M to revenue, what we all our efficiency ratio, of 37.3 versus 37.8 in the year prior period.

Just to refresh you, we've had a nice run of tightening margins, improving margins, and actually lowering the efficiency ratio, which is the inverse.

Let me read you some numbers, and you can see the trend line.

These are year-end numbers, but foryear-end 2007 our OEM efficiency ratio was 42.2.

In 2008, it dropped to 41.8.

In 2009, it dropped to 40.2.

In 2010, it dropped to 38.7.

In 2011, we achieved 38.

And we're hopeful -- with these six months in the bag now all ready, we're hopeful to squeeze another 50 to maybe 75 basis points or more in the margin out of this benchmark for year-end 2012.

Now, there was some confusion after my last call.

We measure our efficiency ratios slightly different than the other large water company, American Water, who is giving these tracking results, and they're doing very good with their [net] results also.

If we use the same metrics as American, which is the regulated division O&M, not all O&M including are regulated, and we adjust for purchased water -- which they do, and that's a legitimate thing to do -- our trailing 12-month June 30, 2012, number would not be 37.3.

It would be 34.3.

I think whichever one you use, I believe it's the best in the entire utility industry.

Now, if we adjust our 2011 results from continuing operations in a non-GAAP matter -- this is taking continuing operations, which I think is probably the best and most relevant basis to use as you're looking at 2012 -- and adjust for a one-time game in Aqua, it was received from a PA bonus appreciation program that did expire at the end of last year December 31, 2011, the earnings comparison for the third quarter of 2012 would be $0.30 -- this is from continuing and adjusted for the taxes -- would be $0.30 versus $0.24, or a 25% gain.

And I broke down the $0.06 genericallyfor you.

$0.03 is from rates, $0.015 is from better operations -- mainly improved results in Ohio and Texas as a result of the acquisitions we made, as also coming close in achieving ROEs in almost all the other states except a couple of the Southern states -- and another $0.015 from weather.

And I think the execution success is complimented obviously by the controlling of operating and interest expenses, which you could argue is also execution.

But the earlier rate awards, which is the regulatory execution, in Pennsylvania this year in June -- this helped the quarter -- it could have been late August if the commission took the full 11 months.

In New Jersey, [you start to] finish, in April we ended a 4 month case.

In Texas, we got interim rates in March, ahead of schedule.

In June in Ohio.

We had two normalized rate cases in January in the original Ohio properties that Aqua owned, but we actually got a rate case one month after doing the transaction with American Ohio in June that American had started, and that was a $4 million addition.

And we had two major accomplishments earlier in the year, February and March, which of course affected the second quarter fully.

In Illinois and Virginia we were able to achieve full consolidation of rates, which is a very, very important thing for the future of the efficiency of the rate making process in those states.

So these awards position us well very well to continue not only to perform close to awarded ROE at each of the states, but also to lay the foundations to utilize the available state surcharges, and they're called, depending on which state, DSIC, SIC, QIPS, and now the recent DSIC in New Jersey which was allowed last week.

Those programs tie-in perfectly with our current planned infrastructure rehab programs, which happen to be the bulk of our $300 million capital program for 2012.

I think the one thing that really points out 2012 [is] that we started with a lot of execution risk, but I'd like to tell you it's behind us almost 100% now and successfully behind us -- is the fact that we are able to dispose of properties in Maine and New York, and purchase properties in Ohio and then the seven smaller systems, in addition to continued to execute the Texas property that we bought mid last year.

And those have performed better than expected and actually helped quarterly results, as the financial performance in the Texas and Ohio properties actually out-paced and exceeded the original performers we put in when we assumed they would be good, accretive deals for us.

I think the same thing, in fairness, is happening to America, because both of us are use our economy scale to improve what we couldn't do with the smaller operations prior to the trading.

Our expansion in Ohio is very timely, as the buckeye state has been expanding its natural gas drilling programs, and just at a time when we're expanding our Marcellus opportunities and learning a lot about the natural gas drilling business.

In that sense, all our permits for the project that we told you about last quarter in Pennsylvania have now been issued.

We've actually started phase two of the pipeline with our joint venture partner in Virginia.

We completed phase one late in the second quarter or midway through the second quarter, and that has pumped enough water in the second quarter [in] a small piece that's called phase one to not only wipe out all of our start up costs that we incurred in Q1 of this year, but actually turn a profit for the six months.

Small, but a profit, and that should continue to generate a couple million dollars or maybe $0.01 a share by the end of the year just on that one small piece.

Then phase two, which is another $40 million investment, won't be ready until November or December, but all the permits are issued, and we've actually started construction, so there's no delay in the original schedule.

We think when that's done, then we start another $40 million phase, which is phase three, you'll see a continual progression just on this one pipeline from maybe $0.01 a share -- $0.01, $0.015 this year -- doubling that in 2013 with phase two online, then doubling it again in phase three online.

Then when it gets to maturity, maybe throwing as much as $0.10 a share off, assuming gas drilling continues at the pace it's at right now, gas prices stay up over $3.

A lot of ifs on this, but we do think the concept of delivering water and taking thousands of trucks off the road is not only cost effective and economic for the drillers, but also prevents a major environmental issue that was occurring with the numerous trucks that were on the road up there, so we feel like it's a real win-win.

All in all, we had a very solid quarter and depending on normal weather continuing -- I'll get into that a little bit -- I'm optimistic of meeting analyst with First Call projections not only next quarter but for the year.

Let me put a little color on the third quarter.

Actually, July, which we just finished today, sales were good in the Midwest, up a couple percent over 2011.

Pretty flat in the South where we had a good 2011 anyhow.

Remember we had that drought in Texas that we were up against.

Pennsylvania had a very good July in 2011, as did New Jersey, so our numbers -- actual 2012 numbers in July, although they were good and solid, came in 5% below what they were a year ago.

Now, that's bad news for the quarter, but the good news for the quarter is last year was Dr. Jekyll and Mr. Hyde.

It started August great, then fell off the map in August.

So we think we'll be ableto make up that 5%, just with a normal winter -- normal summer we'll be able to make up that 5% that we were down in July in the two big states in the Mid-Atlantic, and then hope that September's up a little bit overall.

So we hope to expect a little bit of kick from consumption, but not as much as it would have been had we had a bad July we were up against last year.

So I'm comfortable with First Call.

If we use as the basis last year's GAAP, which was $0.30, but that was affected by a lot of ins and outs tax-wise, discontinued, so on.

I think the more relevant -- now that we're not comparing ourselves to [American Maine] in the portfolio any more, but we do have Ohio -- if you take on a continuing ops basis, last third quarter was $0.33, butthat included $0.03 of one-time PA taxes.

So to me, the GAAP number of $0.30 coincidentally is consistent with what I would call a reasonable base on the adjusted continuing of $0.30.

And normally we say you can predict 10% because of just our model, which I definitely feel comfortable with, but because of the rate cases and because of the expected better weather in August and September, I'd be comfortable [either] with a 15% increase over that $0.30 period basis.

And many of you are in that range, but I wanted to make sure you understood what the basis was and why -- the reason why we think we can do a little better than the 10% this year.

So we're on our way to a solid year.

Many of you right in line with First Call's is fine on a continuing basis from ops.

And that's it.

If you want to take a look at the First Call, which I think is still $1.07, that's up against -- on a continuing ops adjusted for a one-time tax, up against $0.94, so that's a healthy again year-over-year, and a lot of that comes from the fact that things are clicking in operations, ROEs being obtained and O&M.

But it's also because we've had healthy rate awards this year, which are affecting positively this year's numbers.

But I would argue that the transitional rationalization of the portfolio where it's starting to kick in Ohio and Texas for us is also a big plus on why we feel comfortable, not only with the first call this year, but also for the future of the Company.

I'll take any questions.

(Operator Instructions).

We'll go first to Michael Roomberg from Ladenburg Thalmann Investments.

Good morning, Nick.

Good morning, Michael.

Can you just clarify the portion of revenue in O&M that was attributable to other operations in the quarter?

You mean to try and get what the ratio is on the --

The regulated versus the non-regulated.

Okay, sure.

We have to look that up.

Can you get that right away, Bob, or you want to --How about if we get back to you after the call on that?

Sure, not a problem.

Secondarily, there's been some --

It's probably higher now, and it's all in that 373, but it's probably higher now because all of our startup costs and the revenues aren't coming in yet on the infrastructure.

On the Aqua Resources, which is our other unit, probably in the -- I think that's 15% margin, so it's probably in the 80% range, O&M to revenue.

Got you.

But there's no capital needs in that area.

It generates catch year in, year out, so it actually feeds the machine at the regulated side, but nowhere near the margins you get in the regulated.

Right.

I've been coming across news reports, Nick, about the development up the turnpike in Allentown, where they're toying with the ideal of a long-term lease on their water system.

I'm wondering what your thoughts are with respect to that?

Is a model that's potentially attractive to Aqua?

And from a broader, nationwide prospective, do you view this type of arrangement as a way to kind of bridge the gap between the economic justification for privatization versus kind of the public apprehension towards private ownership of water assets?

Obviously, our preference would be asset purchase, because then you can merge it in, synergy it with everything else.

It's our basic business model.

The one-off build, design, operate, or O&M -- just operate -- it's lower margins, but you don't put any cash out.

All depending on how you write the contract, obviously.

We are interested.

We've talked to them.

We've been in discussions with them for over two years.

What's driving it, as you can see from the news articles, Michael, is the wall coming in a lot of municipalities based on their pensions.

And if you assume you're not going to earn 8% on your assets, and the interest rates stay down for any period of time, i.e.

your discounted amounts that you the need in your contribution to make up for only grossing 4%, really has put a large contribution in the visibility of these budgets, which are usually two, three years out.

And that's really what's happening Allentown.

It happened in Scranton, where they actually asked everybody to start working at minimum wage, because it's consuming every possible discretionary dollar without major taxation in some of these middle-sized to smaller cities throughout the areas that have large pensions, mostly police and fire.

It's not going away unless we start getting 10%, 12% returns on the S&P again, steadily, and until interest rates get back up to the 5% to 6% rates for discounts.

Then you'll get more stabilization in these pensions.

So I think that's what's driving that.

Now, having said that, that means the sole purposes of doing it is financial versus we really don't want to be in the business, which makes it a tougher political convincing argument on why would we give up our water system.

And that's why you're seeing more of these unique ideals like leases.

Now, whether the lease makes sense or not, we haven't been privy to the RFP and RFQs yet, and we'll be in the hunt for sure, but there's not enough information on the table to understand -- We understand conceptually what mayor wants, but don't know how he think he'll get there in his best interest and whether that would work for a private company.

Got you.

Thank you, Nick.

We'll go next to Ryan Connors from Janney MontgomeryScott.

Ryan, you might be on mute.

Is okay, I guess he's not there any more.

One second, sir.

We'll go next to Spencer Joyce from Hilliard Lyons.

Good morning, guys, nice quarter.

Thank you.

Just a quick question here.

Nick, I think you mentioned maybe [in] the share as a longer term target for the nat gas water supply initiative.

Once three phases are up and running and in place, as far as the timeframe on that, would that $0.10 be ayear 2014?

I'm assuming we wouldn't quite get there in 2013.

Is that right?

Definitely not 2013.

2013 would be a closer ramp up to it.

2014 would be the third phase of that ramp up, because we won't be done till late 2013, so 2014 would be on the way up.

And I said it would reach maturity in 2015, and that's when the steady state would be occurring for how long they occur.

And I would say it's closer to 2015, but it would ramp up over those three year periods.

Remember, Spencer, that's one pipeline.

We not -- hopefully -- going to stop with one pipeline.

That leads me into (inaudible -- technical difficulties).

I guess we're obviously still pretty far away from being to completion on this first pipeline.

What -- or do you all know any timeframe that you would look to maybe make some set plans for a second or a third major venture here?

Are we still a ways from that?

We're talking to no fewer than four or five major midstream people who are developing the gas side of it, trying to see if the water will fit.

We started this one a year ago, talking about it, then got the first phase done within six months, so I'd say the gestation period could be a year, year and a half on each one.

Okay.

One follow-up question on the expenses.

Phenomenal quarter this quarter.

I think we had to go back and I had to go back to maybe 2002 to find a quarter this good, so congrats there.

Thanks.

I know that the trailing 12-months has continued to come down.

I think we're down just over 37% now.

Do you all have any target in mind as far as that's concerned, or an ideal how low that can go longer term?

Or are you just making smaller picture decisions, then the overall expense hopefully will trend lower?

Right.

Well, the reason I gave you a 5 year trend was to show you it's constantly one of our key objectives, and we have been able to achieve a reasonable, sometimes more than 100%, 100 basis points, sometimes less, but generally that type of reduction.

It does get tougher as you get lower because there's only so low you can go, right?

It's like a limbo bar.

Now, the number was 37.2, I think, Bob?

37.3 so far fortrailing 12, which is 50 basis points better than last year's trailing 12.

Last year's full year was 38, and we're comfortable that we think we can hopefully get closer to the 100 versus the 50.

I always give a range 50 to 100, but some things it affected is the revenue growth, which is on contingent on rate cases.

We're also looking at different tax policies that could change some of that around, but it would be positive from cash flow, which is more important than the O&M revenue.

The ratios only important if the results are better, right?

Bottom line results, so we wouldn't sacrifice results or tax policy or cash generation just to look good in the comparison, especially when we're the top in the industry.

But I'm comfortable we can continue to keep bringing it down.

Okay, sounds good.

One more just kind of small follow-up.

I believe it may have discussed some time ago that there was some chatter about bringing back the bonus depreciation for this year.

Is that pretty much dead at this point, or is there [really] a possibility of getting a back date there or going forward could see that?

I talked to our senator who was on the super committee in Pennsylvania, and he does not think it's dead, but in all honesty no one thinks anything will happen until after the election.

The bonus depreciation is something that the members and the senators feel is an instant way to kick start manufacturing and production in the economy.

I would -- I can't say if it's 50/50 or 25/75 or whatever, but there is a likelihood it will be enacted in the fourth quarter.

And ifthey do they'll probably make it retroactive for the year, or at least spread it over starting in the fourth quarter of this year all through 2013, and depending how Pennsylvania lets us treat it, we might be able to generate again more cash and more net income.

Okay.

Sounds good.

That's all I had.

Thanks for taking my questions.

Thank you.

(Operator Instructions).

we'll go next to Jonathan Reeder from Wells Fargo.

Good morning, Nick.

Good morning, Jonathan.

How are you doing today?

Good.

All right.

The Q2 2011, you indicated weather versus that was about $0.015 benefit?

How is it versus --

Out of the $0.06 of continuing.

Right.

So, I mean, percentage-wise, it's like 15% -- 20%, 25% of the growth of earnings.

You could correlate that to the $0.03, but whatever that would be, 0.75.

Right.

Do you recall Q2 last year?

Was it kind of normal weather?

Was it above normal weather?

Just wondering how you're running this past quarter versus [the typical] --

Last year we had a bad spring, then it got to be a good June.

It was a wet spring, and then -- so we were doing great -- we weren't doing great in 2011 versus 2010 for the first two months, then June and July were just fabulous months.

It picked up the whole quarter last year.

I'd say it ended up being normal versus normal.

Okay.

And that --

The difference here was Ohio, where timing everything, we picked up Ohio right in time for the hot spell.

That was up 5%.

And Illinois and Indiana had great months.

Texas had another good month, but nothing compared to last year's drought weather.

Right.

Then you say Q3 last year, you ended up and all said and done about normal after the strong start from the wet [finish] --

We had a great July, terrible August and September.

This year, July, Midwest is off to a good start, 3%, 4%.

Pennsylvania and New Jersey are down 5%, but I think that will turnaround on a dime in August and September, because -- assume we don't have a lot of rain, because last year was a terrible August and September in New Jersey and Pennsylvania.

Okay, just wanted to a little clarity on there.

On the Marcellus pipeline, what exactly is the timing for phase two and three, and the cost associated with those?

Sure.

Phase two has all ready started.

Should be done by November, December timeframe.

It's 18 miles plus a river intake.

Total costs will be $40 million or so.

I mean, those are the estimates right now.

They're coming (in audible -- multiple speakers) --

Is that your share, or is that the 50/50?

That's the whole thing.

Ours will be half of that.

Okay.

That will hook into phase one, which is all ready built which is 15 to 18 miles in the mountain.

Mike, you flew over that.

Mike actually took a helicopter ride so it's in the middle of nowhere, but we're getting water off of a local water company that has a reservoir there now to feed that, and that will be part of our going forward.

Then phase three -- which we started, but the major phase of it won't really be started until 2013 and won't be completed until sometime in 2014 -- is another 20 or so miles, another $50 million.

Half of that is ours.

It will take the line 20-some miles -- letme see if I have that number -- up to --I don't have that right here -- And thatwill take us up through like [Coleman] County and into [Tyote] County, so it opens up a new area where Shell Oil is now drilling.

I'll get you that phase three and distance hopefully before you get off the call.

Okay, so that's why you're saying it will reach maturity.

You'll finish it up sometime in 2014.

It'll be full year in 2015, and you think it's a $0.10 opportunity?

Yes, that's based on a very -- extrapolating what we've sold so far.

We know the prices.

That's good news.

And they won't change because we have contracts.

It depends on are they going to drill as much as they are drilling now, or maybe even more in the future?

It's all those kinds of questions.

So the price that you guys received is locked in --

Here it is.

It's 30 miles.

Phase three is 30, phase two is 18, phase one was 18.

The costs for phase one is done, $24 million . Phase two is projected to be $40 million.

We'd pay half.

Phase three, 30 miles is projected to be $50 million.

We'd pay half.

Okay.

So you're saying you have the price specified in the contract, but the volume is completely variable, because it's not a take or pay type of thing?

Yes.

They've committed to buy from us if they drill, that's the best they'll do, because they don't know -- if the gas prices are good at $2, they may stop drilling.

Now with gas coming back up a little bit this last couple of months, we're seeing a little uptick in drilling.

That's fair enough.

Last question, bigger picture.

Back when I used to start to follow you guys, you had the 4, 7, 10, 5 targets you used to talk about, and the 10% was really -- I guess you backed off of it a little bit when you were digesting Aqua Source and what not.

What's kind of the long-term target now?

Is it 10% year in and year out, and how does that breakdown between the regulated business and call it the unregulated Marcellus type stuff?

We'll give you the numbers, but -- and I really think you have to do it on a continuing basis, because there's so much noise with the gap regarding tax policies and everything else.

And if you take out the --

Yes, going off the 93 or 94.

And if you go back from 2007, which is when we digested most of the Aqua Source, it's been a pretty steady 10%, if not even higher, 2007 to 2008, 2008 to 2009, 2009 to 20010.

Or maybe it was 2008 to 2009, 2009 to 2010, 2010 to 2011.

And 2011 to 2012 is going be in even in excess 10% based on the continuing less adjusted for the taxes.

And we're comfortable going forward -- visibility being a couple of years -- that the model still holds.

Now, where we've weakened is the acquisitions just aren't out there and organic growth isn't out there, so the four has hurt the last couple of years, but we see a return to that as soon as the economy comes back.

But what we're trying to do is make up part of it with the unregulated, which is done nicely in the septic.

Andthey're making money and growing every year and not taking any cash from the Company.

So the part of the new model, if you want to call it that, with the Marcellus is it's still using a lot of capital, but it's getting paid a lot quicker.

It's not 100 years.

Most pipeline is 1% depreciation.

This one, Jonathan, we're taking in over -- is it 10 years or seven years?

10 years, which is the max, so your expenses are heavy in that JV for 10 years.

But don't want also -- in case they stop drilling at nine years, we don't want a big write-off either.

So it's a lot of -- it's a different model.

Right now I don't see it -- right now it's 2% of off revenue stream, I don't see it growing much more than 15%, 20% at the max over the next five years.

It's really predictable unregulated, [if you can] -- in other words, we're looking at pipeline, stuff we do any how.

It's just a different way.

Rather than having a regulator and rates, we're doing it can contracts with people who will be constant buyers of the water or wastewater.

Right.

So in five years you could envision the non-regulated business being about 15% to 20% of consolidated EPS?

Yes, I think so.

That's aggressive, but -- and we're not going to do it unless it makes more money than the regulated -- or comparable to the regulated.

But if we start growing at 6% to 7% regulated on acquisitions again, probably it won't ever get to 15%.

We have to have something -- to keep that bottom line growing there has to be something to replace the regulated, if the regulated slows up.

Right.

Are you baking in any assumptions around those other pipelines that you're talking about with the four or five other people?

Oh, yes.

Hopefully they'll be prototypes of the stereotype that have -- stereotypes of the prototype we have now.

We now understand the business a little bit.

We know what the contracts should look like with the JV partner.

And we understand the permits needed -- Corp of Engineers -- little different permitting than we're used to, because it's higher pressure and bigger pipes.

And operationally, we take everything for granted.

It works.

That's the big deal.

Again, Michael has flown up there.

He sees the terrain, he saw the terrain and the pressure and everything else.

This was not a slam dunk when we started.

That's what I'm saying.

Execution we take for granted in our Company, and I really do want to reinforce with the people who have followed us all these years, it's something that's accomplished because of the management.

Okay, thanks, I appreciate the time, Nick.

Okay, good.

We'll go now to Nick DeBenedictis for any additional or closing comments.

Thank you very much, and hopefully nice sunny summer for all of us.

See you late.

That does conclude today's conference.

We thank you for your participation.