Essential Utilities Inc (WTRG) 2012 Q4 法說會逐字稿

Good day and welcome to the Aqua America Incorporated full-year 2012 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, Angela.

Good morning, everyone.

Thank you for joining us for Aqua America's fourth-quarter and full-year 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 Emily Herman at 610-645-4271.

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 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 risk and uncertainties.

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

Reconciliation of this 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 for questions.

Thank you, Brian.

Good morning everyone and thank you for joining us for our conference call this morning to announce record-breaking earnings for Aqua.

I would like to also start by congratulating Jennifer Lawrence who won the Academys last night thanks to all the water she drank during the making of Silver Linings Playbook which was filmed less than a mile from our headquarters.

Maybe someday she will be our Company spokesman, but we can't afford that.

To put 2012 results in perspective, it took 125 years for Aqua to break the $100 million net income mark and that was in 2009.

And I am pleased to report today that in just three years, in 2012, we earned $197 million or $1.40 a share, up 37% for the year.

Aqua expects to go over the $200 million mark in 2013, achieving a new milestone in the Company's long history.

2012 marked a 13th straight year of record net income and the 20th year in my 21 years as CEO of increasing earnings.

Since 2008, when we began to profitably assimilate the rapid growth we experienced in the mid 2000s and we started our successful pruning program, our CAGR on net income has grown 15% compounded between 2008 and 2012.

This is well in excess of the 10% expected by the Street and, as a matter of fact, we hit the 10% CAGR goal, which would have occurred in 2015, three years early in 2012.

And I would say the key ingredients for the strong net income showing at 2012 was a solid year of operations complemented by the adoption of repaired tax accounting change permitted in our 2012 Pennsylvania rate case.

Our CFO, Dave Smeltzer, will explain in detail this win-win tax and regulatory policy later in the call.

Let me spend some time now on the specifics of our 2012 operating results.

Overall, 2012 was exceptionally strong strategically and operationally.

From an execution basis, 2012 was a resounding success.

Let me just tick off some of the year's results.

We profitably sold our main operations early in the year with no remnant issues.

We completed the New York for Ohio swap with American Water flawlessly.

The Ohio assets were integrated seamlessly into our existing Ohio properties.

It is accretive to earnings in its first year and Ohio's net income is above earlier projections.

Aqua invested a record $348 million, the most ever in infrastructure improvements, and I think that is one of the reasons we survived Superstorm Sandy so well on the East Coast properties we have.

Our New Jersey subsidiary received its first-ever DSIC approval in that state and we intend to start using that this year.

We lowered our cost of debt to 5.06% on $1.5 billion while maintaining our S&P A+ rating for our largest subsidiary in Pennsylvania.

We worked with through EEI -- Edison Electric Institute -- and we were successful in the interlocking of the dividend tax rate to the capital gains tax, maintaining the 15% taxation level for the benefit of our retail shareholders who make less than $450,000 and most of those are the 55% who hold our shares outstanding.

So that was a big issue for us.

We saw a return of the housing market, and when complemented by the 18 acquisitions we saw our existing customer base grow by almost 2%.

And lastly, continuing with our successful pruning program, we announced in September that we were exploring the sale of our Florida operations.

I expect to soon be announcing a smooth profitable exit from our businesses in Florida in the quarter.

2012 was also a year of new emphasis on our nonregulated business, which has grown to 2% of revenues and in 2012 generated $0.02 in earnings, about half from Aqua Resources and the other half from our start-up business, Aqua Capital Ventures.

That is the one that is supplying raw water via pipeline to natural gas drillers in Pennsylvania.

And we are on track to double the results of this business in 2013.

If we just look at operations and consider the year-end tax benefit of $0.22 which all happened in the fourth quarter, our adjusted earnings from operations which is, obviously, a non-GAAP number would have been $166 million or $1.18.

And that is a 15% increase over the 2011 GAAP earnings of $1.03.

In 2012, revenues were up $70 million to [$758 million], an increase of 10.3%.

Rate increases accounted for 5.8% or over half of this and approximately 4% -- or 40% of the increase came from new acquisitions including the new Ohio properties.

The remainder was from growth in the unregulated business.

So, strong revenue year.

In 2013, we see revenues continuing to grow despite the fact and this is an important facet that no revenues are added through the tax repair or Aqua Capital Venture because they come in through the equity earning line, for the case of Aqua Capital Venture, the revenues come in what we would normally call revenues come in through the equity earning line as it is a joint venture, and of course the Pennsylvania returns come in through reduction in the tax line, even though they both add to the bottom line.

Despite this we will still project a 4% to 5% gain in revenues in 2013.

Regarding expenses, 2012 was a strong year for cost control on a same-store sales basis.

Although you will see a 5.9% increase in the O&M lines between 2011 and 2012, as we explained in detail in the press release, when adjusted for new acquisitions, meaning the large Ohio acquisition which had no comparable expenses in 2011 grew (technical difficulty) [least] and is very pleased with our long-term trend of cost control and I think it is exemplified by the lowering of what we call our efficiency ratio which is O&M to revenue which, in 2008, when we started this program was 40.4%.

Still low in our industry and we have lowered that now to 35.9% in 2012, a 450 basis point drop over the four years over 50 basis -- over 100 basis points a year.

And I have always said we would try and get 50 basis points a year.

We were able to double that.

The efficiency ratio going forward of course will not be as accurate and indicator over the next couple of years due to a large amount of earnings that are going to be derived from two net income generators that don't have revenues.

That is the repair tax and capital ventures.

So this would be like preparing apples to oranges if we keep comparing prior year to current year.

But in any measurement that we will come up with, we believe Aqua is now the most efficient utility in the nation and we don't expect to lose that advantage.

We are continuing in our capital program to deploy expense reducing projects that address electrical expenses like our active solar program, our purchase water program which we lower -- we are continuing to lower our water that we purchase from municipal governments in lieu of treating our own.

We are doing a conversion of our fleet to CNG for fuel savings, Compressed Natural Gas, and we are working in all of our areas where we have residual waste treatment to lower the cost of the trucking and the landfill by having treatment on-site at many of our plants.

In addition, we have already taken and will explore further ways to reduce legacy pension costs and other benefit programs.

Now rates to support our continuing capital program in excess of $325 million, which has been for the last couple of years, will come exclusively from our operations outside of Pennsylvania.

We are -- and Dave will explain the agreement we have set with Pennsylvania PUC.

We are emphasizing surcharge eligible infrastructure programs in New Jersey, Ohio, Illinois and preparing to file 2013 statewide cases in North Carolina, Ohio, and New Jersey.

We also expect to finalize our tech -- our already settled cases in Texas and Virginia and, of course, the cash and returns on all the Pennsylvania capital we will be employing -- deploying will be provided by the repair tax deduction.

Once again, Dave will explain how that mechanism works.

We once again lowered our embedded cost of debt in 2012 to 5.06% on $1.5 billion of debt.

We expect to lower this further in 2013 as we refinance over $50 million on our debt in various states and we expect to get lower interest rates.

And then, we have $60 million that we have to put in longer debt and replace, regarding the Ohio American purchase of last year which we were carrying with short.

Now our cash flow picture has greatly improved since 2010 due to the 2011 100% bonus depreciation program, where we also got a flow-through from the state.

And in 2012, we had the 50% bonus depreciation and, of course, better earnings from operations that we are announcing today.

Now if this trend continues as we expect it to, we will no longer need any new debt to cover our capital needs, including our normal system acquisition program.

We also saw our book value increase 10% this year and our equity to capital ratio grow by 200 basis points, up to 45.5%.

We see this ratio continuing to improve predicting no new stock offerings, barring a large acquisition, for the foreseeable future.

As a point of reference, our last public offering was 2006.

And we continued to experience a small dilution in earnings per share due to Aqua's popular drip program and the employee long-term compensation programs, which due to the rising stock prices has -- in the accounting has to show more shares.

We are investigating a share buyback to minimize the slight dilutive effects of these programs.

Now that I have covered the highlights of 2012, perhaps in more detail than you wish, I would like to turn the call over to David Smeltzer to explain a real simple and exciting topic.

How the repair tax works.

Dave?

Thanks, Nick.

First, maybe talk a little bit of history.

This issue of deducting certain kinds of costs that had typically been capitalized really was solidified in a Federal Express case a number of years ago.

They had expense on their tax return a jet engine replacement on one of their planes.

The IRS determined that in fact the jet engine was the unit of property and, therefore, the replacement of that unit of property should be capitalized.

So it went to court and ultimately the court determined that the plane indeed was the unit of property and actually couldn't fly without the key component of the engine.

And so therefore since the plane was the unit of property the replacement of the engine on that plane was a proper expense.

And that case really opened the door for a number of other interpretations in terms of expensing costs that had previously been capitalized for tax purposes.

Now we studied this potential for some time now and didn't elect to change our tax policy earlier due in part to the fact that sufficient guidance wasn't readily available.

This issue was not addressed at any of our prior rate cases before the 2011 PA filing.

However, many companies including utilities have been utilizing this tax accounting change since the mid-2000s.

Most typically companies who have made this change accelerating deductions account for using deferred tax accounting where the accelerated tax production benefit resides on the balance sheet as a deferred tax liability.

And as you know in these instances, it doesn't flow through to reduce income tax expense.

As the deduction and related benefits to customers became more utilized with much greater clarity in the tax implications, we were asked by the PA office of Consumer Advocate to actually discuss our tax policy plan upon the filing of our November 2011 PA rate case, recognizing that PA allows flow-through accounting for income taxes in a number of instances, and that other utilities had recently reached agreements with the PA PUC regarding their repair deductions, we entered testimony into that case laying out our plan to take the repair deduction and flow through the benefit.

And, again, by flow through it just simply means that rather than tying up that benefit on the balance sheet as a deferred income tax, that benefit -- a cash benefit, in fact -- actually flows through to the income statement as a reduction in our income tax expense.

And so it is important to note this is not a one-time item.

In fact, it is a permanent change in the way we account for repair-related tax deductions and obviously we expect this to be ongoing for a long, long time.

Now recognizing the prospects for enhanced long-term customer benefits related to the this treatment, we entered into an agreement with the parties of our last rate case which was eventually approved by the PUC to utilize this flow-through treatment for our Aqua PA repair deductions, but only to be effective after the Company analyzed its potentially eligible projects and decided to make this tax accounting change.

The potential change itself was not reflected in the order that became effective in June 2012.

Now in return for a commitment not to raise rates in 2013, the 2012 benefits of this accounting change accrued to the shareholders.

Going forward, we would expect a similar annual repair deduction since the key to our settlement was that we planned to continue our significant levels of investment in infrastructure rehabilitation.

And in addition in 2013, the first of a 10-year amortization of the catchup deduction would also accrue to our shareholders.

And many of you know the catchup deduction actually represents the deductions of eligible projects going back prior to 2012.

And we go back as far as we can and accumulate the remaining tax basis on those eligible projects, take that deduction on our 2012 return based on the agreement with the PA PUC that will flow through to income over an approximate 10-year period.

We expect that to begin in 2013.

We fully expect that on completion of our next Aqua PA rate case sometime beyond 2013, more of the benefits of this change will accrue to our customers through a lower revenue requirement than would otherwise be necessary.

And at the same time the next rate case will provide a fair return on all of the capital that Aqua will have deployed over this multiyear period, making us whole going forward.

So while there are admittedly some shareholder benefits which we are beginning to recognize today in our Q4 results, they are also initial and long-term customer benefits related to this mechanism.

That was in fact approved by the PUC.

So I would like to go over some of those.

First is DSIC.

Immediately following the adoption of the tax repair impact on January 1 the Company lowered its rates by eliminating the PA DSIC which was, at the time, set at 2.82% that would have risen every quarter in 2013.

The Company just doesn't expect to make any new DSIC filings or incorporate any such DSIC charges on its customer bills in 2013.

And to put this in perspective, for 2013 we would expect that allowable discharges based on our past practice, spending and qualifying capital projects would have approximated over $22 million.

Or by the fourth quarter of 2013, we would have expected we could have reached the 7.5% cap on the discharge on each customer bill.

And that would represent about $30 million in annualized revenue that we will now be foregoing and essentially replaced with the flow-through benefit of the tax of the repair tax change.

So that is DSIC.

The second is an impact on rates.

If you followed the Company for a number of time you know that we have a long track record of filing a Pennsylvania rate case about every other year and November 2013 would have been the scheduled date for our next rate filing.

Because of the benefit of the 10-year amortization of the catchup adjustment, is catchup adjustment which we expect to begin in 2013 in accordance with the PUC order, we will be notifying the parties as to that rate case of Aqua's intent to postpone its next base rate case filing beyond the expected 2013 filing.

And then the third area of benefit to customers is capital spending.

We don't expect to slow down during this period while we are foregoing a DSIC cost recovery and, postponing our scheduled rate filing, the Company plans to continue spending record amounts of capital in excess of $230 million a year in Aqua Pennsylvania improving its distribution system and other facilities to address system reliability and ensure the long-term viability of our systems for the benefit of our customers.

So that is the quick simple overview of tax repair.

Nick, I will turn it back to you.

Thanks, Dave, for an understandable explanation of a very detailed subject.

And of course we will be available after this call for specific questions on this very detailed, unique process which I deemed as a win-win for both from a regulated standpoint and from the Company standpoint.

I would like to wrap up the call with a general outlook regarding 2013.

We are confident that we have reached a new base in earnings from which we can grow as we continue to invest needed capital in our water systems and wastewater systems.

We intend to continue to grow both the regulated and now the new unregulated businesses through acquisitions or capital development, and we continue to have one of the strongest balance sheets in the utility industry which we intend to capitalize on and maintain our standing as the country's most efficient utility, from both an operating cost and an EBITDA standpoint.

Obviously with the large but sustainable jump in earnings in 2012, even though we just raised our dividend 6% in December, our payout ratio has now dropped to 50% which is below our normal range that our shareholders have been accustomed to.

Our Board will review this in 2013, our dividend policy for 2013.

Clearly, this is a Board decision involving many difficult choices as to alternate uses for the cash.

However, our projections show that our 2013 earnings and cash increases will exceed the normal $0.04 a share increase of recent years.

And so, we have plenty of room for looking at the dividend.

Also, I would like to give some guidance regarding the first quarter of 2013 as there was a lot of moving parts in the first quarter of 2012's earnings.

First quarter of 2012 was $0.27.

But that was enhanced by $0.08 from the profitable sale of our main properties.

So if you take an operational standpoint they would be obviously lower than the $0.27.

We expect on that basis the operational basis to type a gain from operations that we experienced in 2012 and in addition you should impose -- impute a quarterly portion of the 2013 tax repair benefit which, in 2012, was all taken in its entirety, $0.22 in the fourth quarter.

So clearly that should be spread among your quarters this year and would be additive to the base amount less main in the first quarter of 2012 as you project 2013.

Sorry for the length of this conference call, but we will take any questions now.

(Operator Instructions).

Leslie Rich, JPMorgan.

Good morning.

So you expect the tax repair benefit in 2013 to be at a similar level as it was in 2012?

Yes.

And then as you amalgamate all the factors that you said would go into 2013, for example, postponing your rate case, foregoing the DSIC, continuing to spend but then getting the benefit of the tax repair accounting, does that all sort of wash?

I mean, as you think about the pluses and the minuses for Pennsylvania it is a sort of a wash?

Yes, it does.

And I am going to give you a very simplistic nonlawyer, non-accounting answer.

It is simply we are replacing what we would have gotten through rate increases and the DSIC to give us a fair return on the capital through the repair tax method and letting the taxes that we are collecting right now to be a flowthrough even though we are not paying them which we don't have to pay because of this new guidance from the IRS.

It's a very unofficial way of saying it, but yes it is a comparable.

And that is what I think your basic question is from an earnings point.

Yes.

So as you think about 2014 and beyond, this tax repair benefit continues in perpetuity or does it need to be reviewed for renewal or sort of how does that work?

It does continue in perpetuity.

Sooner or later, we will have built up so much new capital additions that there could be lag and we don't know when that will be.

We are analyzing it right now.

It all depends on what projects you do that are tax eligible.

Not everything is eligible for this plan.

So if you have to build a new water plant, that may or may not be eligible to the same percentage as a pipe.

And therefore the amount of the tax repair may or may not cover a significant portion of 2014, 2015 and 2016's capital at which point we would then go in for a rate case and go back to the normal process.

But we will not have been hurt during that time period is really the issue.

Thank you so much.

Angie Storozynski, Macquarie.

I have two questions.

First one is good you tell us what was the average rate base for 2012 and also what is the projected rate base for 2013?

For the whole Company?

Yes.

I think it is $2.7 billion, but do you have that?

Can we get to you right after the call.

It is in there but we will get right to you.

I mean I just (multiple speakers).

Now, how about your long-term earnings growth expectations?

Given that there was a step up in earnings in 2012 how should we think of the 10% EPS CAGR?

Is it still sustainable off the 2012 level of earnings?

It is difficult for me to project that.

We will be up in my mind when we are projecting an up year in 2013/2014 -- over 2012 even though we really hit our 10% CAGR three years early as I said earlier in the case.

I would not project a 37% increase next year because it is now the repair tax has now accumulated in, but we don't see our operational programs slowing down.

So it is on a bigger base now and part of that is the state amount which is the tax repair.

And also on regulated earnings, you said they contributed $0.02 this year and I am assuming so we are assuming $0.04 in 2013 and based on the projects already announced, how much would you expect in 2014?

Divide the unregulated revenues or I should say net income because if revenues only come in through one that's the resources.

That is the one that's septic tanks and services to people's homes for pipeline insurance and things of that sort.

I would not say that would double each year.

Because it is more of a stable state business.

On the other hand, the start-up business which already earned $0.01 in 2012 even though it is a start-up and most start-ups don't make monies for years.

That one, we -- just looking at our projections on the contracts we have, we think that one will double in let's say 2013 and double again in 2014, because it is a huge investment we have made that now more and more drillers are asking for water supply.

(Operator instructions) (multiple speakers).

If you want to call we will get you that rate case.

(Operator instructions).

Leon Dubov, Luminous Management.

Good morning.

Just to follow up on Leslie's question.

So you expect to benefit from the repairs tax to be about the same in 2013 as it was in 2012?

And then on top of that there is another step up from the new 10-year amortization of those taxes that is coming in?

Is that the right way to understand it?

That the 10-year -- it is a 10-year amortization so it is not all in one year like the 2012 and 2013.

So it is a smaller amount, but yes we would expect that to increase and we can give you how much we -- it's actually in the balance sheet.

It was, yes, 25% to 30% I think is what we said in the release.

And (multiple speakers).

So effectively this -- (multiple speakers).

But what we can do for you is give you how much we ask for in the balance sheet.

You can divide by 10 and figure it out.

So, but effectively the way to think about that is the total benefit from this -- from this policy in 2013 is going to be about 125% of what it was in 2012?

Yes, I think that's a fair way to (multiple speakers).

125% to 130%?

Yes, right.

(multiple speakers).

And we can give you exact number and you can fill it out yourself.

The variation -- I don't want to make it sound like it is just you put a dot on the wall and that's the number.

It all depends on what type of projects we do during 2013.

If we did all water plants and no pipe, we wouldn't do as well as we did in 2012.

If we do more pipe and less water plants, we would do probably better than we did in 2012.

But I can't predict that until we get all our permits and know where our capital is all being spent to the penny.

Okay.

But I am giving you clear clarity that we are not going to cut back our capital because of this tax thing.

We are actually going to stay right at the same levels of in excess of $325 million a year which basically is three times depreciation.

Perfect.

And you think the Board will take up the dividend discussion at the next meeting here?

You asked me that a couple of weeks ago I think.

I did and I just want to know if there's either any movement are any movement the other way.

Our Board meeting is not for a couple of days.

I can't say what they will say, but yes I think it is something that is Board level review in the fact that we are normally a 60% payout; most utilities are in that range, some are much higher now.

But we have been always healthy keeping our balance sheet intact by staying around 60% and of course we have dropped out because of this big jump in earnings which although some people think it is one time, is not.

It is sustainable.

So that is how the Board is looking at it.

What should be the dividend policy on a company that is earning $1.40.

Fair enough.

Thank you very much.

Jonathan Reeder, Wells Fargo.

Good morning.

Nick, could you please clarify your comment?

You said about no new debt.

Is that just for 2013 or what was the time horizon around that?

If we stay at the $325 million and look at our cash from operations and obviously the cash from not paying the taxes, which in my mind, Jonathan, is nothing more than if we had gone in for rates it would have been from operations.

This means we don't get rates, but so the ratepayers are happy and the customers are happy, but we are still getting through the tax (technical difficulty).

If that holds plus the increasing depreciation each year which, obviously, helps cash but hurts earnings because we are putting a lot of capital three times depreciation in, that the cash generated from, well -- let's call it operations give me the luxury of calling the tax benefit operations -- exceeds both the amount we spend on our small acquisitions each year and exceeds the amount of capital that we are spending even at these elevated levels.

Therefore, for operational purposes, we wouldn't have to borrow any debt.

Now obviously, the dividend has to be paid to someone, but at this point in time we see very little need for new debt, other than refinancing the debt that we have that comes due each year which is a positive because of the fact that we are probably going to get it at lower rates, at least currently, than what it is on the books for.

Right.

So for the next few years you kind of see interest expense pretty much staying flat maybe even decreasing, I guess, once you roll that $60 million of short-term debt into long-term for Ohio?

Exactly.

I think this year you will see it actually went down on a continuing basis.

That is because we did a lot of short-term debt usage.

We saw plenty of room on our lines, but Dave, I think we are borrowing short at 1?

Right.

1 or less.

So obviously we are using that as much as we can to cut down lag in between cases and we have to -- we are going in for a case in Ohio so, obviously, we are capitalizing that with long-term debt which is the proper way to do it.

So that will add to the overall interest because it is going to be, I think, higher than 1% if we go 30 years.

But not so much that it is not -- it still looks flat.

I mean the days of our 10%, 12% increases in interest because of the ramp-up in our capital seem to be behind us.

It is much, much lower numbers.

Depreciation will stay up there which obviously is noncash net to earnings, but because we are doing so much capital.

And I know you are not going to file the Pennsylvania rate case this year.

Do you anticipate a filing in 2014 or when do you think that next one might come?

When the -- we have all kinds of models and, again, depending on the amount of pipe versus plant, we have to do to keep in compliance and everything else, there is a point where it crosses that the lag starts exceeding the benefits of the tax repair.

And at that point the first thing we would probably do would be to file a DSIC versus filing a base rate case.

And we don't see that in 2013 and we are analyzing 2014.

And 2014 is still up in the air.

So, I guess in 2014 if you do anything it sounds like you would probably file for DSIC stuff and then you wouldn't see an actual full-blown rate case until maybe at earliest kind of end of the year with new rates sometime in 2015?

Is that kind of fair, (multiple speakers) that would be kind of I guess the earliest you might see that?

I think that's a reasonable assumption.

And overall conceptually, is it (multiple speakers)?

(multiple speakers) hedging is inflation starts roaring and it comes back at 5% all bets are off, right?

But --.

Sure.

(multiple speakers) inflation stays down because our operating costs are a key part of rates too, but we have been really cold in operating costs down which is how we can stay out of rates.

And of course, the regulators and the customers like that.

Right.

So is it fair to say then that essentially I guess Pennsylvania's earning contribution is essentially going to be flat until the next DSIC filing or whatever?

The DSIC -- the repairs tax deduction essentially just pulls earnings forward.

Is that the right way to think of it?

Well, look at it this year is a huge part of the $1.40 percentagewise is Pennsylvania because of the one-time infusion of the repair.

I don't think Pennsylvania can -- we could expect that to maintain going forward as the other ones catch up.

But I wouldn't call it flat because we have the repair coming in.

We have the remainder of the 2012 rate case.

We have cost-cutting that we are looking at.

So, and maybe rather than take everybody's time, you call Dave and I, we can explain to you how much more the tax has benefited this year, but obviously it can't keep growing.

It has to -- but it is still faster than probably your model showed without it.

(multiple speakers) those with you.

And bigger picture, where do you see the growth initiatives going forward?

Are you still looking at further pipeline opportunities around Shale?

Are you seeing an increase activity on the M&A front?

Can you talk bigger picture?

Sure.

This is one of hopefully many pipelines.

We are looking at a couple opportunities in Ohio.

Another one or two in Pennsylvania.

Obviously the drilling with gas prices where it is has not -- has slowed down.

That probably is good for the industry in my mind so they can catch their breath.

Still steady, but especially in Pennsylvania where we have dry gas.

The -- but I'd -- this is not a flash in the pan industry.

This is going to be around a long time and the administration even acknowledged that during the State of the Union speech by the President.

So, this is the first of hopefully more that we will be doing in the raw water, I guess you could call it, area.

We are also Capital Ventures is also looking at other type pipeline projects where we may team it up, we call it regulatory light where we team it up with our regulated side.

They sell the water at a retail rate, but we've built a pipeline so that cities could get the water and have a joint venture with us, Public Private Partnerships, things of that sort.

I do think although it you have heard this before from every water company that privatization will become a little bit more of a rule versus an exception going forward, but we -- it is just inevitable.

I just can't predict the timeframe on it.

And of course the core of the earnings will still be built by the capital infusion that needed capital in all these states that, basically, we have to fix the water systems infrastructure and hopefully get fair returns.

And that is what generates a lot of our future growth.

And then the small acquisitions.

You saw a little bit of an uptick this year and housing came back a little bit this year.

Now who knows how to project what is going to happen with interest rates if they do go up?

But at this point we are at least stable.

We are not dropping any more and it came back in 2011.

I am sorry, it started to come back from 2011 to 2012 and everybody is optimistic, at least with homebuilders, in 2013.

And I guess as far as the 1.9% customer growth you cited.

Is that, including, I guess the benefits of the Ohio or is that just the smaller tuck-ins in organic?

No, no, it's Ohio.

Probably if you took the Ohio out it is still less than 1%, but healthier than almost 0 was in 2010 and 2011.

Thanks for the time.

Tim Winter, Gabelli & Co.

Good morning, Nic and Dave.

Nic, I was wondering if you could clarify your comments about the base year earnings for 2012.

I think you said $1.40.

I guess that includes the $0.09 of discontinued in the -- are there any other gains in there?

And then what you expect as far as growth in 2013 or you are expecting growth from the $1.40 level.

Is that correct?

Yes.

Yes if you want to do the -- the $1.40 include -- we have been doing pruning for five years.

So I felt GAAP is the best way to measure us because how do you take one year versus another year and it has been steady GAAP for the last five years.

And now next year we will have Florida, hopefully.

So having if you want to go off GAAP, yes we are going to grow I believe from the $1.40.

And I am not going to give guidance.

We never give guidance.

But we have been predictable in the past and part of it will come from the repair.

Part of it will come from, maybe, the sale of Florida.

Part of it will come from organic and I am sort of saying clearly we are not point to stop or go backwards.

Some people thought this was a one-time.

It is not a one-time.

And additionally it is not flat.

Because there are some issues that will allow us to grow and it will in my mind definitely grow faster than the need for the dividend which is normally the $0.04, $0.05 dividend.

The -- for 2012, if you want to go to and take Maine out, I think or I thought it was $1.33 was continuing ops.

Continuing ops is $1.32.

$1.32.

So if you want to take that out, we will grow from that if you don't want to count Florida.

And if you talk a little bit about the regulatory treatment of this as far as rate based growth in Pennsylvania.

Will there be rate based growth?

How are they looking at returns and what have you?

(multiple speakers).

How do you grow?

That is the beauty of the flow-through.

We are getting paid for it.

It will be in rate base.

We are getting paid for it until we go in for our next rate case through the tax flow-through method and when we go in for our next rate case, that -- all that capital we've done and been paid for through the taxes will be on the table for fair return, but we won't probably get the flow-through anymore.

That is why I said it is a real win-win regulatory wise for the customers, but also for the Company because we don't want to stop on our needed capital program.

But in addition we couldn't afford just to not go in for rates.

Will there be a one-time rate shock as a result?

No.

No, our projections are that it will not be.

Obviously, the DSIC you would have to figure the DSIC in there.

We will probably start with the DSIC, but after the DSIC it would probably be in line with our case that we just got, which was 4%, Dave?

Right.

Around 4%.

So not rate shock.

So, one more question on that.

So the Pennsylvania regulators will likely change the way they treat this in the next case?

I don't know.

I can't say for sure because everybody likes the idea of us putting all this capital in and not raising rates.

So I don't know how they will treat it.

But I gave you in my example a DSIC followed by a single-digit rate case, the worst case from a rate standpoint.

Now again barring no rapid inflation.

Okay.

Thank you.

This was a very unique agreement.

Hard to understand and it took us weeks of negotiation, but I think it was creative on our part and creative on the OCA's part as a win-win for the customers, but also letting the Company get paid back for all the capital we are putting in.

And obviously not filing rate cases which costs money and therefore saves everybody time and money.

Stewart Scharf, S&P Capital IQ.

Good morning.

Can you expand a little more on the M&A and is there any environment and any direction that what types of deals you are looking at out of the municipal system?

There were just a few out of the 18.

Is there any trend or what you are targeting or just depends on the market?

Well, obviously we are concentrating first and initially in the nine states we are in except for Florida.

We obviously are not expanding in Florida.

And we are looking at small, medium, privates.

There aren't many large privates other than the eight or 10 that you know about that are publicly traded.

And then the municipals.

And last year we saw a little uptick in municipal activity.

We got, I think, three of our deals were municipal deals, and that's good because there were a couple of years in a row that we didn't.

I think the growth -- there's only, as I mentioned, eight of us so you can calculate as well as I could the chance of an M&A with those.

But I think the cities are the biggest question mark, and opportunities, going forward.

Many of them have come up with unique ideas on never selling and leasing and you get so much money and we are not going to get into a situation where you get into a negative [ARBS] possibility.

Our goal is obviously build and own.

And in some cases we are looking at like a -- maybe we don't want the whole system, but just a piece of it that they want to sell off or maybe a water plant or a wastewater plant with A, we know how much it will cost to fix and they give us a set amount.

It is like a contract.

So we are looking at all those different things and we have now a department and one of our senior executives, Karl Kyriss, who used to run Pennsylvania is in charge of that and I think we owe you a visit or you're going to come down here.

We will get you with him so he can give you an idea of some of his plans.

And on the efficiency ratio, is there a way to quantify the improvements based on solar farms or you just purchase water (technical difficulty)?

Can you break that down?

You were fading out, but you said the O&M ratio and how to quantify it?

Yes the improvement order like 150 basis points is there a way to break down the percentage of where that is coming from?

With electricity and fuel expense savings, reduced purchase order?

That is interesting.

We will break it down because it is across the board.

A lot of it was in employee benefits which we are still very fair with our employees, but we have changed some of the long-term legacy programs and that helped us and -- but I -- we will break it down employees, benefits, electric and give you that.

I just don't have it right here.

But it is across the board.

Okay.

And, just again, on the tax repair.

Just to clarify, is that -- that continues to be non-GAAP or going forward are you (technical difficulty) [excluding it] in your guidance or your -- but you are looking at when you are comparing it to the $1.33 or the $1.40?

Is it just consistently looked at as you are referring to it as GAAP earnings?

It is in the -- it is both in the GAAP from continuing and it is also in the GAAP.

It is in both.

And it will continue and whether you want to take the continuing, which is $1.32, I think you said, Bob, and/or the $1.40, it will be in those numbers next year and I would anticipate either of those numbers being higher next year.

They will move parallel, I guess is the best way to describe it.

Thanks.

(Operator Instructions).

Spencer Joyce, Hilliard Lyons.

Good morning.

Nice year, nice quarter.

I will try to keep it pretty short here for you.

First question, I know we are still several months removed, but did Sandy wind up having any kind of impact for you guys, I guess from the topline standpoint, not necessarily damage or capital spend?

Yes, I would say less than $0.01.

We had some overtime.

We had a lot of diesel fuel we used to run generators to keep everything going but I don't have an exact number.

Is it $0.005?

Or --?

About 350 in Pennsylvania alone.

Okay, so that would be less than $0.005.

Not significant, but it was noticeable, but I wouldn't say it was significant.

Got you.

Also just to clarify, you said most of the capital spend not in Pennsylvania will be focused in the Ohio, Illinois, and New Jersey which all are now have a DSIC or DSIC eligible.

Is that correct?

Absolutely.

And as far as a breakout there, I think I picked up you guys are mentioning around [230] spend in PA and then if I am back of the napkin calculating here that should be about $100 million in capital spend between those three states.

Is that right?

Not far-off.

Pennsylvania yes altogether all the other states would be $100 million right because 230 and we are going to spend [325] and I am going to say 10, 20, probably about [70] in those states.

We will get you exact numbers.

We have five years of expected spending in each of those states.

We will give you the projections in the states.

Yes.

That would be great.

And then one I guess more bigger picture question and you touched on it a little bit pertaining to Aqua Capital Ventures.

I know you mentioned that the current program or project is one of hopefully many.

I am assuming there has not been any kind of structural decline in the attractiveness of those projects either based on low gases, which are probably always going to be a bit of an issue, but also maybe any sort of increased competition from other firms or companies trying to be creative in that line of business.

It still is attractive there.

Is that a safe assumption?

Yes.

They're still drilling even with gas prices where they are.

But you see what happens as soon as you get a little cold weather, New England the gas prices shot up two weeks ago when they had their storm.

Electric prices followed suit.

I know you follow the electric industry, so, I would anticipate it is not going any lower and they are still drilling but I think if it goes higher you may see a little bit more intensity in the drilling programs.

Either way, we are told now I mean remember, it was three years ago it was a 1- , 2-year industry they were going to get a lot of gas immediately and then it would all be over.

They are talking now is that it could be around 50 years.

So I don't know which geologist you want to believe.

But we are betting it is going to be around for at least five years.

Yes, I think we are in the same camp there.

Again nice quarter, nice year.

That is all I had.

Thanks.

Angie Storozynski, Macquarie.

I have one question, one request.

So for the question if I look up the $1.40 in earnings for last year, was there any gain in those discontinued operation portions for the $0.08 differential between ongoing earnings and GAAP?

Is there a gain from asset sales there?

Yes.

That was the main properties which we sold in the first quarter and it amounted to $0.08 (multiple speakers).

But is that a gain or is it earnings from those properties?

Well, no.

No.

-- oh, I'm sorry, yes it was a gain.

The predominant $0.08 was from a gain on the sale in January of 2013 and 2012.

And that is why I wanted to make sure that when you look at the 2012 first-quarter earnings of $0.27 that you understand that $0.08 of that was a one-time gain.

Now it still was profitable.

You know a lot of companies say, oh, we have discontinued operations and then, you see all kinds of losses.

In our case, discontinued operation is part of our pruning strategy which we only sell if it is profitable.

So I think GAAP for us is probably a better measurement.

But we give you both, the continuing is $1.32, the GAAP is $1.40 and the difference is the asset sale of Maine in 2012.

Which hopefully when you do your quarterly looks you all remember that the $0.08 was in there and not in there this year.

Yes but I am trying to figure out because you've mentioned that you expect growth from either of the numbers in 2013, assuming inclusive of the Florida sale doesn't mean that the gain from the sale of assets would be the comparable number while the earnings plus the gain on asset sales in Florida would be compared to $1.40 EPS?

Yes, I think if the gain from Florida would be comparable to the $1.40 which included the gain in Maine.

Does that help?

And we anticipate in addition to the gain in Florida operationally we are going to have input to that $1.40 that will help it increase.

Okay, that is Florida on its own is EPS positive without the gain?

Yes.

Part of will be EPS -- assuming the sales go through, we don't have deals signed up yet, but assuming they go through we would anticipate that we will sell them for a bit more than rate base.

By the way, rate base is $2.7 billion.

Okay now so I mean this is at least our request.

Could we going forward have actually rate base and CAPEX's schedules maybe not state-by-state but at least up for the next say three or five years?

It would be so much easier for us to go through the numbers and actually project the earnings power because I feel like we are going through notes and trying to match the numbers with our model and a couple of slides would make a big difference for us.

Thank you.

Heike Doerr, Baird.

Good morning.

Two quick questions.

On the Marcellus opportunity I believe we had been expecting Phase 2 to be completed at the end of the year.

Maybe I am mixing up my Phase 2, Phase 3. Can you give us a quick update?

Is that project going as planned?

I thought that there was talk of an additional phase for that project.

Where are we in all that?

Phase 2 is done and water is pumping through it.

Phase 3 will be done by March and that was the third phase we had talked about which extends it another 20 miles north.

And is there a Phase 4?

We are looking at maybe a Phase 4.

Okay but nothing that --

Yes, phase 3 the Board approved, [PBRs] Board approved.

It is under construction and the recipient of most of the water for Phase 3 will be Shell.

The earlier phases, 1 and 2. One -- 2 was to get to the river which is now working and everything is permitted and it is pumping water.

And phase 2 and 2 combined served range resources and [XCo] I think was the other company's name and Southwest.

I mean all of these companies have different areas where they are drilling.

So that is why we call it the pipeline phases, but it is just where is it going next and who is drilling there.

Got it.

And on the Florida divestiture, I believe I saw something that FGUA wasn't interested in buying all of the assets.

Can you share with us if you are planning on piecemealing some of this or if we are going to see it as one single transaction to a single buyer?

I think you are going to see multiple transactions.

FGUA is the furthest along.

They have a signed agreement with us to purchase 56% of the assets and the deal is for $49.2 million.

So as we think about how we will see this on the income statement, we will see this piece announced as a sale, but didn't we will continue to see the earnings stream from the other 44% until buyers can be identified for those systems?

Yes.

I would anticipate late first-quarter early second-quarter close for FGUA.

And all the rest in the second or third quarter.

That's helpful.

Thanks.

That concludes today's question-and-answer session.

Mr. DeBenedictis, at this time I will turn the call back over to you for any additional or closing remarks.

There is nothing more.

I think we have covered everything and thank everybody for all their time.

Ladies and gentlemen, this concludes today's conference.

We thank you for your participation.