Essential Utilities Inc (WTRG) 2016 Q3 法說會逐字稿

Good day and welcome to the Aqua America's Q3 2016 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.

Thank you, Angela. Good morning, everyone and thanks for joining us for Aqua America's 2016 third-quarter earnings conference call. If you did not receive a copy of the press release, you can find it by visiting the investor relations segment of our website at aquaamerica.com. Slides that we will be referencing can found on our website. There will also be a webcast of this event available on our site.

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 certain non-GAAP financial measures. Reconciliation of these non-GAAP to GAAP financial measures posted in the investor relations section of the Company's website.

Presenting today is Chris Franklin, Aqua's Chief Executive Officer; Kim Joyce, Aqua's Vice President of Regulatory, Government and External Affairs; and Dave Smeltzer, the Company's Chief Financial Officer. After the presentation, we will open the call up for questions.

At this time I would like to pass it over to Chris Franklin, Aqua's President and Chief Executive Officer

Thanks, Brian. Thank you all for joining us this morning. For today's call, I'll start with some recent news about the Company, then I'll comment on some of the highlights from the quarter.

I've asked Kim Joyce to join us today, as Brian mentioned, to discuss a new partnership with Villanova University and Dave Smeltzer will take a few moments and review the Company's financial results and rate activity, and then we'll conclude the formal part of the presentation with a review of our guidance for 2016. And then we'll answer any questions that you might have.

So since we've last met, we've had a couple leadership changes on what I'll call the functional side, meaning not the geographic, but the functional side of the business. And we've also had some retirements that have led to changes in our state leadership teams. I point this out because I think it speaks to the depth that we've developed in the organization. That's very important.

So let's start with the functional side of the business. Kim Joyce, who will be speaking in a minute, has been promoted to Vice President of Regulatory, Legislative and External Affairs. I note many of you know Kim and have met Kim at analyst day and regulatory meetings. She joined the Company in 2007 and will hold the role that I once held for several years.

She will continue oversee legislative policy at the federal and state levels, regulatory filings, rate cases, and our corporate communications and community relations, along with the Company's charitable trust. Kim has played an important leadership role in the passage of the legislation we've discussed many times as the fair market value legislation and she's been particularly involved in Pennsylvania.

The second person, you may recall from years past the name Ron Cocco who handled -- he was the Vice President of Fleet Supply Chain until his retirement. Charlie Stevenson has taken that role since the retirement of Ron Cocco and has held the responsibility of supply chain and fleet management for several years as a Director. Charlie's been with us since 1987 and this promotion really of Charlie to Vice President, really taking a proven leader and elevating him. So as the Vice President of Fleet and Supply Chain, Charlie will be responsible for our 1,200 vehicles along with our materials, management and our procurement programs.

As we shift to look at our geographic -- or our state operations, I mentioned during the second quarter call before that Shannon Becker who was our former President in Aqua Virginia took over as President of our North Carolina operations, and that's following the retirement of our long-time North Carolina President, Tom Roberts.

So in our search for a new Virginia President to replace Shannon, we were fortunate to find John Aulbach who will join the team in September as President of Aqua Virginia. And John brings a lot of experience. In fact, more than 34 years of water industry experience to his role at Aqua Virginia. He joined us from the Virginia Department of Health where he most recently served as the Director of the Office of Drinking Water. So John is very experienced and is already adding great value to our Virginia operations.

So let's turn to Pennsylvania now. In late September Steve Tagert, Aqua Pennsylvania's President announced that he'll be retiring at the end of this year. And you may recall from meeting Steve that he's served in that role of President of Pennsylvania division for the last four years, but he's been with the Company for more than 40 years. Replacing Steve is Marc Lucca, who's been part of our succession plan in Pennsylvania for quite some time.

Marc and Steve are going to work closely together through the remainder of the year to make sure we have an efficient and smooth transaction -- I'm sorry, transition in our largest state. Marc brings more than 25 years of water and wastewater operations management, experience. He previously served as our Vice President of the distribution system and Vice President of Production, which is our plants. So he's got broad experience in our Pennsylvania division. He's been with the Company since 2007.

Prior to joining Aqua, Marc had several management positions in other water utilities, largely in California, including a management role in -- at American Cater in California. Now, overall I would say that these new leadership changes will ensure that our customers continue to be put first and our overall operational focus remains on the delivery of safe and reliable service to our customers.

Now, shifting to the next slide, some of these pictures are a little bit tough to look at given what we experienced in North Carolina. But I know probably you've seen the news from October 6 and through October 9,, Hurricane Matthew really battered North Carolina and brought some really unbelievable devastation to much of the South. But our service there in North Carolina was particularly impacted.

Our customers living in central areas of North Carolina saw about 10 inches of rain and those coastal customers of ours saw up to 15 inches of rain. We had large power outages and those outages left many of our customers, in fact, about 20,000 homes reduced flow or interrupted service. The top picture shows a main break where the road literally washed away. Bottom picture there demonstrates that one of our well houses was completely flooded out.

Now, I have to mention that I couldn't be prouder of our Aqua North Carolina men and women, our employees, who handled the storm's challenges with incredible dedication. All hands were on deck as we handled more than 1,900 service calls, kept our customers informed by broadcasting more than 75,000 outgoing calls, and e-mails and texts. We also had a number of our non-operation staff step up and help distribute water from tanker trucks that were brought in from our Pennsylvania division.

We received a lot of compliments from our customers for the work we did and to restore service after that storm. It was a terrific effort and some of that cleanup work continues even today.

Now, with that said, let's segue to the quarter's performance. On the next slide you'll see that third quarter was a strong performance as we continue to pursue our growth strategy and I have to say we continue to be very optimistic about our ability to grow and the water and wastewater market.

So far this year we've added about 5,700 customer connections from acquisitions alone. Including organic growth, our customer base has grown by nearly 12,900 connections or more than 1.3% thus far. Just late last night we received approval from a municipal in Pennsylvania to negotiate an asset is purchase agreement for nearly 600 customers. Like I said, that's brand new. New, just last night.

Also on the customer growth side we have a number of deals which we've signed agreements, four of which are municipal deals and combined all six would add an additional 4,700 customers. Closings for these deals are fluid, but we would expect them to be completed between now and the end of the first half of next year, 2017. Quarterly revenues were up about 2.5% to $226.6 million from $221.1 million in the same quarter of last year.

Keep in mind we've shed a lot of those market-based businesses we've talked to you before. As a result the market-based business units that we have left are contributing approximately $4 million less in revenue compared to the same time last year. With that said, earnings per share were up 7.9% to $0.41 compared to $0.38 reported in the third quarter of 2015.

Now, as we look at the next slide, acquisitions completed thus far in 2016. We've closed 14 deals, 10 water and 4 wastewater systems, which represents about -- a little bit better 0.5% in growth in 2016 from acquisitions alone. We've also seen more than 0.5% in organic growth through the third quarter. And this is an uptick from the last couple of years on our organic growth.

You'll also notice that we continue to clean out our inventory of these smaller acquisitions. We've talked about that in previous calls. While we continue to pursue our strategy of starting larger systems between 2,500 and 25,000 customers. In the future I think what you'll see is fewer deals, but larger sized deals.

At this point we continue to expect to see 2016 year-over-year customer growth in the predicted range of about 1.5% to 2%, which does include our organic growth. We remain very optimistic about the prospect of growth in the water and wastewater sector, and I need to point out that we've not seen this level of activity and what I mean is municipal utilities looking to sell. We've just not seen it before. This heightened activity is primarily in the states where fair market value legislation has been passed.

So let's segue from customer growth to another topic that's very important for the mission of our Company. I remind you as we hand off to Kim Joyce that she's our new Vice President and she's going to talk for a moment or two about an important partnership that we forged with Villanova University. Kim?

Thanks, Chris and good morning, everyone. Excited to talk about our recent partnership with Villanova.

To start off, we're all very proud to be part of a mission-oriented organization and our employee base has always been eager and willing to get involved in the communities that we serve. And we've started a number of new initiatives along these lines, one very exciting one being our partnership with Villanova and their School of Engineering.

This partnership is important for a number of ways. First we have an aging employee population and Chris mentioned several retirements in his remarks today. As these long-term employees retire, we recognize that we need to create an atmosphere to attract and retain really the next generation of Aqua employees.

We've also recognized that we have an employee base that wants to be more connected in our age of cell phones, computers, [best case] there are fewer and fewer opportunities for employees to engage and interact with each other. So the outgrowth of this was several key initiatives and for today's discussion, we're going to talk about our partnership with the School of Engineering at Villanova. Which really taps into the engineering and operating skills of Aqua's technical team and really the genuine generosity of our employee population to bring sustainable water supply to places in the world that it needs.

So we had a number of meetings with the School of Engineering and we realized that we had a unique opportunity to accomplish a number of things through a partnership with Villanova's School of Engineering. And I will note that Villanova is literally two miles down the road from our Headquarters here in Bryn Mawr and we do have a lot of alumni, Villanova alumni that work in our headquarters.

So each year Villanova, their engineering school participates in a number of projects, engineering projects, in various countries and many of them are particular to water projects. So what we've been doing, part of the partnership, we're interacting on a number of levels. We've taken college students on plants -- tours of our larger plants and we've held water company 101 training sessions for them here at our headquarters.

We've also spent a lot of time at Villanova where the students present certain engineering water quality issues that they're dealing with. We ask them questions and help them with the particular issues they're dealing with. And then we've also identified two particular projects for 2016 and 2017 that we'll be focusing on and helping them with.

One of the projects is in Nicaragua and the other one is in Panama. Both are in remote areas of the country and involve issues with reliable water in the communities there.

In the interest of time, I'll just touch on the Nicaragua project this morning. If you look at the pictures, we actually visited the site of the water project this past August. It's an area called [Caskeeto] where we're helping the Villanova students actually develop and put in an actual water system.

Here the issue is the current water source is located downstream from coffee production, which poses risks of chemical pollution and also farming contamination from cattle. And obviously the idea is to help the local residents in this community as well as two primary schools and a clinic.

As you can see in this picture there, once we got to Caskeeto, we hiked up into a very mountainous to where the water source was. We took samples there and really got a better understanding of the project and what we were going to help with. We expect construction to begin in Q1 and we'll be assisting the students throughout the school year.

On the next slide, just to give you a sense of the infrastructure in some of the areas of Panama. And I will note that in those pictures is our COO, Rick Fox, who also made the journey to Panama this past August. And we're really excited about these opportunities, both these trips were great ways to apply our expertise and assist students in our local community, while also delivering our mission.

The work has really engaged not only our engineers, but our chemists, our water quality experts throughout the Company, reinforced the value of our mission, and involved many of our employees, including our younger employees in the Company.

And with that, thanks for the time today, and I will hand it off to Dave.

Great. Thanks, Kim and good morning, everyone. Today I'd like to review the third quarter financial results and some of the driving factors that impacted our performance. I also will provide a look at our rate activity for the year thus far.

So turning to the next slide, you see the third quarter 2016 revenues increased 2.5% to $226 million from the $221 million the same period of 2015. And in a moment I'll show you the waterfall charts, but when we look at the revenue for Q3 2015 versus Q3 2016, it was primarily higher consumption rates and surcharges and regulated growth that were offset by reduced market based activities that created that increase.

Operating and maintenance expenses were up 1.6% to $79.8 million for the quarter compared to $78 million in Q3 of 2015. Here lower production costs and decreased expenses tied to market-based activities, were offset by higher employee-related expenses, regulated acquisitions and other expenses. Net income was $73.2 million, which is up 8.5% compared to the $67.4 million in the same time frame of 2015. Earnings per share was $0.41, an increase of nearly 8% compared to the $0.38 reported in Q3 of 2015.

So the next slide is year-to-date results. Year to date as of September 30, 2016 annual revenues increased 1% to $623 million, up from the $617 million in the same period of 2015. Similar to the quarter, rates and surcharges, regulated growth and other factors increased revenue, but were offset by reduced market-based activities and lower consumption in the first half of the year.

Year to date, O&M expenses were down 1.8% to $227 million compared to $231 million the same time period in 2015. Higher employee-related expenses and acquisition costs were offset by lower production costs, lower market-based activities and other factors.

Net income through the first nine months was $184.5 million, which is up 64% compared to the $173 million in the same time frame last year. Earnings per share was $1.04 an increase of 6.1% compared to the $0.98 recorded in 2015.

So turning to the first waterfall chart on operating revenue, starting with our revenue for Q3 2015 of $221 million, consumption played the most significant role, contributing to a 2% increase. This came from warmer and dryer weather in the northeast, principally Pennsylvania, New Jersey and Ohio. Rates and surcharges along with regulated growth and other factors accounted for an additional increase of 2.2% and from there lower revenues related to reduced market-based activities decreased the amount by 1.7%, resulting in an overall increase of 2.5% in revenue to $226.6 million.

Moving to O&M expenses and starting with our O&M expenses from Q3 2015 of $78.5 million. We had increased employee-related costs, regulated acquisitions and other higher expenses that increased O&M. From there we did see lower production costs and expenses related to market-based activities, decreased expense by 3.4%, getting to us an overall increase of 1.6% in O&M expenses year over year for the third quarter.

One thing to mention here is production costs. Even though our consumption was higher for the quarter, we actually saw a decrease in production costs due to less purchased water in some of our states. Along with favorable changes in purchase power, including renegotiated rates and higher demand response credits.

On the earnings per common share slide, we start with our EPS of Q3 2015 of $0.38. Tax repair benefits, higher consumptions, rates and surcharges, and regulated growth accounted for an increase of about $0.045. We also saw some minor earnings from the shale pipeline due to recognition of a take-or-pay fee from an acquired contract. From there higher depreciation expenses decreased EPS by approximately $0.015, resulting in the $0.41 we reported in Q2 of 2016.

Rate activity, thus far in 2016 we completed rate cases or surcharges in six states with approximately $5.5 million in additional revenue, including $1.1 million of revenues recognized under interim rates beginning in 2015. We also have rate cases pending in Indiana, Ohio and Virginia, requesting an additional $8.1 million in revenue. Additional rate information can also be found in the appendix of this presentation.

With that, I'd like to return the call to Chris who will recap our 2016 guidance. Chris?

All right, thanks, Dave. We'll run through the guidance which is largely unchanged.

Our customer growth CapEx and expense guidance has not changed really through the third quarter 2016 from original. I will say we are expecting full-year earnings per share to be in the range of $1.30 to $1.35, as we said from the beginning of the year, but probably I would say closer to the middle of that range if not slightly below the center of the range.

Now, year-over-year customer growth guidance, as we said, remains between 1.5% and 2% with a very strong pipeline of opportunities. We expect to invest more than $350 million this year in our capital infrastructure program and, again, more than $1.1 billion of CapEx through 2018. Ongoing rate-based growth between 6% and 7%, and on the same system, O&M increase of 1% to 2% for the full year and we feel very comfortable with that.

Before we end the call, I'd like to open it up for some questions, if you have any, and -- questions?

(Operator Instructions)

We'll take our first question from Tyler Frank with Robert Baird & Company.

Hi, guys. Thanks for taking the question. You had mentioned that a number of municipalities looking to sell is the highest you've ever seen before. Can you discuss sort of what the competitive environment looks like? Are you seeing a lot of other bidders out there in transactions that you're potentially looking at?

Tyler, that's a good question. And I would say that the vast amount of activity is in states like Pennsylvania, Illinois, New Jersey. But in Pennsylvania I would say we have seen probably the most activity more recently and it is pretty competitive.

But I would say the competition is largely among strategics and other municipals and we're interested to see how aggressive some of these other municipals are in the market. Really, as you think about Pennsylvania, one or two are more aggressive, but I think it's a pretty level playing field overall, but it is competitive.

Great. And then kind of looking out into 2017, what should we be expecting for potential acquisitions or growth through acquisitions either on a customer basis or potentially on a revenue basis?

Yes. I give you a little bit of a head start as to what's already in the pipeline in terms of customer growth and deals, the six deals plus the one we're negotiating as of last night for an additional 600 customers. So that's a little bit of a head start.

I would say the pipeline is strong, but as we've discussed many times on these calls, the municipal gestation period tends to be a little bit more involved, sometimes complicated, but I think -- I think we have a very, very strong pipeline. I think you'll see a better guidance when we provide our formal guidance later in the year or closer to the early 2016, 2017.

Thank you, guys.

Yes.

(Operator Instructions)

We'll move on to Ryan Connors with Boenning & Scattergood.

Hey, thank you. And thanks for your comments. Congratulations on the partnership with Villanova and I can promise you as a Saint Joe's alum, I won't hold any of that against you, just so you're aware of that.

Got it, Ryan.

Actually I wanted to talk a little bit -- not to beat the dead horse with the acquisition side, but it does seem like that the market, the M&A market has kind of bifurcated a bit into the traditional bolt-ons and then these very large transactions. And I guess my question is, going back to the previous question about the competitive dynamics, how do the competitive dynamics differ in those two different types of deals?

And presumably that maybe the bigger ones are more competitive because they're less of a bolt on to an existing territory or something like that, and how do you manage the tendency to want to score a big trophy win so to speak against kind of the blocking and tackling of just the traditional bolt on deals? So any color on that would be helpful.

Just so I'm clear on your question, Ryan, are you talking about what's called the Scranton-sized deals versus the smaller ones or are you talking even larger than Scranton?

Yes. Let's call it $50 million and above, say, purchase price what I would consider to be an exceptionally large transaction relative to history municipal wise. So anything north of that versus the 1,000, 2,000, you mentioned 600-type customer bolt-ons.

Yes, that's a good question. So I would say that there is clearly more competition as you go to the larger scale. Clearly these are municipals in many cases that are opportunities to spend additional capital and clean some things up.

These are opportunities to add significant number of customers, hence economies scale and so particularly for strategics that are operating in those general areas, let's call it, in that state, those are pretty important opportunities. And I think -- in some cases municipals see it as an opportunity to also build scale. Fortunately I think those are more limited, but if I were to summarize overall, I would suggest that the competition is greater as the scale becomes greater as well.

Okay. But so far you feel like they are at the valuation, the competition has been rational so to speak in the sense that things haven't gotten out of hand with that competition leading to a chase-up in valuations on the larger deals?

No. There's clearly been a chase-up in valuation, Ryan. I think we recognize that and I think as we think about things like Act 11 which is the subsidization of wastewater customers with water customers in Pennsylvania, Act 12 which is essentially the fair market value legislation in Pennsylvania and similar in other states, those are going to allow a greater purchase price from municipals.

But as you start to get beyond what I'll call fair market value, then obviously there's no rate impact and so you do get into the goodwill issues. So I think there's going to be a limit as to what will be paid, but certainly there's been an escalation in prices that can be done in these cases. Now, we are also willing to stand down in a situation where we think the prices are too high and we've done that, more recently.

As a matter of fact, we looked at one system, and it was a very sizeable system, but we felt that the rate increases associated with the purchase price that we would have to pay would not be sustainable in that local community. And I think it was a very tough discussion in our internal investment committee, but we made the decision to stand down, and I think we're going to continue to make very disciplined decisions like that.

Got it. And then I wanted to get your update on -- any updated thoughts you might have and if there is no update, that's fine too, but just on the idea of a extra water deal so to speak, another utility sector. I know that's been a topic of discussion, any evolution in your thinking there in terms of where you might want to go, have you refined that view at all, any update there?

I would say, Ryan, no update in our strategy. Our strategy remains intact with both the three-pronged strategy we've been talking about all year long. And I think -- as I just mentioned in the municipal side, discipline is the name of the game and we're going to do our best for our shareholders.

And to the extent that we can find accretive opportunities that build shareholder value, we will evaluate them and, again, we're focused largely on the regulated sector, and we think that our core capabilities can go more broadly. But having said that, it's gotta be the right deal, it's gotta be -- it's got to bring value, long-term value as well as short-term value. And so I would say no change in our strategy, but our approach remains the same.

Got it. And then one final one from me. As a customer, I get a little interesting channel check here in that I know you've recently launched this lead awareness campaign among a big part of your customer base. And I'm just curious to get your comments on that and whether -- what kind of -- whether there are risks or opportunities associated with that. Obviously it's driven by the fallout from the Flint situation, but are there potential opportunities somewhere down the line to bring service lines into rate base or how are you looking at that whole issue as a -- from a business perspective?

It's an important question that customers should be asking all across the country. We're very fortunate in that we've taken most of the lead out of our system. That's not to say that just since we've acquired there may still be some pockets. But as always, treatment is the critical component, getting that corrosion control treatment so that we don't have a high PH and we don't have lead leeching into our water.

We continue to sample at very high rates and meet all the federal and state standards. But in terms of opportunities, listen, we know that lead service lines still exist and we think about it largely in terms of the areas where we serve. In more affluent areas customers are liable to take those service lines out. In areas where it's less affordable, customers are not.

So we're working with the Pennsylvania commission and the other commissions to change out those lead service lines. At this point we always notify our customers when we discover lead service lines so that they know it. And then where applicable we'd like to be able to change those out, put it in rate base so we get recovery, but not own those service lines. We like to turn the ownership back to the customer again.

And there's, I think, a lot of openness at the commission level to doing just that. Clearly the question is how big is that in terms of an opportunity for companies like ours and how big is it for a recovery hurdle for commissions? And I think that's an ongoing conversation, but I would not say in our existing systems it's a needle mover in terms of capital spend or generation of rate base.

Got it. And then is there any -- go ahead.

I was just going to say I do hear from mayors and supervisors in municipals that it's a risk that they like to offload in some cases. I think the Flint situation has made some elected officials more nervous.

And then in terms of the -- your service line protection program, I assume that's not a -- if someone discovers they've got a leaded pipe or service line, that's not a coverable event with your -- under that program, correct?

That's correct.

Okay. Got it. Well, thanks for your time.

You bet. Thank you, Ryan.

We'll now go to Jonathan Reeder with Wells Fargo.

Hey, Chris. I just wanted to follow up on one comment you made that you expect full-year results to come in at the middle, if not slightly below part of the range. Why is that the case particularly considering, I guess, Q3 weather was warmer, dryer. Is it something that's going to be an ongoing impact when we look forward to 2017 or was it some of the stuff we saw in Q2?

Yes. Let me start and then I'll kick it over to Dave, but we do continue to address our unregulated component, so we're seeing revenue falling as a result. But as we also said, on the net income side, we should be -- remain fairly steady as a contribution from the unregulated, but you'll continue to see revenue falling as we offload those pieces of the business. Dave, you want to dive in further than that?

No, I think Q4 is going to be a typical quarter. We had a better-than-typical quarter I think Q3 with a couple unique items in there, but we don't see that in Q4 reappearing. So just a standard quarter and somewhere around the middle of the range.

Okay. It's not like an overall weather impact of the full year, Q2, was down, did Q3 just kind of offset that are we kind of close to normal weather year at this point?

Yes. I would say all in all pretty normal weather year.

Okay. All right. Thank you.

Yes.

We'll now go to Michael Gaugler with Janney Montgomery Scott.

Hey, good morning, everyone.

Hey, Mike.

Chris, just wondering if maybe you could refresh us a little bit in terms of what your thinking might be on the timeline for the next Pennsylvania rate case?

Yes. So we're still thinking potentially [disc] next year Mike and then PA rate case 2018, 2019. Probably filing in 2018 and getting in 2019.

Okay. That's all I had. Congrats on the nice quarter.

Great, thank you.

And we'll go ahead and take a followup question from Ryan Connors with Boenning & Scattergood.

Great, thanks. Yes, just one followup. Kind of a housekeeping. Dave, on the JV line, the gain loss JV line seemed to actually swing and I apologize if I missed this in the prepared remarks. What's the color behind that because there's a pretty material swing in a positive direction in the quarter?

It's a good question, Ryan. We -- when we signed up our customers, we signed with some fees that were to be recognized over sales and there actually weren't sufficient sales to recognize all those fees. And so there was sales -- there was a fee hung up on the balance sheet that then was recognized this quarter at the expiration of the contract. So that was kind of a unique one-time item related to those contracts that were signed several years ago.

Okay. So the expectation would be -- go from 4Q onward, that reverts back to a little bit of a negative, flat to negative line item.

Yes, that's exactly right.

Great. All right. Thanks again.

This concludes today's question and answer session. I will now turn the conference back over to Mr. Franklin for any additional or closing remarks.

Well thank you all for joining us. I appreciate your time and obviously if there are followup questions, we're always available.

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation.