Essential Utilities Inc (WTRG) 2017 Q2 法說會逐字稿

Good day, welcome to Aqua America Q2 2017 Earnings Conference Call.

Today's call is being recorded.

At this time, I'd like to turn the conference over to Brian to (inaudible).

Please go ahead, sir.

Thank you, Michelle.

Good morning, everyone, and thank you for joining us for Aqua America's Second Quarter 2017 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.

The slides that we will be referencing can be 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 risk and uncertainties.

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

A reconciliation of this non-GAAP to GAAP financial measures is posted in the Investor Relations section of the website.

Presenting today is Chris Franklin, Aqua America's Chief Executive Officer; Dave Smeltzer, the company's Chief Financial Officer; and Dan Schuller, our Executive Vice President of Strategy & Corporate Development.

After the presentation, we will open the call up for questions.

At this time, I'd like to pass it over to Chris Franklin.

Thanks, Brian, and good morning, everyone.

Thanks for joining us.

Quick summary of what we'll discuss today: we'll talk about a little recent news on the company; highlights for the second quarter; Dave Smeltzer, our CFO, will review the company's financial results and rate activity; and then Dan Schuller, who is our Executive Vice President of Strategy & Corporate Development, will take us through an update on our acquisition and growth programs.

Then we'll conclude with a formal portion of the presentation by recasting our guidance for 2017, then we'll take any questions that you might have.

Let's dive in.

By now you've seen our release, and we started the year with a good, solid first half.

We feel very good about our work on the growth front, and I'm going to let Dan discuss that in a little more depth just shortly.

Our annual infrastructure improvement program is off to a strong start and we've invested about $210 million so far this year in water and wastewater infrastructure and we remain on track to spend a record spending of capital at about $450 million for the year.

I'm happy to report that we're on track to replace about 150 miles of main this year.

This includes pipes replaced across our 8-state footprint.

We're also installing some new water main.

As opposed to replacement, we're installing new projects as well as some plant expansions.

And I'll just mention 2 that I think are interesting, the 2 projects are both in Illinois.

First is our University Park pipeline project.

University Park is just South of Chicago.

We are building a 16-mile pipeline to bring our award-winning Kankakee River water up to the University Park area.

Previously, University Park was served by wells which needed significant treatment to improve their water quality.

This new pipeline is a much more cost-effective solution compared to treating each of the wells in University Park that -- to bring them up to, what we would call, best standard.

The new pipeline will also provide increased capacity in that University Park area.

The second project is related and it's the expansion of our Kankakee water treatment facility and -- which also supports some -- a pretty significant economic development in that area.

In particular, a biotech plant there which is doing manufacturing work.

And that plant expansion will provide -- our Kankakee plant expansion will provide additional reliability and redundancy for the current plant and will also bring make some new and additional water supply to these industrial users who are already requiring about 1.5 million gallons a day and we expect them to ask for more in the future.

One other project I'll mention, a little closer to headquarters here in Pennsylvania.

We completed a pipeline in Bucks County, just north of where we sit.

We were purchasing about 3.5 million gallons a day of water from the Bucks County Water Authority.

But upon completion of our new pipeline, which now connects the customers to an existing and recently expanded Aqua water supply, we're able to eliminate that contract with Bucks County.

The result is an annual operating expense savings of about $7.3 million.

This is significant for us.

So this is another one of our examples that we've talked about before of these 7-to-1 projects, where we can spend up to about $7 in capital to eliminate $1 operating expense, which really in benefit to the customers and the shareholders.

We're always working to identify projects like this and look to see more of them in the future.

We'll switch gears a little bit to board governance.

We added a ninth board member to our Board of Directors who met earlier this week.

We welcomed Dan Hilferty, who is the CEO of Independence Blue Cross in Philadelphia.

We were excited to have Dan on the board as he has really expanded his business.

He is also very familiar with the regulated world, albeit healthcare, and he's been a big player on the national scene with healthcare reform.

So Dan is a great addition to our board.

Now let's turn to the highlights of the quarter.

Year-to-date, we've added 5,326 customer connections.

This accounts for about 0.5% in customer growth.

We acquired a system called Tobyhanna in Pennsylvania just in July and 2 small systems in Indiana, both investor-owned, so far this year.

And these small systems were in that backlog that we've often mentioned of these small private deals that we've amassed over the years.

Now regulated revenues were up in the quarter to $202 million, compared to $198.1 million last year, and total operating revenues were $203.4 million in the quarter compared to $203.9 million in '16.

Now rates, surcharges and regulated customer growth increased our revenues by about $4.3 million for the quarter.

This was offset by, what we've talked about many times, as decrease in market-based activities, and we really concluded that program at this point.

Consequently, earnings per share were $0.34 compared to $0.33 reported in the second quarter of 2016.

And lastly, important to mention that the board met this week and raised the quarterly dividend by 7%.

The new quarterly cash dividend is just over $0.20.

The fractional amount is in the release, $0.20 per share, and on an annualized basis, nearly $0.82.

This marks the 27th increase in 26 years and the company has paid consecutive dividend, quarterly dividends, for more than 72 years now.

We are very proud of that.

We have a long history of enhancing value for our shareholders and we are pleased to continue building on that history by increasing our quarterly dividend.

This strong growth in the dividend, is reflective of our confidence in the business and our commitment to delivering long-term value for our shareholders.

The board continued to target 60% to 70% payout ratio, compares to where we are right now, we are in the high 50s, call that 58%, 59%.

And with that, let me turn it over to Dave Smeltzer to take us through the financials in a little more detail.

Dave?

Thanks, Chris, and good morning, everyone.

Today, I'll review the financial results for the quarter, discuss some of the key factors impacting our performance and provide a look at our 2017 rate activity.

So we reported revenues of just over $203 million for the quarter.

Our regulated segment reported revenues were $202 million, up 2% compared to the $198 million in 2016.

I'll show a waterfall chart on this in a minute, but when we look at Q2 '17 versus Q2 '16, the increase in revenues from rates, surcharges and regulated growth was largely offset by reduced revenue from market-based activities, as we've been talking about the last few quarters.

O&M expenses were down 4.2% to $70.9 million for the second quarter of '17 compared to $74 million in the same period of '16, largely as a result of expenses that were associated with our former MBAs.

For our regulated segment, O&M expense increased by 4% to $72.6 million, compared to $69.7 million last year.

And we reported net income of $61 million or $0.34 per share compared to $59.6 million or $0.33 per share in Q2 last year.

For the year-to-date, annual revenues decreased slightly to $391.2 million from $396.5 million the same period last year.

Regulated revenues, however, were up 1.1% to $388 million as regulated revenues exclude the impact from our market-based activities.

O&M expenses were down 5.1% to $140 million for the year compared to $147 million in the same period last year, largely due to lower production expenses and continuation of the story of our reduced market-based cost.

Regulated O&M expenses were up 2.2% due to a number of prior year items, including a gain of $1.1 million recognized for the buyout of an operating contract, a reduction in claim reserves of $1.6 million and a system sale gain of $1.2 million, all of which occurred in Q2 '16.

Partially offsetting these increases was a decrease in pension expense.

And also for the year-to-date, net income was $110 million compared to $111.4 million last year.

Earnings per share was $0.62 compared to the $0.63 reported in '16, and the year-to-date waterfall chart on EPS is in the appendix and that would give you more color on this year-to-date matters.

Looking at different components of the 0.2% revenue decrease, rates and surcharges, consumption increases and customer growth in our regulated operations increased revenues by approximately $4.3 million, but then the market-based revenue decline of $4.4 million and other minor items offset the increases.

O&M expenses were almost $71 million for the second quarter compared to $74 million in 2016.

Expenses related to regulated acquisitions, a prior year reversal of reserve due to the settlement of a contractual obligation and other expenses in the quarter increased O&M $3.3 million.

Reduced market-based activities expenses, lower production costs and lower employee-related costs, primarily insurance, offset the aforementioned increase by $6.4 million for a net decrease in O&M expenses of approximately $3.1 million year-over-year for Q2.

And like me, you may have noticed that an anomaly in our O&M expenses, the fact that we would've had negative O&M expenses at our nonregulated operation kind of stands out, and it was very straightforward matter.

Our costs are way down and we did have a contract in that nonregulated sector that we're able to reverse the reserves on this year upon exiting that contract that we had inherited with a previous acquisition.

So looking at earnings per share, starting with the $0.33 we reported last year.

Regulated growth rates and surcharges, consumption and tax repair benefits increased our earnings per share by $0.015 in the quarter and reductions in market-based activities and other expense increases in aggregate decreased our earnings this quarter by over $0.005.

Net for the quarter, we reported earnings of $0.34 per share.

Moving to rate activity.

So far in 2017, we completed rate cases or surcharges in 6 states with $11.1 million in additional annual revenue.

We also have rate cases pending in Illinois and Virginia, where we're requesting an additional $14 million in revenue.

And lastly, I want to provide you with an update on our plans to file a rate release in Pennsylvania.

As you'll recall, we've not raised customer rates in Pennsylvania since the conclusion of our 2011 rate case.

And sticking with our prior guidance, we do anticipate, we'll begin implementing a PA DISC later this year and plan to gradually phase in the increase which we would expect to reach 7.5% over multiple quarters.

We expect to file a full Pennsylvania rate case in 2018.

And additional rate information can be found in the appendix of this presentation.

Chris?

Thanks, Dave.

When I became CEO, I talked with many of you about our desire for greater transparency and greater exposure to our management team, and we've really attempted to do that over the last couple of years.

And today, to continue in that trend, I'm going to introduce you to Dan Schuller, our Executive Vice President of Strategy & Corporate Development.

By way of introduction to Dan, today is Dan's second anniversary with the company, exactly today.

Dan is going to talk a little bit about our growth strategy and the review of the acquisition landscape.

Dan?

Thanks, Chris, and good morning, everyone.

First I'd like to refresh your memory as to how we think about our growth strategy.

You'll recall that our views on growth strategy are anchored in our core competencies, which include capital investment, regulatory affairs and operational excellence.

Think of that as prudently rehabilitating and expanding our infrastructure, earning a fair return of and on those investments and running our business in an optimal manner.

We believe these core competencies can be leveraged in 3 primary areas of -- or avenues of acquisition growth: municipal acquisitions, strategic M&A and market-based activities.

Today, I'll provide an update on our municipal market -- or municipal acquisition activity and touch on the completion of our exit of a legacy MBA or market-based businesses.

First, let's look at the acquisitions we've closed so far this year.

This slide summarizes what we've completed to date.

We acquired a couple of investor-owned utilities in Indiana in the first quarter and we recently added Tobyhanna, a municipal wastewater system in Northeast Pennsylvania.

Next, I wanted to provide an update on our municipal activity thus far in 2017.

This slide depicts the municipal systems we have under agreement this year.

We closed Tobyhanna in June, adding the 740 customers that I mentioned a minute ago.

This was system C on the chart that we showed on the last earnings call.

You'll note that we added system E as it is now under contract.

It's a fairly sizable deal, adding nearly 3,000 customers.

System E includes both water and wastewater connections and it's in our target range of 2,500 to 25,000 connections.

The deals either closed or anticipated to close in 2017 represent nearly $114 million of purchase price and nearly 9,000 customers or 12,000 equivalent dwelling units.

In total, the systems represented on this slide, consists of about 12,000 connections at a purchase price of approximately $126 million.

On future calls, we'll keep you updated as these systems reach financial close.

Lastly, while there are not as many deals on this slide as some may expect, we remain excited about the numerous opportunities that we are seeing in the municipal market.

As Chris has indicated previously, we're seeing more interest than ever before on this front, especially in those states with fair market value treatment.

Given our pipeline and anticipated regulatory approval schedule, we're still targeting the 1.5% to 2% full year growth that we discussed as part of our guidance call in January.

Now let's turn to our top prospects slide.

You've seen a slide like this from us before.

This is meant to provide you with a sense of our opportunity set.

It simply segments the top 70 deals on which we're working by system size.

As you'll recall, we're most focused on those deals with 2,500 to 25,000 connections.

As the header indicates, 94% of the nearly 500,000 connections represented here are from systems within that target range.

While we clearly don't expect to close all of these potential transactions, when one falls off, it's quickly replaced by another opportunity from our much longer list, which has many more acquisition candidates.

Now let's turn to our market-based activities.

In June, we completed our last planned divestiture of a market-based activity.

Our efforts to divest many of our subscale market-based businesses are now complete.

Therefore, this is the last time we expect to talk about this on an earnings call.

The one primary market-based activity that we plan to keep is the HomeServe product, a product that protects the service lines between our mains and our customers' homes.

You may recall that we receive a royalty on these contracts.

We'll also keep a limited number of O&M contracts that are close to our owned utility operations.

We occasionally evaluate market-based opportunities which are closely related to our core business and expertise.

And if we find something that is of the right scale, within appropriate risk and profitability profile, we may decide to expand our market-based portfolio.

That being said, we don't envision this segment of the company becoming more than 10% of Aqua America as we continue to place our primary focus on growing the regulated water and wastewater business.

And now I'll turn it back to Chris.

Thanks, Dan, I appreciate the update.

And Dan will stay for questions when we wrap up as well.

Now let me just quickly reaffirm our 2017 guidance and then we'll move to questions.

We expect our full year earnings per share to be in the range we predicted of $1.34 to $1.39.

And as always, we remain laser-focused on minimizing O&M expenses and expect year-over-year increase in the 1% to 2% range.

We expect to invest more than $450 million in infrastructure in 2017, again, a record amount for us.

And this will be about $1.2 billion of CapEx over the next 3 years, that's through 2019.

This will improve and strengthen our infrastructure for our customers in the systems we currently own and it's important to recognize it's these improvements that allow us to provide this high level of service to our customers.

But in addition to that, we expect to spend additional capital to make improvements to the newly acquired systems.

Again, this isn't captured in that $1.2 billion CapEx budget, this would be an additional CapEx on top of that $1.2 billion.

We expect to grow rate base in the range of 6% to 7%.

And as Dave previously discussed, we expect to file a DISC here in Pennsylvania this year and we expect to file the Pennsylvania rate case, full rate case in 2018 and would see resolution sometime in 2019.

Finally, as Dan said, year-over-year, we expect total customer growth to be in the 1.5% to 2% range.

So before we end the call, I'd like to open it up for any questions you might have.

(Operator Instructions) Your first question comes from Ben Kallo of Robert W. Baird.

Ben, is your phone on mute?

Okay, maybe we should move on and come back to Ben.

The next question comes from Spencer Joyce, Hilliard Lyons.

My question is for Dan.

2 years into your tenure here, I was just wondering if you could talk about the development of the M&A pipeline versus, perhaps, what your initial expectations were.

And then, just kind of give you the floor a little bit to discuss anything as far as the go-forward outlook with respect to kind of your initial assumptions.

Sure, and I appreciate that, Spencer.

And 2 years ago, we sat here with the senior team and the board, really, the day before the board meeting.

And today, we sit here after having really accelerated -- really, I'd say, formalized and accelerated our municipal acquisition program.

So as we talked at Analyst Day 1.5 years ago now, putting that process and place with investment committee and putting a database in place where we're tracking our opportunity set and shepherding the opportunities through that process, working with our state teams and so forth.

What we've done is built a strong pipeline and we showed you that slide today with the top 70 opportunities, and we continue to advance these and move them forward.

And we would expect that the fair value legislation will continue to be beneficial to us in bringing us a pipeline of opportunities.

We've certainly seen that, as I said earlier, in all of our fair value states, a real acceleration in the opportunity set.

Now as you know, they don't develop overnight.

Takes a while to develop these, to get them into the pipeline, to convert them to a signed agreement at some point and then to get them through regulatory approval.

Fair point there on the time line and appreciate the color.

Talking about the fair value legislation, is it safe to assume that most of the top 70 prospects would be in those fair value states?

That is a -- I'd have to look at the numbers exactly but that is a fair assessment that a good percentage of those would be in the fair value states.

Whether that...

Or, I guess, another way to ask would be, have you seen a migration over the past couple of years towards that list, I guess, shifting towards the fair value.

Well, yes, let's put it this -- let's put it this way, that list, if we'd looked at it before, when we were in the kind of pre-municipal initiative days, would've been -- the top 75 would've been shifted to the left.

There'd been many more small opportunities to acquire, small investor-owned utilities.

What we've really pushed for is to increase the scale of our targets and to move those targets to being municipal.

So that's why we show that slide to you and we show that slide to the board, saying that this push toward the 2,500 to 25,000 connections has taken hold, many of those being fair value type of system acquisition opportunities.

Spencer, I think one of the things that Dan has brought to the team here, too, is we are more a sales team now.

In other words, we're out there more actively speaking with and generating sales.

In the past, we would wait many times for regulatory agencies, call that environmental DEPs, EPAs and PUCs to call us with troubled systems, we'd react and we'd purchase them.

Now we're out there actively, more aggressively talking with various systems and [outside], as Dan mentioned.

Yes, to that point, are you comfortable with kind of the current size and scope of the business development or the sales team?

Or are there, perhaps, any additions or changes there over the next few quarters?

That's something, Spencer, we constantly evaluate.

But I think at this point, we're pretty comfortable with the team that we have in place and their ability to generate and develop opportunities for us.

Yes, I don't think we want to get into the secret sauce here.

But on the other hand, I think it's fair to say, Spencer, that since Dan has arrived, we have ramped up both the number of people and the activity around the sales.

(Operator Instructions) The next question comes from Jonathan Reedy -- Reeder, sorry, Wells Fargo.

So with regards to the PA rate release plans, Dave, do you have to hit the 7.5% DISC cap before you can make the general rate request?

Or can you continue implementing DISC increases as the rate case runs its course?

Well, the answer is no and yes, right?

We could file before reaching 7.5% technically, right?

But generally, the way we would prefer to do it would be to reach 7.5% first and then file the base rate increase, which would be beyond that 7.5%.

So that's our expectation right now.

Right.

But once you file the rate increase, you can't keep, I guess, implementing DISC increases, is what you're saying, right?

Well, certainly, if we reach 7.5% before we file, as is our intention, that's exactly correct.

But just from a generic standpoint, if we hadn't reached it, we certainly could continue to increase during the pendency of the rate case.

Okay.

So it does give you that flexibility if you wanted to.

I'm just -- I was just trying to think of the trajectory of the DISC increases, if you're not starting until late in '17 and then maybe in position to file the rate case still in '18.

So in terms of the timing of the rate case filings, do you think it will be consistent with when you Aqua typically filed in the past, i.e., November?

Yes, we haven't nailed down a time yet.

I'd like to think it'd before that.

But again, we haven't made that final decision just yet.

But when you -- if you think about it this way, we've already decided that rather than go to 7.5% on the DISC immediately, as we're qualified for, having put over $1 billion of pipe in Pennsylvania since the last rate filing, we've decided that instead of hitting that 7.5% all at once, to roll it in over several quarters to be more gradual and more customer-friendly.

So when you think about that, in order to do that, and implementing our first DISC, obviously, we haven't implemented our first DISC in Q3, which we are in today, right?

So the first DISC will likely be Q4 and then you'd see further increases in Q1 and Q2.

So it would likely be sometime thereafter, the implementation of that third DISC that we would file the rate case.

Okay.

That helps.

And then, Chris, maybe if you could kind of give your updated thoughts on M&A, both within the water space, as we saw EverSource agree to acquire Aquarion as well as potential opportunities outside of water and wastewater as you see it today?

Yes.

Well, I think it was a little bit of a surprise to all of us when EverSource ended up with Aquarion.

I did call Jim Judge at EverSource and congratulate him and welcome to our space.

And I think when he explained, they had substantial cash from the sale of coal generation in New Hampshire and were going to redeploy it on "clean water," I thought that was great, and hopefully they'll be a player in our space.

But I don't know that electrics necessarily are moving back into water.

As you know, they were in, they got out.

So you have to talk to your electric friends.

On a broader sense, the multiples are just so high, Jonathan, in the water space, and for that matter the regulated utility space, that it's tough to look at -- you really have to search for accretion.

And as you know, we have been and continue to be very disciplined buyers.

So when we look at these opportunities, we're looking for increased shareholder value in the form of not only accretion but enhanced long-term growth rate.

So all I can say is, as we look for opportunities in our space, we will continue to look for those opportunities and only move when we think it's going to meet our shareholder value requirements.

Okay.

And then one question for Dan.

What types of nonregulated businesses would you find attractive and consider moving into?

Yes, Jonathan, we haven't -- we've done some initial work on that.

But I would say, it's too early to really have the discussion.

We're -- it really looked -- it has been, really, a lower priority for us than the municipal transactions.

And we've -- our focus has been growing our business through the municipal transactions and making sure that, that acquisition activity is building our base, customer base for the future.

Yes.

And Jonathan, we've talked about this theme of complementary and supplementary.

We'd get into a market-based business, it needs to be close to the core.

We in the utility business understand what we're good at, and particularly here at Aqua America, understand where our strengths are.

And if it's complementary, i.e., a business that would give us access to -- opportunity to grow the regulated business, and obviously, supplementary in the sense that it would be -- it would enhance earnings, then that would be attractive.

But I think, as Dan said, we've been very active on the municipal front.

We've been very interested in opportunities on a larger scheme of the M&A world, and this market-based business has sort of taken a third tier.

Yes, I think -- we spend a lot more time -- Jonathan, we spend a lot more time divesting the subscale market-based businesses we've had rather than looking at additional ones.

As Chris said, that would be complementary and supplementary.

The next question comes from Tim Winter, Gabelli & Company.

I wanted to know, given the sort of significance of returning to the Pennsylvania rate environments, if you could talk a little bit about where your Pennsylvania rates are relative to peers or where they've been in the past?

And how much of a percent increase you think you need in '18 once you revisit that?

And maybe what that's done to your earnings over the past several years, staying out of Pennsylvania?

Jonathan, it's Dave --or Tim, sorry.

Tim, it's Dave.

Yes, I'll try to hit a couple of those things, you might have to remind me.

But yes, in Pennsylvania, it's interesting.

Our rates were comparable to our peers for many years.

We might have gotten a little bit ahead in the kind of the 90s or early 2000s as we ramped up our infrastructure rehabilitation program.

But the last 7 years have fixed that, right?

Because our last rate cases was filed in 2011.

And since then, our peers have continued to spend capital, implement surcharges and raise rates and we have not.

And so today, as we sit here, our rates are certainly comparable with our peers in the utility space.

So that's how I would judge our rates.

In terms of our process, I mentioned -- we've mentioned before that we'd like to file the case subsequent to reaching the maximum on our surcharge.

We felt that jumping to 7.5%, although certainly, technically possible, having put that $1 billion-plus dollars of plan in the last number of years, that wouldn't be the right thing to do for our customers, so we've decided to spread that out over multiple quarters.

And once we do reach 7.5%, then the timing would be appropriate to file that next rate case.

So I expect it'd be sometime in the middle of the year.

We haven't nailed down which quarter, which month yet, but I would expect it will kind of be some time near the middle of 2018.

If I could just jump in and supplement, Tim, because I think your question is a really good question.

It's interesting to think about, despite the fact that we haven't had top line growth really since, as Dave said, 2011.

Our Pennsylvania unit still is operating at about 29 cents on the dollar O&M to revenue, which is pretty impressive from the operating team here at the company, I think that's important to keep in mind, really been expense conscience.

The second thing is, we're keenly aware that our -- the fact that we've been out of rates for nearly 7 years now helps us in our municipal acquisition program because there's often, as you're all aware now, this rate differential between what municipals charge and what we charge.

So to the extent that we can be efficient for our customers, keep that overall rate down, it makes our deal making on the municipal front that much easier.

We're also very aware though that we'd like to see -- continue the single payer pricing.

And so to the extent that, that gap is smaller from where we buy our municipals and their rates and to where they get to, to get to a single payer price, that's an advantage for us.

Anything else on that we can help you with, Tim?

(Operator Instructions) It appears there are no further questions at this time.

Mr. Chris Franklin, I'd like to turn the conference back to you for any additional our closing remarks.

I have no additional remarks.

I just want to thank everyone for joining, and obviously, Brian and the team, Dave, we're all available for follow-ups if you have them.

Thanks so much.

Ladies and gentlemen, this does conclude the conference call for today.

You may now disconnect your line, and have a great day.