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American Water Works Company, Inc. (NYSE:AWK)

Analyst Meeting

December 17, 2013 12:30 pm ET

Executives

Jeffry E. Sterba - Chief Executive Officer, President and Director

Walter J. Lynch - President of Regulated Operations and Chief Operating Officer of Regulated Operations

Sharon C. Cameron - President

Susan N. Story - Chief Financial Officer and Senior Vice President

Mark Chesla - Vice President and Controller

Analysts

Brian Chin - BofA Merrill Lynch, Research Division

Adriano F. Almeida - Cramer Rosenthal McGlynn, LLC

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

Neil Mehta - Goldman Sachs Group Inc., Research Division

Angie Storozynski - Macquarie Research

Kevin Cole - Crédit Suisse AG, Research Division

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

Jeffry E. Sterba

Well, good afternoon. It's always a little weird when you watch yourself on TV, do I really look that bad? But I want to welcome you this afternoon. I think if you look outside, this is kind of proof positive of something we've told you many times before. We don't control the weather. But I understand, it's not too bad, although the subway seems to be having problems. I'm sure a number of you all saw a little announcement that we put out last week that as of May, I'll be retiring and will be succeeded by Susan Story, who I know most of you have had the opportunity to meet.

This is something I've tried before, and I didn't succeed last time retiring, so I'm going to try it again. And when you do this, what you hope is that your personal plans and aspirations jive effectively with where the company is that you're going to be departing. And I got to tell you that what I think you will see over these next intervening months is going to be an exceptionally smooth transition. So give me a chance to go back and fulfill some commitments that I made the last time I tried this.

But this company has come so far and accomplished so much but yet has got such great opportunities ahead of it. And to have Susan Story to lead the team and take it through that next step is just going to be wonderful. Because everything that we earlier accomplished is because of the team of people that we have.

And so let me just take a quick moment, if you haven't met them all, to introduce them to you so you understand and know some -- a few of these folks who will be joining me in the presentation, but that you will understand why we've been so successful.

Let me start with Walter Lynch, who is the President of our Regulated Operations and has done a tremendous job in driving our cost efficiencies as he'll talk about later; Sharon Cameron who has run our market-based business and, in fact, was one of the initiators of the Homeowner Services business a number of years ago, and you have -- we'll talk about the great results that we've had in our market-based business; Kellye Walker, who's our General Counsel and Chief Administrative Officer; go back to the back, John Bigelow, John runs our business services and so he's been the prime driver for our development of a culture of continuous improvement and the push on our Six Sigma and the like; Mark Strauss, who runs our Strategy and Business Development, and if you want to hear some great stories, Mark is a great storyteller. And then also with us today are 2 people that many of you know, Mark Chesla, our Controller; and Bill Rogers, our Treasurer.

And so this is the team I've had the pleasure of working with. Now I'm a little biased, but I also tend to think that we've got one of the best IR teams in the utility space, led by Ed Vallejo as Vice President of IR. So Ed you get to stand up. And I still don't understand why he doesn't pronounce his name the right way, Vallejo, but he gave up trying to do that a long time ago. But he is ably joined by Muriel Lange in the back; and where's Kathy, I think she's up front, Kathy Dumont [ph] .

So one of the things that you learn with an IR team is it's best that they remain calm. So to help ensure that, let me refer you to the cautionary statement concerning forward-looking statements. You have it in front of you, and it's now on the screen. So I have done my duty, Mr. Vallejo.

Let me just briefly run through what we're going to talk about today and who's going to do what. I'm going to spend a little bit of time on our strategy and looking both how we got where we are and what we're doing to continue to advance the company. And then Walter is going to get up and talk about our foundation. This is what we rely on as our core business. It has been always will be our core, and it has come a tremendous distance in a fairly short period of time in terms of improvement. And then we'll take a short break. And Sharon will bring us back to talk about how we take our core business and build adjacencies where we create some market exposure and a higher growth opportunity, but do so in a regulated-like risk parameter set. And then Susan will come up and translate all of that as to how it fits within our financials, and then we'll go -- come forward and do some Q&A's with whatever questions you all may have as a result of that and see if the snow has stopped by then.

If you think about what we have done with American Water, I think hopefully at the end of this session, there'll be 6 key takeaways that you can take with you. About our investment and why we think it's so -- such a solid investment.

Building a culture of continuous improvement is foundational. A lot of times in these presentations, we get focused on numbers, which are important, but numbers are the result, not the start. And this culture of continuous improvement is foundational for us. Why? Well think about it. It's what makes the success that we've had replicable. How many times have we seen companies that have done a great job in cost management, only to see it creep back into their business 2 or 3 years later? The way in which you combat that is to ensure that you truly build a culture of continuous improvement, not just on the cost management side, but also on your business extension -- business line extension side the ability to look at adjacencies and for our people to always be looking at how can we take what we do best and extend it into another market or add another product or create additional value for customers through something else is core to what we've been able to accomplish. It is the primary driver of us being able to control our costs and minimize consumer price increases. Remember, one of the things that we've talked about a lot is the small equation of $1 of operating cost has the same impact in customer rates as $6 of investment. But that $6 of investment creates greater service, better service, for the customer and generates $0.30 per year of earnings. So the better we can control our cost side, our operating cost side, not by slashing and burning but actually through continuous improvement, reducing those costs, the greater headroom we create to invest capital, to better serve customers and provide earnings for our owners. Let's put some numbers to that. The plan that we are -- that we have implemented as of now will save over $900 million of operating cost from 2012 through 2018. That's $900 million that creates headroom, which we can then use to put more investment into our systems. And as Walter will talk about, that's something that water and wastewater systems across our country desperately need.

We care greatly about the rate impact that will occur to customers. And as we've talked about before, a number of us on the electric side saw what happens when you just kind of say, utilities said, "Well, we're rate-regulated. We'll get these costs recovered." And regulators found ways to say no. And at the end of the day, caused over $40 billion of shareholders equity to be written off over about a 7-year period in the late '80s, early '90s. That is not going to happen to us. Why? This plan that we're implementing will allow us to have bills for our customers go up, on average, over the next 5 years across all of the states we serve by 2% per year. Now, that doesn't mean every year in every state, 2%. No, it varies from 0.5% to 5% across the state for that 5-year period. So some years it may be higher, and then it's 0 the next year. But those are averages. And that is including every state that we have. So when you think about a value equation of 2% rate increase, $900 million O&M cost reduction, growth in the 7% to 10% range, we think we start to have something that really hums. It is a lot of that cost control that helps us ensure that the regulated and regulated-like cash flows are the main driver of our earnings per share growth.

Now, one of the things that's really important is within that 2% rate cap or rate structure on average, what does that mean we can do on the investment side? So over the last 5 years, American Water has invested $4.4 billion, almost all of which was into the regulated end of the business. So $4.4 billion over the last 5 years. Over the next 5 -- and that's through '13, 2013. Over the next 5 years, we will invest $5.8 billion, $300 million of which we have set aside as strategic investment. This can be used for things like concessions or in the shale arena or other things that we'll talk about, biogas, use of water waste to develop biogas and then to sell that biogas. So there are a number of things that can be used for it. The lion's share of that $5.8 billion, as Walter will go through in more detail, is committed to our regulated business. And that 2% average rate increase across all of our states over the 5 years includes that level of investment, which is, as you can see, a sizable increase from what we've done in the past 5 years. And even with that, investing that level of capital, under normal conditions, normal operating conditions, we see no reason to issue any additional equity for the foreseeable future.

So now you take those component of 2% average bill increases, $900 million O&M reductions, $5.8 billion of capital, $300 million of which is set aside for strategic capital, all helping fuel, in which we're going to talk in more detail about, the 7% to 10% growth, and it provides the great opportunity for strong dividend growth. And you couple that with a fairly transparent policy, which says we will pay out 50% to 60% of earnings in dividends. Today, we're just under 50% payout ratio, if we look at the midpoint of our 2013 earnings. And that we will have dividend growth at a rate similar to what our growth rate in earnings is.

Now just like the culture of continuous improvement is core, so is having the customer at the center of what we do. A lot of companies say that, the question is what do they really do? Well some of you have heard us use the formula, if you will, B greater than P, greater than C. The value of the products and services we provide our customers has got to be greater than the price that they pay, and the price that they pay has got to be greater than the costs that we incur. Half of that, the front half of that, is a customer equation. The back half of that is an owner equation. We have to make sure that those things stay in balance. So when we put value and creating superior value for our customers, how does that translate? Well, certainly continued capital investment to help make sure that we've updated the infrastructure as necessary, and we've just talked about investing $5.5 billion into our regulated business. And we have to have affordable prices. Well, it won't be 2% every year for every customer, but average over 5 years across our 16 states, 2% rate increases.

Reliability matters, but reliability is not just when I turn the faucet on, is there water? Or maybe more importantly sometimes, when I flush the toilet, does it go down? But it's also the health and efficacy side. So does the water have an odor? Does it smell? How does it taste? Because remember, this is the one utility that people ingest. So to help make sure that, that water is clean, safe and usable. Now, when we think about things as we've talked before, Hurricane Sandy, it still is amazing to me we only lost 2,000 customers through all of the implications of Superstorm Sandy. And when we went through the droughts in the Midwest in 2012, we didn't -- there was no instance where we didn't have water to supply customers. So we've done things to harden our system, to build security and safety within our system, so we have redundancy and that we can do things that help provide greater value to customers. You saw in the screen, on the -- in the video, Mark LeChevallier talking about what we've done, and that was only one example of many, on the energy water frontier to help using technology to reduce energy use and reduce our carbon footprint. We also use that technology as he mentioned, in areas like reducing leaks or better leak detection, so we can catch small leaks before they become main breaks. But our future of putting the customer in the middle is to help also extend that technology so it's more customer facing. So that in the future, we can call a customer and say, "Based on what we see happening in your meter today or yesterday, we think you've got a leak on your side," because today, they have no idea. If we can stop a leak, particularly then through our homeowner services side, you can stop a leak, take care of it before it becomes a full rupture, that's value added to the customer.

Walter is going to spend some time talking about regulation and the way we approach building constructive relationships. And he's going to give a number of examples about the things that we do to help enable that. I want to use -- I want to give another side of that, though. A lot of times, it's easy to say, "Well, the regulators didn't treat us well." And I probably even said that at one point or another and one particular commission that comes to mind. But a lot of times, the first thing you got to do is look at yourself, and say what did we do to contribute to that? Let me just give you one example. If we take the State of Tennessee, when I came to the company, we had just finished 2 rate cases up -- over the 3 years prior to that. Each of those rate cases took over 20 months, we're fully litigated and had bad outcomes. And we looked at that situation by -- under Walter's leadership and said, "You know, in this one, we need to look at ourselves. We're the problem." So we changed that management, we changed out the approach, we brought in people that had a different ethic and a different approach to the political and regulatory process, but also in running a business. What was the result? The next rate case we filed from the day we filed it to the time rates went into effect was 5 months. That's also a state where we just closed an acquisition yesterday to add another 2,800 customers to our Tennessee system. So a lot of times, we'd look inside and say "Are we doing the right stuff?"

Our theory goes another step and it's that notion that results are, in fact, act that. They are results. They're not the things that we engineer. They're the sum of the things that we do to help serve customers, to do effective cost management, to innovate and bring technology to bear, the kind of constructive relationships we build with our regulators on our regulated business, and are we really part of the community that we serve. Let me give you an example of that. One of our communities in Illinois has the opportunity under an 80-year-old agreement to buy the system every 5 years. All they have to do is say, "We're going to buy it. We want it." They just went through that and the outcome was they said, "No, we're not buying it." Why? "Because you all provide great service and we think the rates are fair." Now, that's in an arena where 2 -- all frequently you hear about people saying, "Oh, we need to take our water systems back." But [indiscernible] said, "No, we like the service we're getting, we like the prices that we're getting, you provide great service." And they passed. These are the things that will lead us to the kind of financial prospects, financial growth and financial results that I think you've seen from us and that we'll talk about.

So speaking of that, if you are a shareholder today, we hope that you've been happy with 139% total shareholder return that we provided to you since the IPO. And that we hope after our discussion today, you'll come to the conclusion that maybe it's worth putting a little more money into. Or if you're not a shareholder today, it's not too late. Because I can tell you, the things that I was excited about when I came to the company 3.5 years ago are even more so, in my eyes, about what Susan and this company is going to be able to do going forward.

So let's talk about earnings and earnings growth. You all have seen us go through some different kinds of presentations trying to communicate what is growth going to mean for us, and we started with this, which we euphemistically called the sandbox. And in this sandbox, what we're trying to demonstrate is that what drives our growth is going to change over time, because frankly we have a lot of ROE catch up to do. We also knew that we could drive cost out of this business that we're going to add value. You all as analysts kept looking at that saying, "Okay, but where on that line are we?" Well we're not on one point. We're at different points on different lines. And we went through that for a while and said, "This isn't working." Now you can blame me for the sandbox. This was my creation.

So our next incarnation was when you think about it, we really have core growth, we have our core operations and there are different components that grow within that, and we have enhanced growth. And marvel of marvels, the idea of putting it into a water pitcher came out. Now, this one, you can blame on Ed. This is Ed's creation. We went along with it, because he'd given me such grief about my creation. So I decided that I'd be polite. I would -- we would do this.

So these are the 2 things we've used to communicate growth and, quite frankly, that didn't work all that well. Wait for it. So we decided, let's try something different, because what our hope is and what I think you will see us doing today is providing a great deal of added clarity and specificity to our projections and our business directives and what really makes up that growth. So ought to be a drumroll, let's introduce you to the triangle.

We're using a triangle to kind of give a sense of size but also components. And this will change from year to year. So, for example, this is looking at our growth between 2010 and 2012, we're on a weather-adjusted basis, we earned a 17% CAGR on EPS growth. And what were the components of that? Well the biggest was our regulated investment, the making of the investments we made in our 16 regulated states, that generated 8 percentage points of that 17% growth over that period from '10 to '12, 2010 to 2012. The improvement in our ROE and, really, this is comprised of 2 things, regulatory lag but also portfolio optimization. So the exiting of certain states where we just felt it was not a good place for us to put our capital, that generated 6 percentage points of the growth during that window.

Market-based business generated 2 percentage points, and keep in mind, the market-based business only accounted for about 4% of our net income, and about 9% of our revenues at that point in time. But it added 2% of our 2 percentage points to our growth and acquisitions that we made added a little less than 1%. So that's 2010 to '12.

Now, let's go to '13. And in '13, going again from a weather-adjusted 2012 result, which Sharon -- Susan will go through in more detail to, let's call it, the midpoint of the landing zone or that range of high and low, it -- we have a range of what the impacts are. So regulated investment is still the most important. It's our core. And it's generating 6 to 7 basis points of the growth we'll experience this year. We have continued to make improvements in our regulatory lag and the full implementation of transactions that occurred in 2012. And that's another 2% to 3%. Our market-based business has continued to grow 1% to 2% -- adding 1% to 2% growth that's growing obviously much more rapidly than that, but it's adding to the company bottom line, 1% to 2% of growth. Corporate expense reductions, which Susan will go through, because you'll see this also recurring in '14, Susan will go through it in detail, but that's adding 1% to 2%, and then acquisitions, frankly, less than 1%.

Let's go to '14. So in '14, we've told you in the announcement that we made this morning that we've established a new range and that range is $2.35 to $2.45 per diluted share. And if you look at that range, that's roughly 7% to 10% growth, again from the 2013 and what are the components? They've shifted a little bit in composition but, again, regulated investment. That's going to be 4 to 5 percentage points of the growth. Corporate expense reductions, which Susan will go through in more detail, 1 to 2 percentage points. Acquisitions 1 to 2 percentage points and this is not so much acquisitions that were going to make, it's frankly internalizing the ones we've already made. Because of the acquisitions that we made in 2013, most of them are closing toward the end of the year. So they really didn't affect '13 that much. They will affect '14. And Walter will spend some more time regarding our acquisition strategy.

Our market-based business is going to go about 1% in shale. Let me just spent a brief minute on shale. If you look at Butler County, I don't know how many of you know Pennsylvania that well but Butler County is out in the Western part, a little south, but it's on the Western part of Pennsylvania. And it's in what's called the liquids-rich fairway of the Marcellus. It's really kind of in the heart of that liquids-rich fairway. In 2013, we will supply water to 70% of all wells drilled in Butler County. If we look at the entire state, we're supplying water to 8% of any frac-ed well that's been drilled in 2013. Now, this is largely -- it's all been done on a regulated basis. We have 34 points of interconnection with 18 different companies. We are, today, working with about 11 companies on another 14 points of interconnection with mainline extensions to serve them in 2014. In fact, we'll probably build as much pipe to serve the shale industry in 2014 as we did in 2012 and '13 combined.

As we work with these entities and these are more and more the, what I'll call, the majors and the mids. As we've worked with them, we are finding that there are other ways in which they need assistance. And some -- and in many instances, we're now talking with them about doing something not on the regulated side but on the market-based side. But for us to do it, it has to be done in a way that takes -- makes the risk look regulated-like. So we are not going to build pipe and have them come. We will build pipe when there's committed demand for that type, for that water. So we're not -- it's not going to be a speculative play. But the -- and it's now moving, it's not just Marcellus, it's Utica. And so as we look across that range, you're starting to see patterns develop where we can see and are working with drillers as to how we can meet those needs by building some trunk lines, from which they can take spurs.

So that's 2014, $2.35 to $2.45 per diluted share. Now, let's go to the long-term, which is looking '15 through '18. And so this -- these ranges are a little wider because, frankly, they're going to vary year-to-year. And so we're now talking about a 3-year period instead of just one year over another year. But there may have pretty much the same, regulated investment CapEx is 3% to 5%. Market-based business will add another 2 to 3 percentage points of growth. Acquisitions will be 1% to 2%, and that's because, as Walter will talk about, what we have seen on the acquisitions front this year is probably more the norm as we go forward, not so much on the waterside, but on the wastewater side. Shale, broader range between 0% and 2% because if some projects go, they can move the needle fairly substantively [ph], and then the other, what's the other? Well remember I talked about setting aside $300 million for strategic -- you did that very well. No one saw it, it was very graceful. And I'm not going to walk over there. So remember we talked about the $300 million that we set aside. This is what can fuel the other. What would it be? Well as I said, it could be concessions. It could also be in the shale frontier or in the biogas world as we move more into wastewater side. So that gives you a sense of the 2015 through 2018 side.

So when you take all that and you translate it, what are we saying? Well 7% to 10% long-term growth. We're reiterating that, frankly, our level of comfort with that has gone up. As we've done more detail in our planning, and we've progressed the way that we have, we can see our pathway where we'll be able to generate that kind of growth, provide better service to our customers and not dramatically cause unacceptable rate increases. And again, I'll remind the 2% is over time and across all states. It can vary fairly significantly from 0.5% over 5% a year, depending on the state. The 7% to 10% EPS growth, we will be free cash flow positive by the end of this period, which when you think about the amount, we're investing 3x our depreciation. That's pretty significant.

We're increasing our CapEx to $5.8 billion from $4.4 billion over the last 5 years. We have no plan, no need for equity offerings to create dilution under normal operating circumstances. It means we could, if we saw a tremendous opportunity, it creates value. But we don't have to, to finance our baseline investments to provide safety and security of supply for our customers. And the average customer bill, about 2%. Now that 2% on the bill includes the impact of declining usage, which we continue to forecast will occur with our residential customers.

Now let me close with this pictorial. Ed put together a group of utilities that are reasonably similarly sized, some are a little smaller, some are a little bigger, but generally within our universe. And then included 3 water companies: Ourselves, WTR and CWT in that group. And what we did is we took the consensus estimates for our long-term growth and what their P/E ratios are. And you can see that the consensus for us is 7% growth and our P/E has moved up. We've closed a lot of the gap, but not by any means all of it, that has existed between ourselves and other water companies. In reality, if we then not only look at that growth, but if you take a look at the midpoint of our range of growth of 7% to 10%, what does that imply relative to our P/E? When I came to this company and I realized that we traded at a discount. Of all the obvious things, why? And you come up with all these reasons. Well, we don't have a track record. We've only been back in the market for a very short period of time. Well, your return on equity is low. Well, you don't have -- you really are still so institutionally held you don't have the stickiness of retail buyers. Well, now you look at what we've accomplished. We're pretty happy with the track record that we've established. We've shown year-over-year growth, frequently in excess of expectations. We've changed the internal part of the company to make sure that, that kind of growth is -- continues to be replicable. We've taken our retail shareholders. This is really one of Ed's great successes from about 12%, 13% at the time of the IPO to now about 32%. And he keeps creating phantom new retail holders to increase -- I'm just kidding. But we did. Went out St. Louis and found out we had another 4 million retail customers we didn't know were retail customers. So that stability and that people buying into this notion of dividend and dividend growth and the prospects for the company takes hold. We still trade at a discount.

Now, some of us feel so good about this business and the way -- and where we've come that maybe we think we should trade at a premium. But I'll just take elimination of the discount. Because we still are trading at about a 1.5 to 2 turn discount, which we hope to see vaporized over time, as people become even more comfortable with us.

So you all have to decide where you think that growth will be, obviously, and you'll have to decide whether or not what we're doing is replicable and whether or not this provides the kind of insight to give you a better comfort level about where that growth will come from.

Unknown Attendee

I understand the P&L start very low [indiscernible]

Jeffry E. Sterba

Yes, it has. But -- not as good as we did a long time ago, but very well. And I was chair through 2012, so I was still involved with them, but they've done very well. And I think here's -- this is a -- New Mexico changed its regulatory environment by law. And that had to happen. So they made changes to the statutes associated with regulation in that state and that helped stabilize did a bit.

So with that, I'm going to turn it over to Walter to talk about our fundamental reg ops.

Walter J. Lynch

Thanks, Jeff. Okay, so our success is built on Regulated Operations. I want to start with a quick overview in our industry, and there's an urgent need to invest in our water and wastewater infrastructure in the United States. It's been approximately 1 million pipes in the United States, and every 2 minutes, there's a major main break. And I'm sure many of you have seen the main breaks in your communities where you live and where you work. We're very disruptive to people's lives on a daily basis. We lose 2 trillion gallons of untreated water, 2 trillion gallons a year of untreated water, the cost of $2.6 billion. That's about 15% to 20% of the treated water in the United States. And just to put in perspective, 2 trillion gallons is about the annual household usage of 22 million homes.

On the wastewater side, approximately 800,000 miles of collection pipes. Many of those pipes in the infrastructure was put in years ago and are in dire need of repair, and are also posing a risk to the groundwater. 900 billion gallons of untreated sewage is discharged every year. Now, think about Hurricane Sandy that came through here not long ago. 11 billion gallons of untreated sewage was discharged in those affected states. So 11 billion gallons, to put that in perspective, that's in the area of Central Park 50 feet high. That's a lot of untreated sewage. And in Long Island, 2 billion gallons were discharged into the streets, and there's still a lot of ongoing work to clean that up. By 2020, 44% of our pipes are going to be classified as either poor, very poor or life elapsed. That's up from 10% in 1980 and it's pretty indicative of the lack of investment in our infrastructure. So we're going from 10% in 1980 to 44% in 2020, over 40 years. And that's why the American Society of Civil Engineers gave the water and wastewater infrastructure a D rating, and that was the lowest of any infrastructure rating they gave. And there's been many surveys, but they range anywhere from $650 billion to $1 trillion as far as the amount of investment that's going to be needed over this 20 years to improve our water and wastewater systems.

So let me give you a quick overview on American Water's Regulated Operations. We serve 11.7 million people in 1,500 communities in 16 states. We own 80 water treatment plants in various sizes, anywhere from a couple of million gallons a day up to 150 million gallons a day. We own 100 wastewater facilities. We have 87 dams and I'm going to talk about -- and Ron Macqueen [ph] talked about a dam. We did have 90, we decommissioned 3 in the last year. And we have more than 46,000 miles of mains and collection pipes in American Water. The regulated business provides about 90% of the revenues, and we operate from coast to coast. We operate from New York to California. That really -- that geographic diversity helps us in a number of ways, but primarily from weather so it could be raining and wet in the Northeast, which has happened many times, particularly this year, and that would be offset by some dry conditions either in the Midwest or the West like what happened in California this year. And also because we operate in 16 states, we're able to mitigate regulatory risk. And that's unlike many other utilities, operating in 16 states.

You can see here, our top 2 states New Jersey and Pennsylvania account for about 40% of our population served and our top 7 states account for about 87% of the revenues on a last 12-month basis ending September 30 of this year.

We're very proud, as Jeff said, of our performance in American Water and I want to give you an overview of some the key performance indicators, our targets that we set in accordance with those in the actuals in 2013. So on a customer satisfaction perspective, this is vitally important to American Water for the long-term success. We survey our customers on a routine basis and ask them how satisfied are you, overall, with the service of American Water? And they're giving 5 answers: So it's extremely satisfied, very satisfied, somewhat satisfied, somewhat dissatisfied, and then dissatisfied. This measure is based on our customers answering in the top 3 categories, extremely, very and somewhat satisfied. We set a goal of 90% or greater, and we're at 90.5%. So we're very satisfied, but we want to continue to drive that number up.

On the second measure, customer service quality. Those are the customers that call our customer service centers and ask us to provide a service for them. We then send a service order out to the field, the field service rep goes to their home and conducts some service. So within 7 days of completing that service, we pull our customers and asked them, how satisfied were you with the outcome of your contact? This measure, 85%, is the top 2 category. So got the answer, extremely satisfied, very satisfied. And so that's a pretty aggressive goal, 85%. Happy to say that we're at over 87%. And this is through 3 quarters, September 30 of this year. Now, this is all in light of what I'm going to talk about in a second, SAP implementation that we've been undergoing for the last 4 to 5 years. We've gone live with a number of different platform systems and this really shows the dedication of our employees in providing the greatest customer satisfaction for our customers.

Environmental compliance, this is another area we take great pride in. We establish a more challenging goal every year. So we have this year a goal of not to exceed 15 notices of violation. And you can see where we are at 5. But to put this in perspective, American Water serves about 5% of the U.S. population. Last year and on average in prior years, there's about 11,000 notices of violation. So if we were like the industry and that percentage we would have roughly 550 notice of violations, and we have 5. And our aspirational goal is to get it down to 0. And this is again the dedication of our customer -- our employees in making sure that what we're doing is in the best interest of our customers. On an efficiency ratio, this is a measure of how efficiently we run the business. We established this goal 3 years ago to get below 40% by 2015, and you can see, we're performing against that. We're 40.3% in the last 12 months ending September 30. So we're almost there more than 2 years early, and I'm going to talk more about that in a minute.

And lastly, SAP implementation. We've been at this for 4 to 5 years and this has been a key project of mine, Jeff's and the entire ELT. We spent a lot of time in this engaging with the business. We've implemented SAP platform systems, we've implemented new financial systems, new asset management systems, new customer information systems, new HR systems and new supply chain systems. And I've got to say, we are very pleased with the outcome of our implementations. Not to say we don't have problems, we do have some problems and we're working through them on a really consistent basis and a professional basis to make sure we're addressing the issues of our customers in realtime. But overall I couldn't be more pleased with the progress here, and a know Jeff has said this on many occasions. And this really touched every one of our employees and customers. And so our employees were up for the challenge and weathered through a lot of challenges along the way. But you can see the results from our customer surveys. It's right on track of where we want to be.

So constructive regulatory policies, we work very cooperatively with the commissions in each of the states where we operate to reduce regulatory lag. We do that by looking at infrastructure surcharge tools and forward -- future test years. You can see the red line that indicates 60% 2014, 60% out of our invested capital is going to be added to rate base in the year it's invested. And that's up dramatically from 30%, so we double that in the last 3 years. Tremendous progress. We're going to continue to work with the commissions to enhance these mechanisms. But right now we have this mechanism in 5 -- our 5 largest states, including New Jersey, and I think that's a very successful program, and we have future test years in 8 of our states. So tremendous progress in the last few years, making sure that we're reducing regulatory lag.

So this shows the long-term view of our capital program. This is the first time we've done this, so you can see out to 2018. And as Jeff said, we've increased our investment in our infrastructure dramatically. Last 5 years, we invested overall, $4.4 billion. The next 5 years, we're going to be investing $5.8 billion. That's a $1.4 billion increase. On the regulated side, the last 4 years, we're at $4.4 billion, obviously, the vast, vast majority of the capital invested was in the regulated side. And this year, including growth -- or this 5-year plan, including the regulated acquisition is going to be at $5.5 billion. The other $300 million that Jeff talked about as far as providing capital for the market-based businesses to grow.

So included in this is the biggest component of this obviously is the regulated business. In this, we have pipe replacement that I've talked about, upgrading water and wastewater facilities in our 2 large California projects in the video, Rob McLean talked about them, the San Clemente Dam and the Monterey Peninsula Water Supply Project. They're all in this number. Also, in the red, is our regulated acquisitions. I'm going to talk a little bit more about that in the future, but those are utility acquisitions, not concessions or anything else, utility acquisitions that are in our plan.

So if you look at the regulated capital by purpose, the biggest component is asset renewal. And again, that's back to pipe replacement. As I said before, we have 46,000 miles of collection pipes and mains. On an annual basis, we're going to be replacing about 300 to 350 miles of pipe. We also are upgrading water and wastewater treatment plants. To give you an example of some of the work that we do on a routine basis in American Water, we're upgrading -- we're doing basin work at our [indiscernible] plant in Chattanooga, Tennessee; we're doing electrical work at our central plant in St. Louis, Missouri; and we're general rehab work at our [indiscernible] plant not far from here in New Jersey. Those are the things that we typically do in our business and we do on a routine basis.

Next category, regulatory compliance. There's a lot of things in there, but the biggest component -- the 2 biggest components: One, is length of service meter change-outs. We're required by the commissions to change our meters every so often, anywhere from 10 to 20 years. And so we do that across American Water, and we change out anywhere from 250,000 to 300,000 meters every year. That's the biggest component, and we do that in a way that we're implementing new technology. So all of those meters are automatic meter readers. And I'll get to that in a second.

The other component, when we talk about the 2 major California projects, they're in regulatory compliance as well, San Clemente Dam and the Monterey Peninsula Water Supply Project.

And lastly, capacity expansion. That's where we expand our services within our existing franchise areas, and that includes additional mains and valves and hydrants. Those kind of things in meters to expand within our existing service territories.

As Jeff said, we strive to build a culture of continuos improvement in American Water. And part of that continuous improvement is operating as efficiently as we can. And I think this tells a really compelling story. If you look back to 2010, our O&M efficiency ratio was 44.2%. We have been able to drive that down, and we're projecting in the landing zone this year of 39.5%. Remember what I've talked about before in our targets. We established a long-term target of less than 40% by 2015. Based on our landing zone for 2013, we're going to be below that target. And that requires dedication and commitment that we have from our employees in American Water. We've also established a long-term goal in 2018 to get down to 35% or lower.

When we first established aspirational goals back in -- 3 years ago when Jeff first joined, we established -- okay, we're going to have an aspirational goal of 35%. And there were a lot of people were going, "What are you guys thinking? That's way too low." And now that we've worked for it, we're below 40% at the end of this year, that looks so doable. And we've built that into our plan. So our 35% is a commitment that we're making to get down by 2018.

If you look at the pipe replacement, a lot of our investment, obviously, is in pipe. And what we've been able to do is drive down the replacement life from 250 years. If you look to 2010 down to our projected in 2014 of 150 years, our goal is to get down to 100 years, but we've got to balance that with the impact on customers. And as Jeff said, the average annual increase for our customers on their builds is about 2%. We can get down there sooner, but it's going to have an impact on the customers and what they're going to be paying on their bills.

I want to re-emphasize one of the things Jeff said. Our employees understand the why. That's very important. Why do we need to drive cost out? When I first joined the Regulated Business back in 2005, there's a lot of questions around why do we need to do that? We can just pass those costs through. And that's not the formula for success in this business. We want to continue to invest, so we need to be able to take cost out of the business, operate efficiently so that what we're doing is asking for a recovery in our capital and not pass-throughs. So all of our employees understand that $1 of cost equates to $6 in capital. It's very important so they understand that. So we're providing better service with that capital investment, and then from a shareholder perspective, we're able to earn $0.30 on that investment.

And if you look back to 2009 and 2010, our rate filings, our revenue requirement of rate filings had 58% of our revenue requirement asking for a recovery of operating expenses. The rate filings that we have right now, that's down to 6%. So we went from 58% to 6% in a short period of time in 3 years. The vast majority of our revenue requirement in our filings is due to recovery of capital, 94%. That's something we're very proud of at American Water.

So we look to growth. This tells another compelling story. 2010, '11 and '12, we averaged about 5,000 customers a year and adding to our customer base through acquisitions. You can see in 2013, we're going to be about 30,000 customers. Just to put in perspective, those 30,000 customers, that's more than the 5 prior years combined. A big part of that 30,000 is a 20,000 customer acquisition that we did in Dale Services in Virginia. It was a private wastewater company that we just closed down last month. That's an excellent fit for us. Let me explain why. We owned the water system in the area, so essentially we're providing service down the wastewater side for the customers that we have on the water side. What does that do for us? Well, we're able to operate more efficiently, provide better service, using the same trucks and employees to provide the wastewater service as we do the water service. That's part of our long-term growth strategy. If you look at the targets in 2014, we've listed a number of targets here. These are targets that we expect to close in 2014. If you add up the numbers there, it's well in excess of what we closed in 2013. Many of these are on the wastewater side, and another great thing too is that this culture of growing our business and the need to grow our business is really prevalent across the entire system, 16 states on a regulated basis where we're operating. So everyone is out looking. And so it doesn't require for us to hit our target for this year. It doesn't require us to close 1 big deal or 2 big deals. There's a multitude of deals that we're going to be closing across the business. This is a great story. Stepped up in 2013, a lot of this was due to the work that we did in the prior years in establishing where we want to grow, putting the right team in place and effectively executing on it.

So you're asking yourself, why is your pipeline more robust? What's different now? We look at this in 2 different ways, from an external perspective and an internal perspective. On the external factors, continuing aging of the infrastructure that I talked about. Every year, it gets worse. Every year, we're not investing in our pipes on the water and wastewater side, upgrading our water and wastewater treatment plants. So there's a need. So less attachment to wastewater than there is water. We continue to focus on the wastewater, and we're talking to municipalities. They're much more willing to talk to us about wastewater acquisitions than we are with the water. Not to say we haven't done water and continued to do water, but they're much more willing to talk about acquiring their wastewater system. And EPA regulation is increasing. This is posing a challenge for many in the industry because it's going to require significant capital upgrades. There's also an increased effort for the EPA and on the regulatory bodies enforcing existing regulations. And there's a number of additional consent orders out there that are posing problems from a capital investment perspective for many of the municipalities.

So those are the external factors driving our growth. From an internal perspective, we have a new focus on wastewater, as I've said. We've got tremendous expertise internally and experience internally, to drive this side of the business. We have a strong presence in communities. Part of American Water model is that we just don't have 50 people in business development. We've got 7,000 employees in business development. And this is getting better every year. Our employees are engaging in their communities, they're talking to people and they're uncovering opportunities. And we're seeing those opportunities come to fruition, and more cost-effective service when we have both customers. Dale Services is perfect example. We have others. When we're providing service with the same employees, the same trucks, the same back-office, it's much more cost-effective and efficient and better service to our customers. And we're going to continue to get on that road.

So one of the things we're doing is we look at the external factors, and what can we leverage internally to drive higher acquisitions in our company? So don't take from this that the dam of opportunities is going to break. It's not. We get asked that all the time. With all the problems out there, why aren't you acquiring more systems? We took a very focused approach. We looked at the external factors. We leveraged our internal capabilities to address those, and that's what you're seeing in 2013 and we'll see in '14 and beyond.

This is my last slide. I'm going to spend a little bit of time on this. You can see here the key strategic objectives, really centered on investing in our infrastructure, growing our business and mitigating regulatory lag. Those are the 3 things that are contributing to the 7% to 10% EPS growth. So what we do on a broader scale, we look at what key strategic objectives do we want to accomplish over the long term. And we say, as Jeff said, what enablers are we going to put in place to allow us and enable us to achieve those objectives? And it's not just filing in a rate case. That's too late at that point. You've got to do a lot of work meeting up, having a constant discussion and interaction with the commission and municipal leaders. And then we set key strategic or key actions by people who have accountability of delivering these. And that's what on the right, the enablers, that's what's meant to show there.

This is a result of our efforts over the last couple of years, and I want to take you through some of these. The single tariff for water and wastewater. This is a result of Act 11 in Pennsylvania, which allows us to combine the wastewater rates into the water rates. Let me give you an example. If we made an acquisition, which we have many times in Pennsylvania in wastewater side, typically as I've talked about, they require significant capital upgrades. When we do that, the increase in rates on those wastewater customers, so we have to go in and ask for 100%, 150% increases. We know that's not sustainable, so we work with the commission, we work with the legislature, say we want to be able to do more wastewater acquisitions. So let's come up with a mechanism where it actually work those into the water rates. So now if we do the same acquisition, we have those capital upgrades. Those costs are going to be shared across our entire customer base including water to mitigate the impact of those increases. That's enabling many more wastewater acquisitions in Pennsylvania, and we actually completed one and integrated into the rate case that Pennsylvania has. Right now, they're going to be addressing later in the week.

Enabler 2, facilitating acquisitions of smaller or troubled systems. We've been pretty successful in 2 states among others, but these 2 I want to spotlight. In Missouri, House Bill 142. That requires the commission to combine any acquisition of 8,000 customers or less into an existing system in Missouri. That's to mitigate the rate increase. We worked very diligently with the commission to see the benefits of this, and I think we're going to be seeing the benefits of this in the future. Missouri doesn't have single tariff pricing so what we're able to do is combine that with an existing system that's closest to that. In Illinois, the Water Systems Viability Act. In Illinois, prior to this act coming about, the only thing we could pay was cost less depreciation. And so, some of these systems had very small valuations that didn't represent the fair value. So we couldn't really go in effectively and acquire systems without paying a huge premium. And so, what this allows us to do is go in and get an appraisal and tie the acquisition to that appraisal, instead of the cost less depreciation. Again, another enabler for acquisitions in Illinois.

We've got some other things and innovative mechanisms for capital recovery. Again, as part of Act 11, we now have a DSIC mechanism on the wastewater side like we have on the water side. And also as Jeff mentioned in Tennessee, those legislation passed that allows the commission to consider innovative regulatory mechanisms. And so, in our filing that we just filed, we requested 4 innovative regulatory mechanisms, one of which is DSIC, and the commission will be looking at those as we work for the rate case process.

And then, applications of future test years. As I said before, we have now 8 states within the American Water system we have future test years. Indiana and Pennsylvania were recently enabled by a legislation that passed Act 11 in Pennsylvania and other legislation in Indiana to provide for future test years.

So these are things that we've done. We're going to continue. We've got a number on our plate right now that we're working in the states where we operate, and we're going to continue to do this for the long term in American Water. It's the way we really deliver value for our customers and our shareholders. So with that, I believe that we're going to be taking a break, 15 minutes. So quarter 2, if you come back at quarter 2, and I'll be around if you have any questions. All right. So thank you.

[Break]

Sharon C. Cameron

If I could get everybody's attention, if you could take your seats now. We're going to try to get started.

Hi. My name is Sharon Cameron. Good afternoon. It's exciting to be in New York City around the holidays, with the snow coming down. So it's a great welcome for us coming over from South Jersey. I am very excited to be here today. It's really been personally rewarding and exciting to work with the colleagues that I have in American Water, and I think because we have an incredible track record, and we've had some great success. What I want to share with you today is the performance we've had over the past few years, give you a little more insight into the market base segment and then hopefully exhibit to you that the same sort of strategies that got us to where we are today. We have a lot of momentum, and I think they're going to take us to great results in the future.

So quickly, let me just give you a quick overview of the Market-Based segment because some of you may not be familiar with what our current portfolio is today. But the Market-Based segment really is a portfolio of businesses that capitalize on the core competencies and strengths of the Regulated Business. And furthermore, they benefit from the very strong brand reputation of American Water, as well as over 125 years of customer trust. And what our focus is, is we develop and we want to build profitable businesses that provide a customer solution and that also are aligned with what I will say our regulated-like business characteristics or traits that you see here because we know that's what our shareholders expect of American Water.

We have 4 businesses to date. We have our Homeowner Services business, and that really came out of a customer need. We heard from our customer service reps and field service reps about 12 years ago that when a customer had a waterline leak and we went out to tell them and said, "Mrs. Jones, you have a leak, and it's on your property and you're responsible." That about 90% of those homeowners were not aware of their service line ownership and their responsibility. And so we decided we needed to educate them about that, and we also developed a warranty program that was optional to provide them with peace of mind. And it's been a very successful program, which we'll talk a little bit more about.

Our second line of business is the Military Services Group. In 1999, Congress passed legislation that required that every military base evaluate privatizing their utilities, including water, wastewater, electricity and gas. And American Water saw that as a great opportunity. It was a way to do what we do today, provide water and wastewater service to a long-term 50-year regulated-like contracts. In 2003, we won our first military award, Fort Leavenworth. And today, we have 9 military installations, 8 of those are Army and one of those is Air Force.

Our next line of business is the Contract Services Group, which we call CSG, and they provide water and wastewater operations and maintenance to about 40 municipal customers, about a dozen industrial customers and 8 commercial projects as well.

And finally, we have Terratec. Terratec is the largest biosolids company in Canada. We acquired Terratec back in 2001. We provide turnkey residuals from operations for municipalities and for industrial clients. But Terratec also is very highly regarded for their beneficial reuse of biosolids. And that is done through land application on farmland across Ontario as well as through Class A technology and a pelletizer that we do with the City of Windsor.

Let me talk to you briefly about the performance of this segment over the past few years. If you look to the right, our operating income, you'll notice, has doubled since 2010. And that has been with a focus on cost reduction, portfolio optimization and targeted growth. And next year, we're projecting our profits to come in at just around $51 million. However, if you look at the revenue chart on the left, you'll see a little bit different story. You'll notice that our revenues were flat for the past 3 years, but that really varies considerably by line of business. So if you look at the chart on the left, that dark blue bars in the middle represent our Military Services business. The Military Services business has doubled their revenue since 2010. And they're projected to grow an additional 33% next year. The lighter blue bars underneath military is our Homeowner Services business. Homeowner Services have had a top line CAGR of about 14% over the past 3 years, and Homeowners is projected to grow another 15% next year.

Conversely, however, if you look at the orange bars at the top representing the Contract Services portfolio, we have been highly focused on eliminating and shedding low margin poor-performing contracts. The result, our revenues have declined $44 million, but we have a much more stable and a much more profitable business of Contract Services. And you'll see Terratec, indicated by the yellow, has remained relatively flat. Next year, for this segment, we're estimating that our top line growth will grow about $48 million. And what's significant about that is that represents 1/3 of American Water's total revenue growth that's estimated for 2014. So we've got a big growth challenge ahead of us. But as I hope you'll see through the end of this presentation, we have a great track record and a lot of strategies in place to deliver on that.

So let's take a closer look at Homeowner Services. I came to American Water about 11 years ago to work on this business, and my background is not utility. I came out of Cambell's Soup and Comcast and a lot of other different types of companies. And I've had a lot of really exciting opportunities in my career. This has been the most fun and the most exciting growing this business because it really takes a true customer need and we're really able to grow this through the footprint of American Water through the brand and the trust that the customers have in each of the states.

This business has grown really 2 ways. We've grown by expanding our geography. So we started with waterline protection, in blue. And we originally went to the American Water footprint. And then over time, we took it further to partnerships with municipalities. And also, we do a lot of the dedicated targeted marketing across the country now. In addition to increasing the geography, once we gained that household with waterline protection, we then upsell them with other adjacent complementary products. Once you've identified or sold a warranty-minded risk-averse customer, you're then really able to bundle services and get more wallet share or more revenue from that household. And so, over the past few years, we've introduced sewer line protection and home plumbing protection. And if you see that little green piece on the top of this year, we are currently in a pilot test for an electric and gas line warranty protection program.

So what are we going to do going forward? That chart prior showed you how we got to where we are today. We're just going to build on that same track record. We're going to continue to expand geographically through targeted marketing initiatives and through partnerships. And we're going to continue to develop and launch adjacent and complementary products and services to our captive footprint of warranty-minded customers. In 2014, Homeowner Services, as I mentioned before, is projected to grow about 15% in revenue, and that will bring this business to just under $100 million in revenue.

So why do we feel confident about this growth? This is a map of the top 100 cities in the United States today. And the purple dots represent cities today that currently do not have a service line partnership. It's about 85% of the top 100 cities. Our cities where we partnered are designated in red and our competitors are in green. We have seen a tremendous amount of momentum just in the past year. We've seen more RFPs for this type of service offering in this year than we have in the past 3 years combined. We've recently expanded our business development team, and we also have met with at least 12 of the cities that you see here on the map. So we think there's a tremendous opportunity. Of course, on the heels of our launch to New York City, which is not even a year old, we launched last January, we already have 1 in 7 New York City homeowners who have enrolled in our programs, with 98% of them taking both water line and sewer line protection. In fact, I met John when we got here today, and he said, "American Water, I love you guys. I just signed up for your service line protection program." So we might bring him in to do a testimonial a little later today. He's showing it to all of his neighbors.

But on the heels of New York, we have such a great story now to go and promote across the country, and we won national right after -- pretty much soon after the launch of New York. So we are very excited and hopeful that we can grow and expand, geographically, through these partnerships. But as I mentioned earlier, the other path to growth is through introducing adjacent products, and there's a lot of opportunity.

The homeowner warranty and maintenance market is about $15 billion and it's growing. We feel that American Water is really well-positioned to capitalize on this opportunity. As I mentioned, we already have the customers. We have close to 700,000 customers and 1.25 million contracts, so we have an audience that we know is responsive to these types of programs and offerings. I think you'll be hearing a lot about a lot of new products over the coming years. We have a lot of work. Many of these are in different stages of product development, and as I mentioned, we do have some that are in pilot test today.

Okay, let's talk about our next, I will say, very successful business, our Military Services business. It's interesting to me, but when you look at the business, it's really grown the same way that Homeowner Services has grown. It has grown from a focus on expanding its customer base, or in this case, military bases, specifically, and then, once we win that award, focusing on getting more revenue, if you want to call it more wallet share, from each of those bases that we serve. Today, we have 8 army bases and 1 air force base, and the way that we have an opportunity to get more revenue, once we have the award, is through the items you see on the left side. The first is called price redetermination. After we win an award, 2 years after we win an award, we have the opportunity to go back and say that economic changes and fluctuations have occurred in the market, and we can also look back and say that now that we've been on base for 2 years, we've identified a lot of assets that we were not aware of during the original due diligence period. And we have the opportunity to work with the DoD and reset our service fee. Additionally, we get the opportunity to do that every 3 years throughout the 50-year contract. So again, this is really very reg-like in a sense in that we get to recoup -- recapture costs as they change in the marketplace.

And the second way that we get to add revenue on an ongoing business is through infrastructure projects on the bases. Let me show you a similar chart, and I'll talk to you about that a little bit, this is the history -- this is revenue for Military Services group. The blue bars represent the service fee contracts, the operations and maintenance contracts for each of the bases. I think what you're going to see, is that all of a sudden these yellow bars start showing up in about 2010 to a pretty significant level. And you can see, coming into 2014, it's almost half of our total revenue. What we realized, after we got onto the bases, is that similar to what Walter talked about, the assets have been completely neglected on base. Garrison commanders are really no different than mayors. They have a certain amount of dollars that they are able to spend each year. And they have a lot of priorities, just as city mayors do. Your water assets and your wastewater assets, they're underground, they're out of mind, people aren't thinking about spending money on them. But as I will share with you shortly, I can do it right now, we have a very effective mechanism that we have been focused on for the past few years to be able to get funding to do needed infrastructure projects on bases. And this is a cycle that we now follow, and we're very focused on, and we do it every year. We start in October, right after the awards are made in September, which is the fiscal year, for the government, and we start working with our customers to identify what are the most needed infrastructure challenges on the bases, we work together, we do pricing and then, in September, we are awarded contract modifications. What makes this very unique and very successful is that there is a dedicated funding mechanism through utility privatization that provides for this funding each year. We do get delays very often because the processes can be very slow.

Remember, earlier, I talked to you about the price redetermination process, for example, that process often gets delays. But one thing good about the government is, everything is retroactive back to the effective date. So for example, this year, we were awarded $4.4 million in retroactive price redetermination. That obviously had a great impact on our profits this year. But again, a lot of these processes, you might hear often in our earnings calls, that things are slow and they slow down a bit, but we do always get the payout in the long-term.

Let me just also say that, currently, we have $200 million of backlog in infrastructure projects that are already awarded. And that backlog will be executed in our plans over the next 3 years. And that $200 million does not include the infrastructure projects we will be awarded in September of '14 and going forward.

So there have not been a lot of recent awards that we've told you about on our earnings calls in the past few years. But we think we're at the point where that's going to change. Right now, there are 15 RFPs that are pending for water and wastewater across army and air force installations. Now, we don't bid in all of those, because they're not in our target. They don't match our business model. We're interested in those installations that have significant utility assets and that have 50-year revenues between $250 million and $0.5 billion. So we're actually bidding on probably less than half of those pending awards that are out in the market today.

The procurement cycle, shouldn't surprise you, is about 4 years long. Things move very slowly, but they do move. We are pleased to say that a few of the pending RFPs we're working on are nearing the end of the procurement cycle. And so we're hopeful that, that, along with, hopefully, the sequestration that's been lessened, things are moving, there is momentum and we will be able to announce new awards in the near future. So, what does that mean? Our portfolio in MSG today is worth about $2 billion. The RFPs that we currently have in the markets that are pending would double our size. And then we see another $9 billion in army and air force opportunities that are in, what I'll call, our sweet spot, in that $250 million to $0.5 billion range with significant assets. So again we see strong momentum in the Military Services arena as well for continued performance for this line of business.

I just want to talk to you for a moment, and this is my last slide, that about how beyond Homeowner Services and Military Services, we're thinking about growth for the market-based business. Just started off talking about us having a customer-centric focus. As somebody who runs competitive businesses, we have to be customer-centric. We can only be successful if we identify true customer need and then, work to think about how we capitalize on that and leverage our American Water strengths, our core competencies, our brand, our customer trust, and that's where the opportunities really become exciting. So we're making an investment this year in business creation. We're looking at all 4 of these quadrants, and we have market landscape assessments that we are actively analyzing and executing on. We are looking at the entire water and wastewater cycle, maybe not where we've traditionally looked but really pulling back and looking across the entire cycle to see, again, what can we leverage from our competencies, from our customer footprint, from the strength we have, as a company, from our brand, what are the customer needs in the marketplace, what are the growing categories of opportunity, and where can we profitably scale businesses that are aligned with those regulated-like business traits that I mentioned at the beginning of the slide. And that is really how we're going forward and thinking about growth for the market-based business at American Water.

So again, I thank you. I'm very excited about the future. I'm very excited about the colleagues that I have the opportunity to work with. I'm going to miss Jeff terribly, I can say that personally. But I can also say, in the short time that I have known Susan Story, I'm thrilled to be working with her, and I know that we're going to deliver on great growth in the future. So with that, I'll turn it over to you, Susan.

Susan N. Story

Thanks, Sharon. So you've heard a lot today. You heard about -- Jeff talked about our strategic kind of direction in the future, and you looked at the triangles we looked at, so where we've been, where do we look at 2013 landing, what does '14 look like and what about long term. Then you heard Walter come up and talk about, here's how we're going to achieve the regulated CapEx and the regulated acquisitions. And then Sharon came up, and I think this may be the most, in this group, at least, that we've ever had this type of discussion in depth, about the market-based business, the bigger components that you're very familiar with, on Homeowner Services and Military Services Group, what goes into them, but more importantly, what are we doing looking forward. It's not just what's happened in the past, but for what we can learn going forward.

So what I want to do kind of closing up the formal part of our presentation, first of all, talk to you again, about the 2013 landing zone; then I'm going to go back and summarize for '14, the components of growth, summarize; and then I'm going to going to lower detail about the corporate expense management piece that Jeff alluded to. Then we will come back to the guidance again for 2014, and then we'll go to Q&A.

So let's talk about the 2013 landing zone. We've shown you before how we got to the 1.99, which is the base, from which we started our growth. You will also see for 2013 landing zone, the reaffirmation today, or the affirmation today, of the 2.17 to 2.22, with the landing zone, the gap 2.03 to 02.08 for continuing operations, which, I guess, makes it still non-GAAP, but -- and then the -- we have for the year '12, last year, we had the sales that we had as operations, so some of that will show up from the year-to-year comparison. And then, the tender, the premium and fees. Now, just in 2012, the way that we built back in and basically said the favorable weather should be taken out, where we land in 2013, for all the projections you saw us make on the triangles, we will add back in $0.03, because we had unfavorable weather, mid-range of the unfavorable weather was 3, so where we end the year we will add $0.03, and that's what we've done when we projected growth, just to let you know, so that this is a weather-normal basis.

So let's talk about 2014, again, this is the same slide you've seen. Walter came up and talked to you about regulated CapEx. He mentioned 3 key things. One is the -- really, how it is recognized, acknowledged that we have an aging infrastructure and that we can only go so long in this country without replacing the pipes, the valves, things we need to deliver clean, safe, reliable water. So we know that, that's out there. He talked about the continued investment into capital expenditures to replace that, and that 66% of 2014 reg CapEx was going into asset renewal. He also mentioned how a growing percentage, what we estimate to be 60% next year, will be through mechanisms that do not require us to have a rate case to get recovery from customers. So 60% through mechanisms like the distribution system infrastructure charge, as well as the future test years.

He talked about regulated acquisitions. We talked about the growth of this. A few key points here: Walter mentioned 30,000 new connections that we will close on in 2013, and Jeff and Walter both mentioned, and this isn't -- we say, we were going to focus on wastewater. Well, this year, of the 30,000, 8,000 are water customers and 22,000 are wastewater customers, as Jeff said. So as we go forward, you can see, and as Walter talked about, the -- what we get when we are able to combine water and wastewater. And the internal efforts that we're doing to ensure that we can provide the most efficient services by having dual customers. He also talked about the fact that we have these enablers. And this is really important. We've talked about 2013 was a good year in acquisitions, more connections than we've had in the previous 5 years combined. He showed you targets, that was not an exhaustive list, that 2014 we fully expect and hope that it will be better than 2013. But he also showed you only enabler's pay, this is going forward. It's one thing to sit back and say, we think we can do this, then we've got this 1 or 2 ways that we're going to reach this goal, but what Walter said, we're stepping back, going -- so how do you deal with the real issues that would prevent us from expanding into wastewater and water? And those are regulations or laws, or things that prevent us from being the competitive choice and for being what's best for customers. And that's the core thing that I hope you heard everyone talk about today, which is, when we do this, it's not just what's best for American Water's shareholders, it's what's best for our customers. Because we really believe, as Jeff said, if we take care of our customers, the financials will follow. And that's part of the regulated acquisition. When people come in, I know a West Virginia acquisition we did this year, they were so excited about getting American Water, water. Because it was clean and it was -- they could depend on it. So we take very seriously the fact that we're there to make sure what do the customers need, what will make them happy and let's work through the regulations or the laws that prevent us from doing that.

We talked a little bit more about the 5 year CapEx, and, as Walter mentioned, we've not, before, actually shown the rolling 5-year CapEx plan. We wanted to show you this because we've added the pies in, this is not our plan, but we want to show this for contrast. And you heard both Walter and Jeff talk about the fact that, from 2009 to 2013, our CapEx budget was about $4.4 billion, and you see the breakdown between regulated services and service company, most of that is IT, business transformation, it's recovered basically through the subsidiaries. And then, you see market-based, as Sharon said, very asset-light, very CapEx light. And then regulated acquisitions, for the past 5 years, have only been about $100 million, including this year.

Our plan, that you've heard about, is the middle, $5.8 billion. You see that $5.1 billion of that is regulated CapEx, not acquisitions, we've broken that out here, regulated CapEx and services. Then, you see the market base, regulated acquisitions, over this 5-year period, we're estimating $400 million, and strategic, $300 million.

Now, the strategic is, for 2014, we have $100 million of strategic investment. We have not put into our financial plans a return on that, to be very conservative. So that is, if an opportunity comes up, as Jeff and Walter discussed on unregulated shale, if an opportunity comes up on a major concession, we're just looking at a way to identify some strategic capital. But what we wanted to show you, and as Jeff and Walter both said, the average impact on the bill is 2%.

Now, if you look at the last chart, here's what we did, we said, "Okay, so let's look at how much capital we could spend without stretching our credit metrics or putting our credit ratings in jeopardy, and without having to issue new equity. Could we spend more money than the 5-year plan we have?" And the answer is, yes. In fact, we could spend $600 million more, not all in 1 year, we could spend $600 million more and, if we assume, that all $600 million goes into the regulated side of the business, the difference, because we've already taken into effect the declining usage, rather than a 2% average, and as Jeff said, that's less than 0.5% up to 5%, depending on the state, that increase to our customers goes up to 4%, and that was not acceptable to us.

This is a real-world illustration of how, when we do capital budgeting, we are clearly looking at what impact will this have on our customers and affordability and regulatory relationships. Although, just from a strictly financial standpoint, we could do this. Now, one thing I just want to mention to you, too, and we're in a very good position, the EPA has, what they call, an affordability index for water. The Department of Labor, the latest statistics that we can get from an EPA deal, well, 2011, they said the median income was $40,000 and the EPA estimates that families spend about 10% of their median income on all utilities, that's electric, it's telecommunications, it's gas, it's water. Water is about 10% of the 10%, or 1%. They have an affordability index, the EPA, that says 2.5% of median income is affordability for water, which is about $84 a month. Our bill in American Water range from about $33 a month to a high of $74. So comparing that to the EPA Affordability Index, we're still well within the range. But just to let you know, as Walter mentioned to you all the customer satisfaction numbers, we're always looking at this, and this is critically important that we compare this anytime we are doing any of our budgeting.

You heard Sharon talk about the market-based business, you heard her talk about Homeowner Services, you heard her talk about partnerships and geographic expansions, and products and services expansions. We are very careful when we go out in market testing. We do significant risk analysis. You also heard her talk about the Military Services Group, which really plays to our strength, being national. The larger bases are the ones that we're interested in. We have built a history of performance with the Department of Defense, and that has a value. So all of those things come into play when other opportunities come up, both the army, the air force and, as Sharon mentioned, for a period of time, there was -- there seemed to be very little movement, but we've seen a new interest in terms of even new RFPs especially from the air force. She also mentioned that towards the end of the 4-year cycle for a lot of RFPs that have been pending, some of which go back to 2009.

And then, shale. And Leslie asked a question at the break, Jeff talked about this shale in the regulated side of the business. We have a tremendous amount of experience in Pennsylvania, especially, with providing water for drillers and ensuring the quality of the water because that's a source of water we use to serve our customers. The unregulated piece is, and as Jeff said, we are not going to do anything speculatively. It will have to something to like the rest of our market base, mimic the regulated side of the business. But we're building a lot of relationships and our reputation and an image for being a great partner in terms of ensuring that we care for the water, and we provide a great service at a great cost. The bogey is, of course, trucking water in. We're working with a lot of the major players to say, what if is not in our service area, what would the opportunities be.

But you'll also notice on the triangle, shale always has a 0 to 1, 0 to 2 in the outer years, and that's because we are not basing our future financial plan on shale and what happens.

Corporate expense reductions. Let me spend a little bit of time going through this. And this is significant for us, this year, for reasons that I know that most of you are already very familiar with. You've heard it from the electrics and it has to do with interest savings, as well as pension savings, along with other post-employee benefits. I want to talk about cost controls. When we talk about corporate expense management, we also want to talk about cost controls because the ability to hold our costs down helps mitigate any of the O&M increases. You heard Walter talk about the fact, and this is critically important, when we go in for increases for our customers, when 94% can be based on capital investment, that makes their systems more reliable, improves customer service, then it gets a lot better treatment than the perception, perhaps, that you could have as a company that you're not maintaining control over your O&M cost. So it's a lot better to go in for the capital, and as Walter said, we've gone from 58% in 2010 recovery for O&M to 6% for the rate case of this year. And Jeff mentioned a little bit about this, the green line, starting in 2011, the business plan was 3% growth in O&M a year. And that sounds not that much, right, 3% a year. So our previous plan, we came in and said, "No, we think we can do better than this," and we put some controls in. This year, in developing the 2014 to 2018 plan, you see where we've come. Jeff mentioned that from the green line to the blue line, that you're talking about, over the 5 years, $920 million. But the difference in the red line and the blue line just last year's plan to this year's plan is about $240 million difference. How are we going to do this? I don't want to repeat everything that Jeff and Walter said, but the SAP efficiencies are a big part of this. There is very specific projects I'm not going to go into, but I will just remind you of a thing. The SAP system has allowed us to have a tremendous amount of information. We have resources dedicated to the manual generation of data. With SAP, we don't need resources dedicated to the manual generation of data. It is value-added analytics. We are looking at our enterprise asset management system with management being automated. The efficiencies from SAP, we believe, are going to be significant. We have different areas of our company who are doing a tremendous amount of work, not just saying, "well, what report can I quit doing?" But stepping back and looking at their entire businesses, saying based on the system, if I started today, what is the most cost-effective and efficient way to do this process. And they were coming together, across organizational lines, making sure that we're fully leveraging those efficiencies. And because we're completing conversion, now, the fourth quarter of this year, next year, it's a big year for us to step back and after we've gotten the system fully stable, everybody's comfortable, we go, so what's next? What's next?

Plant automation, the idea of a virtual water treatment plant. You heard on the video, you heard Walter talk about a lot of the things we're doing to implement technology into our company and how technology can help us be much more efficient. And like Jeff said, again, also, it's not about quick cuts for 1 year that make your earnings for a quarter or a year. We're not -- that's not what we're about. What we're about is changing how we do our business fundamentally. Jeff, what he brought in 3.5 years ago, the value is greater than the price, which is greater than the cost. And how do we do that were effectively?

AMR, AMI. In the water industry, contrasted to some of us who have a background in electric, the meters are required, as Walter said, to be changed out every 10 to 20 years. So you have an opportunity where you're going to be implementing and deploying new meters, anyway. So we have a chance to move that technology there. And I believe, now, we're what? 80%, Walter? 80%, 85% with AMR, and where it's cost-effective, AMI. And Process Excellence Projects, a group John Bigelow heads up, which consults throughout our company with how can we do our business better.

Now some of the big things, and Bill Rogers is here, and you all know him, the Treasury group has had a really tremendous year, this year. They've done an outstanding job of looking at our liability management and our debt management. One of the things, I know you're already familiar with, the $226 million tender offer, that was for how much we were able to get in, we basically went out and said we wanted to tender up to $300 million. The purpose of this was to reduce capital markets volatility in 2017 and 2018. We have, what we refer to as, parent company debt of $750 million maturing in 2017, and the other $450 million maturing in 2018. So we went out with a tender. The results of the tender, we took an extinguishment charge. However, we also expect, over the life, to save $80 million. That wasn't the purpose, but because we've not only reduced the market risk, and you've seen the chart with how much, how spiky it got in 2017, but we're also going to have significant interest savings. The plan is to finance with commercial papers through mid-2016. Of course, we're always looking at the market to determine the optimum time to do that. And in 2014, we project the interest savings from the tender will be $7.5 million. If you combine that with some of the redemptions, the refinancings we did on redemptions as well as maturities, we had $150 million worth of redemption at 10% coupon and 8.25% coupon. Now these were ones that we were happy to refinance, and we were able to refinance at 3.5% coupon. And also some of the activities that our Treasury group had this year, increasing the size of our revolver from $1 billion to $1.25 billion and taking out maturity for $1.18 billion of that, an extra year, as well as on the commercial paper program, we went and expanded from $700 million to $1 billion. So when you look at the interest savings to net income, you look at the impact of the tender, the redemptions, the retirement refinancings, it's about 7% EPS diluted impact.

We talked about pension a little bit. I know several of you have written up about pension. So when we look at our pension costs, we work with Towers Watson, as most utilities do, we went in with them and we looked at our assumptions, let me talk about that first. Discount rate, we're showing you what was used for 2013, what's being used for subsequent years, with the latest Towers Watson study that we just received about a month or so ago. Our expected return on assets is actually decreasing in our model, and here's why. At one point, we were close to 70% equities. We want to derisk our pension investment. So what we will -- our target, through the end of 2014, is to be about 52% equities, 8% real estate and about 40% long-term fixed income. The impact of the new numbers for the pension, for 2014, and this is incremental to the previous plan, so these savings compared to the plan that we earlier had, $7.5 million on pension post-retirement benefits $2.7 million for a $10.2 million net income impact or $0.06.

So that is where you see the corporate expense reductions. Now, I want to go back and just be clear, the O&M controls that we're doing are helping keep us flat. As you know, because of the increased CapEx expenditures, we are seeing an increase in depreciation and amortization. So we're having to make sure the cost controls help us offset that, as well as some purchased water increases that we're seeing.

Now, so what's kind of the -- some of you've seen a chart similar to this before, we've had various names for this chart. So where are really kind of the variabilities for 2014 in terms of our guidance? Well, in terms of in cents, [ph] the weather, of course, is the biggest. We did not show a weather impact as big as we saw in 2012, that we just believe was extraordinary year, extraordinarily hot and dry, over a big part of the country, which is why we had a 13% to 16% range, then. So this is what we're showing as kind of a plus and minus. Market-based businesses, and Sharon talked about this, on the downside, the timing of the military awarding new contracts, the RFP, price determinations, where -- and then also price redeterminations, where we could actually get it, but it might be delayed in terms of when we would actually see it realized. And on the upside, we could have more partnerships, we could see more of the Military Services Group, the price redeterminations, or RFPs, come into play, that we have in our plan. Corporate expense reductions, this is predominantly -- the plus or minus would be in terms of pension, could be better or a little less than what we thought, insurances and interest. And then, regulated acquisitions, a little bit tighter around that based on '14. We have, as Walter said, a pretty well-defined pipeline for that. So these are kind of the variances we see that could impact the 2014 guidance.

So moving from the guidance to some financial metrics, free cash flow. Let me first of all note, if you look at the bottom, our -- we use a very conservative calculation which is, net income plus depreciation minus capital expenditures. Also note, regulated acquisition capital expenditures are not included in this. Regulated CapEx and strategic CapEx does not include a return. But this does not include regulated acquisitions, of course, or dividends, pretty standard. But you look and see, as Jeff said, we start showing a positive free cash flow in 2017. Also, you'll see that we continue to strengthen our balance sheet. When you start looking at our equity, a slow growth, and also, one of the things, and Bill Rogers takes the full credit for this, we've typically had very, very little variable debt. And so we're basically setting an amount of variable debt that we want to ensure the floating debt that we keep through the years and we're doing that through the debt management program. We will do most of that, by the way, if not all of it, Bill, I believe, at the parent company, typically not the subsidiary, which is fixed. And again, this was a good year for us in terms of our credit ratings. We're both raised by S&P and Moody's. And as we've said over and over and over, no planned equity offering under the normal course of business.

Now we're very proud of this slide. This is a terrific slide. When you look at 2011, we've got our net ROE that was earned by the regulated subsidiaries. You've got ROE impact the parent company debt or parent company debt drag, as we refer to it, and you've got the regulatory lag. That's either not being able to earn authorized or having a lag between when we can realize the investment that we make. 2014 plan, we go from 7.2% to 9.1%. The parent company lag goes from 100 basis points to 50 and the regulatory lag from 100 basis points to 40 basis points. And we're very proud of this. Of course, the parent company debt drag goes down because not just the tender, which was 2.26 out of 1.2, but the fact, of course, that as we've refinanced, interest has gone down and shareholder equities we got in the business has gone up.

And our dividend history, as you all are very familiar with and on December 13, last week, our board declared a quarterly cash dividend of $0.28. And you see the dates there.

So on EPS, we come back to our 2013. We are affirming $2.17 to $2.22 for 2013, and we're putting the 2014 initial guidance at $2.35 to $2.45.

Jeff?

Jeffry E. Sterba

Thanks very much, Susan. I hope that we've provided you with some good information about our business. In this presentation, we have tried to give a greater level of transparency and insight in detail about our business, our prospects, where the growth comes from. And I know most of you, or at least a number of you, are well enough to know, we probably aren't meeting all of your wants. I'm not sure that, that's possible to satiate but at least, I think, or hope that you'll agree that we are providing a lot more. So you can get to decide about your level of comfort as we see the growth and prospects for the future.

The other thing that I hope you take away from this is the level of comfort that I and our board have in the hands that we're leaving this company. From Walter, Sharon and Susan, you heard people that understand this business, have a laser-like focus on what we're trying to accomplish and the drive and the commitment to the culture that we've started, which will sustain the results. That's exceptionally important. And if the other 3 senior execs that had been able to come up and talk, you would have heard the exact same thing from them. So the level of confidence that we have in the ability of this company to actually accomplish the things that we've talked about is quite high. So that gives me a lot of comfort that this will remain my core retirement investment.

One of the things that we started 3 years ago was, at the beginning of every year, when we gave guidance, was to provide to you a list of those things that you can hold us accountable for during the year. So that as we go through the year, you can either check off or decide, 'well, I don't know if they're doing this or they are doing this,' and we will also report on this every quarter.

So let me just go through them very quickly. Optimize capital spend. We're focused on this capital investment side, not only in how much we spend, but the efficiency with which we spend it. It's what we spend and how much do we accomplish. And so we have instituted within our company a series, and we've got more to go, of measurements that are all around the effectiveness of our capital spend. So a lot of this involves our supply chain initiatives, but it also involves our workforce initiatives to help ensure that the productivity on both our capital and our human capital side continue to increase.

The constructive regulatory frameworks, we will resolve 3 rate proceedings during the course of the year. We're looking at filing up to 5 rate cases this next year. We won't tell you which states, because the first conversation -- that conversations had with those states for us. But we're looking at filing up to 5 rate cases. And you will see us continue to pursue these kinds of initiatives and opportunities to expedite the return of capital through mechanisms other than a rate case. Because quite frankly, they've been -- this benefits customers, it benefits, certainly, the flow of capital into those states that enable it, and it helps manage the risks that are associated with things that either have volatility or the investment of the capital.

Our O&M efficiency. Walter said it, but I got to reinforce it. When we established the 40% target and an aspirational 35%, I mean, they've really thought that we needed to go see a certain kind of doctor, because it was just something very different than they're used to. But to now see our employees absolutely believing they can achieve 35% and not at any risk to reducing the quality, safety or reliability of our service. This is being done by technology, innovation and efficiency, not by slash and burn.

So the fact that our folks feel good about saying, "Yes, we beat the 40%, 2 years early. We can do 35%." And frankly, also remember that the 35% is going to be done in a period where rates are going to be going up at a slower rate of increase than they have over the last 5 years. So it really takes a level of discipline and trade-offs. And it all starts with us, these 3 questions that we've talked about before, that we ingrain in our heads and our folks' heads, A is what we're doing adding value. And by value, I mean, at the end of the day, is it better providing service to customers. If it isn't providing value, why are we doing it? And it's amazing how many things you all and we end up doing because we've done it. Not because it makes sense to do it in the future, but it's the way we've always done it.

And then once we say, "Okay, it adds value." Is it being done through an efficient process? And there's so many different ways to think about efficiency of process. But that drives bureaucracy. And, so, whether it's de-bureaucratizing our policies and procedures, whether it's changing the process by which we get work orders into the hands of the people in the field, whether it's the process by which we're able to produce our financials in 6 days, and Mark made 5.5 by the way this -- last month, versus 12 days, which was the rate before, that's a process improvement.

But then even when we've got an efficient process, our big focus and the enormous strain on business is associated with errors and rework. And there are -- there's case after case where our folks are now -- they didn't even think about counting errors. We didn't know what error rates were. Now, our folks do. And so we start -- once you've started identifying errors, now you figure out how do you start to reduce those errors? How do you take them to 0?

So this O&M efficiency side is one that, it's not just about reducing our cost. It's about the mentality of our employees, how they think about the business, how they make incremental continuous improvement. Our regulated acquisition strategy, Walter and Susan both talked about that. This is not, as Walter said, we're not turning around now and saying, "Oh the dams are going to break, look at all of these acquisitions." It's absolutely not. We don't believe that's going to be the case, particularly in the water space. What we are saying is we serve 3.2 million customers water everyday, great water. Only 100,000 of those do we provide wastewater services to. Our big wastewater businesses are on our market base business. So only 100,000 of those do we provide wastewater service to. That means even where we already have a footprint, there's 3.1 million customers that we can talk with those communities about, "You know, we can use the same trucks. We can use the same supply chain. We can use many of the same tools to provide wastewater services to your community in addition to water." And again it's not necessarily about laying people off, at all. It's about using capital investment more efficiently.

And then the continued growth in our market-based business. One of the things that's really important to us is that while our market-based business is growing more rapidly, we are absolutely focused on having that occur in a way that does not change our risk profile. So while it becomes a bigger share, it is -- the lion's share of it is reg like. It's military service contracts, 50 years. And we reprice every 3 years. It's Homeowner Services where we have 85% renewal rates, and it's incremental to what we're doing, and it's tied to our overall customer satisfaction. So -- and if we move into the market-based shale side, it will be not on the com [ph], it will be fixed revenue sort of streams associated with it. So that is what you can hold us accountable for through the course of the year.

At this time, we'd like to open of the floor for any questions that you have. You want to get the chairs? While they're grabbing chairs, because I want everybody up here, because I just get to direct the questions they have to answer them. I do want to make note of something that goes along with the cases. You noticed at your table, these cases which -- I'm sorry we don't have any for BlackBerrys. I'm still trying to figure out who still has a BlackBerry. I see Steve does. And you call -- you thought the utility industry was hard to change. They don't break, I agree with that. The one disappointment as we wanted to put Ed Vallejo's mug on the back of that, but we're just not going to do that. But we also have made an app that you can pick up for either your Apple or your Android that has our investor water -- Investor Relations app in it. And you can go to AWK IR on any of the app stores on the App Stores, iTunes or whatever, and you can download it. And in fact, the presentation that we've done is on it., and I'm sorry, that's the wrong price. I think we're up about I don't know, $0.70? A percent and half or so today alone. So please feel free to use that. And I must say that there was some comment around the naming the app, AWK IR just fit, I guess.

Question-and-Answer Session

Jeffry E. Sterba

So with that, we'd like to open up the floor for any questions that you have. Yes, sir? Mr. Chin. And we've got a microphone, because we're still on our webcast.

Brian Chin - BofA Merrill Lynch, Research Division

Great, Jeff. Brian Chin with Bank of America Merrill Lynch. On Slide 43, the cost controls with the current plan, just wanted to make clear that, that current plan is now embedded in your '14 guidance and going forward. Is that correct?

Susan N. Story

Yes.

Brian Chin - BofA Merrill Lynch, Research Division

The reason why I ask is because when we look at that current plan on -- I'm sorry, I guess, in my book, it says Slide 43, I think in the slide deck it's the Slide 45.

Susan N. Story

It's the pie chart. The pie -- the 3 pie charts. That one, okay.

Brian Chin - BofA Merrill Lynch, Research Division

That one, 45. The only reason why I ask is because when we look at the magnitude of the difference between the previous plan at the current plan, it looks like there's a fair amount of savings there. And then when we look at the EPS trajectory, your long-term compound annual growth rate, which I believe hasn't changed from your prior disclosures, your new guidance for '14 doesn't seem to account for the difference between these 2 O&M plans here versus how much higher '14 guidance is above the long-term trajectory. So is there like an offset that we need to think about?

Jeffry E. Sterba

No, the thing -- the red bar was really the 5-year plan that was developed in late '10, 2010. We've done -- redone annual plans, so a lot of -- some of the change for '14 was baked into the plans that we did in '12 and '13 and '14. So this is just looking at two 5-year plans, one that was really done in 2010, and then the one that was done in 2013. So it's not a year-to-year change. Okay, so if you look at our O&M for 2013, it's going to be right about where that blue mark is.

Brian Chin - BofA Merrill Lynch, Research Division

Okay, great. And then I've got one more follow-up, and then I'll jump off. In general, for the shale commentary, you had said there's going to be no speculative building of infrastructure that's being contemplated by the company. Who are your competitors out there that are looking at shale? Because, to the extent that they start grabbing market share or opportunities, I got to imagine you're going to have to balance well how much of that risk do you want to take on versus potentially giving up the share. Can you walk through what are some of the competing interest you might think about as you sort of face that decision on a going-forward basis?

Jeffry E. Sterba

Well, I'll start and others will add. The primary competitor is trucking. So if you look -- I think I mentioned that 8%, we basically serve -- provided water for 8% of all wells in Pennsylvania, 70% of the ones in Butler County. All the other water that was provided in Butler County was self-supplied from drillers. They may have put in a small pipe on their own for -- with a river permit, or they're using a trucker that has an outtake permit for raw river water and they're trucking it. We don't see a lot of competition on the actual building of pipe. There are a few that, of the companies that have tried to do a little bit on their own to bring water, but not in a significant way. If you look at -- I mean, Aqua built one pipe, that's up in an area that's dry gas, predominantly dry gas, but not down in what we call the wet gas region. So we're very -- our primary approach is we're looking at what it's going to cost the truck, so what's -- because that sets a ceiling, and are we going to be able to deliver for less than that? And what's the right sizing of that pipe? So we will take some risk, sure. You always -- I mean, but how much -- but placing capital at risk versus placing a little bit of return at risk are 2 different things. So we're not -- we're focused on not facing capital at risk. The -- any of you got anything to add or Mark is there something you would add?

Mark Chesla

The only...

Jeffry E. Sterba

Hello, Mark. Grab the -- use the mic. No, right behind you.

Mark Chesla

Brian, your question, what we've seen, and I'm not claiming that we have encyclopedic knowledge about the whole industry, but from what we've seen, some of the companies or the midstreams do try to self perform, but there's no other major company that's out there trying to do on an aggregated basis. So trucking is the best reference pricing. And then some of the drillers or the midstreams have tried, in limited circumstances to, do their own piping.

Jeffry E. Sterba

Yes, sir?

Adriano F. Almeida - Cramer Rosenthal McGlynn, LLC

In the very beginning...

Jeffry E. Sterba

Just for the people, if you could give your name and where you're from -- what.

Adriano F. Almeida - Cramer Rosenthal McGlynn, LLC

I'm Adriano Almeida with Cramer Rosenthal. In the very beginning of the presentation, I think you highlighted some -- that you have had some challenges with the SAP implementation. Can you kind of elaborate on what exactly those challenges are? And also kind of quantify, because I know there have been some cost pressures related to installing this, so to the extent that it's going to go online and everything is going to start running smoother, there's going to be some cost savings associated with that event.

Jeffry E. Sterba

Let me give a bit of an overview, I'm going to ask Walter to give some details on areas that we continue to work with. They're not major, but we continue to work with them. One of the things about this SAP implementation, which frankly, is very surprising, I mean, very pleasing, but surprising. This may be the first or one of the only few utility implementations of SAP that is on budget and on schedule. And this is a budget and schedule established about 5 years ago. So we've basically been able to keep this thing at the budget that was originally set and on the schedule. The kinds of challenges with this -- with as much as we did is, typically, you'll find a company that they'll put in the ERM system or the CIS, but not all of it. We put in everything from the CIS and EIM system to the ERP of reporting in financial system. So it's been a big chunk to take on. You want to talk about the...

Walter J. Lynch

Yes, sure. I mean 2 areas that I'd like to spotlight, one of them is on our dispatching function. We deployed some software that we programmed with certain priorities and how to effectively dispatch our field service reps. And it's not working exactly the way we want it to. So what we're doing is taking a look it. We've put a team of experts internally looking at what's the best way to modify that to be able to increase our productivity in the field. And that's an ongoing effort. We were expecting in the next couple of months we'll have that solved. But in the interim, we've done some things to really alleviate some of the issues there and giving the latitude down to the field service rep and their supervisors to determine what makes most sense. What we're doing is traveling a little bit longer distances than we wanted and we're just putting some common sense back in where the field service reps can say, "Okay, instead of going there, I'm going to modify my schedule somewhere." But that's been an issue that's been out in the field. And we really discovered that having gone to the field, spending a lot of time in the field and asking our employees, where you guys have issues? What's not working as well as what you expected? And that was a common theme that we heard and that we've acted upon. Because it's one thing to go out in here, the next is you've got to act upon it and do it in a way that displays common sense and business judgment, and that's what we've done.

Jeffry E. Sterba

And I think this speaks to the culture of our workforce. We've had our implementation reviewed by an independent third-party. And they basically are calling it a textbook implementation. But one of the things we agreed on -- how many pages of metrics?

Walter J. Lynch

4 pages.

Jeffry E. Sterba

We have very specific set of metrics that we were going to measure ourselves by and they helped us develop it. One of the things that they kept telling us is, "Look, you're going to see a 10% or 10 percentage point erosion in your customer satisfaction." Utilities have put in place SAP, it happens, because you don't -- you were not able to respond, they're on the phone longer, the service doesn't get dispatched. You have to shake through this and you see, typically, a 20% to 40% productivity loss as you put in place a system. Well, based on the customer statistics that Walter walked through, we're not seeing that. And I really think even though we have had some bumps with the implementation system. It's not perfect. Our folks work through that. They're not letting it get in the way of serving and providing that service to our customers. That's pretty special.

Adriano F. Almeida - Cramer Rosenthal McGlynn, LLC

How about the cost? [indiscernible]

Jeffry E. Sterba

We incurred some higher operating costs when we implemented ERP last year. And Susan, you may want to mention that.

Susan N. Story

Right. So when we did ERP, which was the first phase in 2012, in the implementation all at once, there were what we call workarounds. And so it took a little more time to get the system stabilized. Mark Chesla is here and he has the groups that are doing this. So what you saw in the first quarter this year was we had a few million of O&M expense. We expense the -- we basically had some expenses, and then we have gradually, if you look in the first quarter disclosure, second quarter and third quarter, that number has gone steadily down as we have basically stabilized the system.

Jeffry E. Sterba

And on the capital costs of the project, it's on budget. And it looks like it will be completed roughly on our budget set 5 years ago.

Walter J. Lynch

So one of the great things in our culture too is we never have to worry about our employees telling us what's on their minds. So as we go out to the field and ask, "What's not going, in the way -- the ideal way?" They share with us because we've got a tremendous passion for customer service. Anything that gets in the way of that, they're communicating with us. And we take that and learn from it.

Susan N. Story

And also, by the way, the people who are out in the field aren't just Walter and Jeff. Every member of the executive leadership team, we have in our goal, it's called casual conversations. We go out and we go to where the service technicians are, we go to call centers. We have our executive team meetings all over the country where we have employees, and we have breakfast with them, lunch with them. I mean, the whole point is to not have things filtered from all parts of our company to the executive leadership team, and it's really remarkable to see how open all the employees are.

Jeffry E. Sterba

And it's not just even limited [indiscernible], for example, every officer of our company is required to do, and it varies based on what their role is, anywhere for doing 4 and 12 safety walks. What that means is when you're out in the field, with a crew, on site, and you're not there to critique their safety but you're there to talk to them about safety, to get it front of mind. But the other part of it is, is it opens a door to a lot of other conversations. And so it keeps us very much in tune with what's going on. It helps us pick up, for example, when we've got messages that aren't getting cascaded down through the company, they're not hearing about something that's really important for the future of the business, or -- so we find bottlenecks. And we're then able to address those bottlenecks such as our folks, they engage, because that's critical. Yes, sir?

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

This is Ryan Connors with Janney Montgomery. And by the way, let me just -- I wanted to say, Jeff, I actually like the sandbox and the pictures, so I was glad to see it go down the toilet like that. There was, I mean...

Jeffry E. Sterba

Did you want say anything about the picture?

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

But 2 prominent industry topics that I didn't hear you mention in your prepared remarks were decoupling and repair tax accounting treatment. So just, respectively, on decoupling, I mean, there's lot of talk about that spreading beyond, it's kind of home base in California to become a broader phenomenon. I just wanted to get your perspective on whether you see that occurring. And if so, that's something the company would be viewed as a positive or want to encourage or what is your view there? And then on repair tax, recognizing that's a pretty complex topic, just give us your update on how you're viewing that, how you're treating that and whether that something you might utilize more heavily going forward.

Jeffry E. Sterba

Okay, on your first one regarding decoupling, look, we are, as an industry and as a company, dealing with this issue of declining residential use. And it has to be dealt with. Or those states that don't appropriately deal with it, quite frankly, you can't afford to invest that capital, because you're investing -- you're -- where 80% of our cost are fixed, but on average, only about 25% of our revenues are coming in on fixed charges. But our approach is that's the problem. How do we address it? And there are multiple ways to address it. Decoupling is one, and we have decoupling mechanisms in California and a variant of that in New York. It doesn't have to be done through decoupling, but we are very open to talking about and pursuing that mechanism in other states. There are other ways though. For example, the more you move to future test years and you reach forward 2 years on what you're building determinants will be. So that by -- when the rates are going into effect, they're actually being collected on what that level of usage will be or what that -- at that time. So you get them synced up, if you will. That's one way that some of our states have chosen to go. Some states, they don't want to reach out that far, to which our response is, "Folks, tell us another way." So, for example, in Kentucky, the entire rate increase that we've -- the commission has yet -- no, they have not formally acted, all of that rate increase was put into the fixed charge side. So it's reducing the amount of revenues that we're collecting on the volumetric charge. So our approach is to say, "Look, there are a couple of different ways we can look at this. It doesn't have to be decoupling or nothing." But every one of our states has got to address it. You want to add anything here?

Unknown Executive

No, it's really around the declining usage. As Jeff said and looking at what's the right way to address it in each of the states, and we work very cooperatively with the staff and commissions to say, "Okay, this is the issue and this is how we see the best way to address it, and they're not all the same but they're tailored approach to meet the needs of the commission and the staff."

Jeffry E. Sterba

And on the tax issue, Susan, you want to take that?

Susan N. Story

Sure. We actually do -- we have implemented repairs tax accounting. We were one of the first companies to adopt it in 2009. The difference is coming in that there's 2 ways that you can implement it. You can implement it through the way we did, which is called normalization, where we basically take the benefit -- the tax benefit, and we apply it over the life of the asset and it basically goes into the deferred income taxes. So customers benefit because, of course, you get the reduction of the rate base through deferred income taxes. But it's over the life of the asset, so it's not as drastic. The other method that we do -- we have not chosen to utilize. And at first, we couldn't. When we first adopted this, the IRS said, you have to use the normalization method. However, they changed that before some other companies adopted it. But we wouldn't change. I mean, given the choice, we have -- we're not interested in going back. Because for us, it aligns the benefits over the life of the asset for the customers who are enjoying that asset over its life, but those are actually acceptable. The flow-through and normalization method, are both acceptable. We're just very conservative and we've chosen to do it on a normalized method. But we are employing the tax repairs accounting and it is a major contributor to our deferred income tax balances.

Jeffry E. Sterba

Let me add just 2 quick thoughts. And, look, we focus on running our business. We have -- other people will make different choices in how they run their business. For us, we're in this business for the long-term. And so a long-term approach that recognizes the value of this, benefits the company through receiving the cash benefit and normalizes that for customers over a longer term, keeps it smooth. So you don't end up with sawtooth. Because if you flow through and you file a rate case, it's all going to go through in that 1 year. So it's -- whether it's philosophy or not, we're very comfortable with what we've done. The second thing is, rules have not been issued for the water industry. What we're waiting for is to see the rules that will be issued for the gas industry, which are expected, Mark, this next year, maybe?

Mark Chesla

That's best guess.

Jeffry E. Sterba

Best guess, 2014, sometime. Because gas and water have a lot of similarities in terms of the types of equipment, compressors, pipes, all that stuff. We have, fairly conservatively, held or what we've put on our books. And so a lot of what, even under our methodology, would be taking it into account, we reserved for. So once we get through the gas rules being issued, then we'll be able to see where we are. I don't think we've ever said what percentage we've been reserving, but it's significant.

Susan N. Story

10 48, right?

Jeffry E. Sterba

Yes, 10 48 [ph]. Okay, right there.

Unknown Analyst

I have 3 probably somewhat unrelated questions. One is on deferred taxes. When you went through your free cash flow calculations, did you include the benefit from these deferred taxes?

Susan N. Story

Yes.

Unknown Analyst

Okay. And then, one of the cost that you mentioned continues to increase besides kind of D&A going up from additional investment is the purchase order expense. Can you just talk a little more about that and how that big component is and where that comes from? And then, after that separately...

Walter J. Lynch

In our various states, in New Jersey and California and others, we purchase water from different purveyors. Typically, we have a pass-through mechanism. I know in New Jersey, we have purchase water adjustment clause where we'll file for that and get recovery in that in a short amount of time. There's a percent -- it's relatively small, what we do. It's larger in California but smaller throughout the rest of our system.

Jeffry E. Sterba

So give a sense, in California, roughly what percent is purchased water? 25%?

Walter J. Lynch

I would say 20. 20% -- 20%, 25%

Susan N. Story

And over the 5-year period, the purchased water is like 36 million [ph] total over the 5 years. So it's not anything close to the increase in depreciation and amortization.

Unknown Analyst

You said that mostly has pass-through mechanisms?

Jeffry E. Sterba

Most states.

Walter J. Lynch

Yes.

Unknown Analyst

Okay. And then finally, you talked about a few legislative initiatives being enablers for kind of some of the growth that you're planning for. Can you talk about sort of legislation that we should expect? Or perhaps that we should be looking at in any of the states that might become kind of the future enablers for continued growth?

Walter J. Lynch

We prefer not to do that.

Jeffry E. Sterba

We like to talk to the legislators first.

Walter J. Lynch

Would like to work it through first.

Jeffry E. Sterba

But mention the approach that we use with the initiatives for every state, et cetera.

Walter J. Lynch

Yes, we have goals. And as I said, we look to the long-term. What key strategic objectives we want to accomplish. And we have goals in each of our states. We had a goal in 11 of our states to level the playing field between municipal systems and ours and also be able to accelerate acquisitions. So each one of those states have goals or multiple goals in how we're going to drive that. And every month, we look at that and then report out against it. And the great thing to American Water, we have so many states that we're able to learn from one another. So if something is going down a path in one of the states and they learn from it and were able to get something through the legislature, we take that learning and apply it to another state, if it makes sense. That's what we do on a routine basis. So each one of our states have these goals and we routinely review them, learn from them and then execute on them.

Jeffry E. Sterba

And we create very specific metrics that are built into people's performance plans. So I'll just give you -- I'll tell you one of Walter's. Of those 11, he had to get 5 done. He's gotten 6 and probably will have 7. So...

Walter J. Lynch

Yes, thanks. And as we say, we don't have to [indiscernible] when we're batting about 450, in baseball terms.

Jeffry E. Sterba

Neil, and then in the back, and then here.

Neil Mehta - Goldman Sachs Group Inc., Research Division

Neil Mehta at Goldman Sachs. On the dividend philosophy, you stepped up your dividend by 12% this year, thus in excess of the 7% to 10% range. And you're at the low end, still of the 50% to 60% pay-out guidance. Could you see yourself on the top end or even above that 7% to 10%, as you look forward? And how do you think about where you want to be within that 50% to 60% payout?

Jeffry E. Sterba

Well, there's always that trade-off between returning funds to shareholders through dividends and reinvesting. We are in a position where I think we can use good judgment about what that right mix is because we've got headroom, both from a cash side but also from that 50% to 60%. I don't think -- we don't think about it as there's a magic percentage. We are on the low end. We would rather have a sustained growth than a big spike. So we'd rather see a more sustained growth that's at or above what we have as earnings levels than do it all in 1 year or something like that. So I don't think you will see us do a big jump at 1 point in time. But 12%, you look at what we showed we have grown in 17% normalized and then in excess of 10% in the last year. So it was appropriate.

Neil Mehta - Goldman Sachs Group Inc., Research Division

And then on the military side, it sounds like you're making some progress on some of these RFPs. How do you think about the timing for when some decisions can materialize?

Sharon C. Cameron

Well, as I said earlier, a few that we have RFPs on are nearing the end of that 4-year procurement cycle and with the recent budget settlements last week at least, which is lessening, hopefully, sequestration, and also through the conversations that we've had, we basically feel pretty good that we'll hopefully -- some of these will be awarded. We hope to be a recipient of those awards which, of course, these are competitive bids. But we are hoping that, from a timing perspective, a few of those that are pending will come to fruition in 2014.

Jeffry E. Sterba

Sharon, mention the -- our understanding about the additional resources.

Sharon C. Cameron

Yes, we were also recently told that the Department of Defense, I guess the actual -- I'm trying to think which arm it actually does the...

Jeffry E. Sterba

Contracting officer.

Sharon C. Cameron

Yes, he's a contracting officer. They have actually added staff which, I guess, for today in Washington, is pretty unique. I think they really see the value of utility privatization program. And again, because it is a mandate, they do want to see the program go forward. So again, that's another positive indicator that we see.

Angie Storozynski - Macquarie Research

Angie Storozynski, Macquarie. So first, about your ongoing operations, you mentioned that you're going to file 5 more rate cases next year. I thought the strategy was to say out of rate cases now that the GAAP between allowed and realized ROEs is getting close. And secondly, with the M&A playing a bigger role in your earnings trajectory, your earnings growth trajectory, how should we think about your ability to -- first of all, have the 60% of ongoing CapEx being derived from writers? I mean are we -- are you planning to acquire assets only in the states where you have this superior treatment of CapEx? And also, secondly, we all remember how some of the M&A strategies worked out in the past and so how can we make sure that we're not going to have any years where acquisitions are actually serving as an earnings drag?

Jeffry E. Sterba

I'm going to have Walter and Susan take your second set of questions. I'll take the first one, relative to rate cases. What I said was up 2 5, and I'll think about it. We serve in 16 states. Even if you move to a 3-year rate cycle, that's 5 a year. So the fact is, we were filing in the 9-plus every year. And what we're doing -- what we're able to do because of the cost control work that's been done is create potentially a little greater time. So an 18-month cycle moves to 2 years or maybe 2.5 years. So we'll still be in the rate case business. This is -- there's no way around it. But the frequency and the magnitude of those rate cases is what I think you will see change.

Susan N. Story

M&A you want to...

Walter J. Lynch

The acquisitions we have in our plan are in the states where we currently operate. Obviously, we want to expand in those states. And in consideration of recovery on capital, it's one of the things that we look at. So it does play into the objectives on where we're going to close deals.

Susan N. Story

But in terms of the amount of capital, if you look, and there's about $118 million in capital that we're looking at for regulated acquisitions for 2014. It goes down significantly for '15 and then there's a hold in place. You will notice that relative to the size of the total capital spend, that's still not that great when you look at the reg CapEx, as well as strategic capital. So it is a significant part of growth, but when you look at the outlay, and that is base [ph] '14. As Walter said, we have a pretty good line of sight on '14, pretty good line of sight on '15 out there. We are looking at, as Walter said, things were starting to look at now. When you look at these acquisitions and, you're right, people say, "Well, there's going to be a floodgate." And I think Jeff was very clear and Walter, we're not expecting these big concession things. And all the municipalities are going to decide if they want to privatize their systems. We don't believe that. What we believe is this 1 by 1, looking at our service area, where we already have regulated operations, where we're known, looking at systems. Specifically, waste water is a special focus. Not that we're not looking at water, but wastewater and the benefits we get from wastewater combined with where we already have water customers or contiguous systems. So going back, if you just look at the relative size of what we're putting in for M&A, it's smaller than what we're doing for the rest of the CapEx.

Angie Storozynski - Macquarie Research

And 1 follow-up. So what type of volume erosion are you assuming in your projections, especially vis-à-vis those M&A transactions? Because your gaining customers this way doesn't make any-- is there any dent in the detriment to your volumes from the M&A?

Susan N. Story

In terms of customers?

Angie Storozynski - Macquarie Research

Like volumes served basically. Should we still assume a 1% degradation on annual volumes served? or is the M&A somehow offsetting that detriment?

Susan N. Story

Offsetting number of customers, I think, you're talking about.

Jeffry E. Sterba

Yes, there's declining usage. This, as -- we're adding customers and that customer set brings usage. And so in terms of total volumes sold, it's going to offset the decline, but it doesn't offset the decline in the same territories. So we will still, the declining usage is per customer. So we will still have declining usage and so the issue of needing to pick up change rate structures, get more on the fixed side, et cetera, is still a pressing issue. Particularly remember that a lot of these additions, we think, will come on the wastewater side. And so declining use in our drinking water is like, really, a given for, well, all of our territories.

Unknown Executive

And Jeff, one more point on the rate cases. If you look at the number of rate cases, less than 5 is a heck of a lot less than what we experienced over many years. If you go back 4 and 5 years, we were in the double digits of rate cases filed. So less than 5 is significantly less.

Jeffry E. Sterba

Right here and then Steve and then right here.

Unknown Analyst

[indiscernible] for Franklin Templeton. In the places where you're developing water infrastructure for the shale drillers, for the next 2 years and for the top 15 customers, potential customers that you're looking at, what is the difference in costs in terms of cents per gallon between what you can provide and what their cost is, alternative transportation cost is? And is it -- can you provide it at 80%, can you provide it at 20% of their cost? That's one thing. And secondly, is the hurdle more on the contractual side where, I mean, are you looking for 2-year contracts to meet your return calculations? Are you looking for 3 years? Are you looking for more than 5 years of contracts for those customers? And from a perspective of where the hurdle really lies?

Jeffry E. Sterba

Okay. Relative to the first question -- well, let me take them in reverse order. On the second question, in terms of what's really the hurdle for us to build feeder systems for the wells, the issue -- the real issue is -- if we trade off between how much demand or how much will they commit to and the life that they'll commit to. Typically, these guys don't like to make commitments more than tomorrow. So when you make it 3 years or 5 years, you're really stretching them. But we think that's viable, we think that's possible. And we believe, that at least the ones that the ones we're taking a hard look at, we can get adequate recovery of the capital within a timeframe that they're willing to make a commitment. But the challenge is each of these drillers has their own driller plant. And so how do you get the plans to come together at a point where you can get enough drillers to subscribe to a pipeline in the same window of time? That's probably the biggest challenge. Because they each -- they have different leasehold interests and locations and then, in that, they will develop their own wellhead plan. And you've got to get them to mesh. So more than the issue of how much of a commitment will they make, getting coherent timing is probably the bigger issue. And then in terms of -- remind me of the first question?

Unknown Analyst

The cost.

Jeffry E. Sterba

It's all over the map. There is no formula of we'll provided it to you at 80% of aborted cost because it really depends on how big is the trunk versus how big is the feeder side. So one of the things though you got a keep in mind, the drillers are increasingly under real pressure around road traffic, safety of the public, as well as pollution, and road damage. Now they bond for the road damage, if you will. But in a lot of these communities, the notion of 1,000 trucks a day or 500 trucks a day going through an area is really concerning. So -- in fact, what we did in 2013, that took about 60,000 truck hauls off the roads of Pennsylvania. That's becoming more of an issue. So we may be able to price up pretty close -- reasonably close to the avoided cost, but they have the benefit of no truck hauls. The trade-off for them is they can call a truck tomorrow, right? They make a commitment to take water out of a pipe, it's going to be a longer period of time. So those are really the variables we have to work on.

Unknown Analyst

2 questions. First, just on the 7% to 10% growth rate. Can you just -- just want to make sure and clarify, is that off the 2012 adjusted base of $1.99 through to 2018? Is that kind of what you're committing to?

Susan N. Story

Actually, when you look at the triangle to triangle, it is the growth were expecting year-to-year. So the long-term EPS is 7% to 10%. The triangle to triangle is the year-over-year.

Unknown Analyst

Okay. And then secondly, on the homeowner services and military...

Susan N. Story

And by the way, they approximate each other, if you add up the numbers.

Unknown Analyst

Close. [indiscernible] to make sure. But on the military services and the homeowner services business, you did a great job laying out the current revenue growth outlook. Could you maybe just elaborate a little more on margins? And if you can't do it on margins, just the risk of the business?

Sharon C. Cameron

[indiscernible] I mean as a competitive business, we're pretty cautious.

Unknown Analyst

Right. [indiscernible] more important part of the story, right? So we need to know, from an investment standpoint, what the risks of the business are and the costs. So maybe, for example in the military, when you have these 2- or 3-year re-openers, do they always go up or could they go down? Or for example, in the Homeowner Services business, like what -- how are you pricing the products and what are the -- could we have a whole bunch of people come in and say, "Hey, my stuff broke and you have fix to it." Could you just give us a sense better of how -- what is the risk profile of these businesses?

Sharon C. Cameron

Yes. Absolutely. I'll take homeowners first, I'll go backwards. We do a tremendous amount of work to mitigate risk for Homeowner Services. Everything from the way the terms and conditions are written, which really limit our exposure to the cap we put on the claims to the geographic expansion that we're now similar to the Regulated Business to really mitigate if there was a unique geographic impact to the business to a tremendous amount of analytics for pricing variables, again, to meet with the severity and frequency might be in certain markets versus other markets. We've gotten pretty sophisticated over the years as we've grown in being able to really manage that, I'd say, with a very focused -- and we also, because of all of the reporting analytics we have in place, we would have very early warnings about things as well. We track things on a very micro basis. For military services, the price redeterminations, again, are based on 2 things. They're based on economic fluctuations and [indiscernible] living. I haven't seen that go the other way, so it's really based on the cost, right? The cost of what it cost to run the business. And then secondly, it's also based on assets. And if anything, those assets just increase. They really -- they don't go the other way because we're actively on base rehabilitating and upgrading the assets on base. So I have a pretty high confidence that the price redetermination would be in our favor. And in those negotiations, we have always -- we've really gained the trust. We really -- our military services group just does an amazing job servicing the customer. And they've built that trust and they've built a really great model of how to work with the customer in ensuring that that process works smoothly.

Jeffry E. Sterba

Let me add 2 thoughts, Steve, on the risk issue. On the military side. The biggest risk is that when you initiate a new contract, that you underpriced it. Because when you do that, if you underprice your bid, in order to win the bid for example, you're not going to make that up because they're not going to allow you to change your cost because you estimated wrong. They're going to allow you to change your cost because you put more capital into the facilities so there's new facilities or general increase in wages and those kind of things. Materials, et cetera. So once you're in, if you came in at a good point, you're going to stay at a good point. I think that's a very good point.

Sharon C. Cameron

That's right.

Jeffry E. Sterba

And there has been some examples where players have gone to work for quite a long time to get out from under -- having under bid. I think we've shown a track record. We don't underbid. If we don't win something, we don't win something. But we're not going to make it up on volume. On homeowner services, one of the things that our folks do very, very well is in our contractor management. Because if you think about it, what are the real risks? Well, 1 risk is that your claims rate goes up. And so how we -- the way in which they verify claims so that it's not someone's signed up and the next day, they're saying, "Oh, by the way, I've got a leak today." And then also on the claims -- on the management with the contractors, so that we've got full control of what the costs are when a repair has to be made. Those are the 2 big risks that you have in that business. Yes?

Unknown Analyst

Along those same lines, Sharon, you mentioned $200 million of backlog. But it wasn't clear exactly what that referred to. Are those projects that have already been approved and you're just waiting for them to be implemented or those are RFPs...

Sharon C. Cameron

Yes.

Unknown Analyst

[indiscernible] being awarded? What is that $200 million?

Sharon C. Cameron

So if you remember that process cycle that I showed you. Each year, our military team works with the folks on each base to identify and prioritize what are the greatest infrastructure projects and needs. And they submit those. And then in September each year, projects are awarded. That backlog of already-awarded projects is approximately 200 -- a little over $200 million. That also includes, I'm calling it, the initial capital upgrades from the initial awards. When we first win an award, there's also an amount of capital work that needs to be done that is aligned with that project. So that total backlog today is $200 million. Just because of timing, of permits, of managing the contractors through the process, we will execute that work over a period of 2 years. And then each year, we hope to be awarded new contract dollars. Part of that is we're going to be doing an entire water treatment plant in Fort Polk. That's about $80 million and that will take several years to fully execute and build that plant.

Unknown Analyst

Okay, and then also in municipal industrial contracts, you talked about how you were shedding the less-profitable contracts. Sort of what is your outlook for that business going forward?

Sharon C. Cameron

Yes. We've done our shedding. We're done shedding.

Unknown Analyst

[indiscernible] there or is it going to stay a stagnant part of the bar chart? What happens?

Sharon C. Cameron

So what we're do -- so what we have now is we have a stable portfolio of about, as I said, 40 municipal and about a dozen industrial and some commercial projects as well. These are typically 3- to 5-year contracts. We certainly want to maintain and continue to get renewals for projects that have strong margins. But we're not going to be investing a lot of pursuit dollars to continue going after this category if it's not something that the customer wants to -- a lot of customers are not interested in upping out-servicing O&M right now. Where we think there's an opportunity is in upselling our existing contracts. So we're working very closely with our existing customers in those contracts and thinking about additional ways we can help service and provide extended service options to those customers. So gain, a little more wallet share from out existing customers. What I talked about at the end is we really need to take a hard look at the municipal segment and the industrial segment. There's a tremendous amount of opportunity in those segments. But we want to really be focused on, again, what are the products and services that the customer really wants from American Water? Where they want us to provide service? And where we can build the business that capitalizes again on,let's say, our core competencies and strengths. But that also has those regulated-like business traits. The -- call it the vanilla O&M business that we were in for many, many years, it was a very challenging business. It was not a growing category. The margins were low and we took all the risk. We don't want to do that going forward and we feel that there's many other business opportunities in both of those sectors. We're intrigued by waste energy. We're intrigued by back office for municipalities. You look at what Walter talked about and what we've been able to achieve in our call centers, the efficiencies we've been able to drive, we have a lot of expertise that we think we can potentially offer to municipalities. Again, these are just ideas and that's why this year, we are investing at what I'll say is business creation to think about all these things, to identify where we think there are really profitable and scalable growth opportunities for the future.

Kevin Cole - Crédit Suisse AG, Research Division

Kevin Cole of Crédit Suisse. First, congratulations, Jeff and Susan, on the promotions for both of you. And I guess first question is, I guess, piggyback on the last 2 questions, is that could you talk a little bit about the cost to acquire for the customers for the homeowner services? And then what the average renewal rate is? And just kind of how to think about the overall earnings gearing as you wrap this up?

Jeffry E. Sterba

The average approval rate of what? I'm sorry...

Kevin Cole - Crédit Suisse AG, Research Division

The average renewal rate.

Jeffry E. Sterba

Oh, renewal. [indiscernible] cost to acquire and average renewal rates.

Sharon C. Cameron

The cost to acquire really varies considerably by which initiative we're executing upon. When we launched, for example, within New York City, we're not going to see the profitability of that probably in year 1 because we spent a major amount in marketing in that initial year, but we see a profitability by year 2. Our renewal rates are extremely high where we can offer the product on bill and we do that in the American Water footprint, probably to about 70% of the market and in New York City, we're offering it on bill. So not only is the take rate extremely high in New York where, again, we've penetrated 1 out of 7 homeowners who have already taken the product in less than a year. We expect renewal rates in New York City to be around 92%. Now where we don't sell the product on bill, we do have lower renewal rates because we have to go out and resell that customer each year. And we have a lot of strategy because, you can imagine, in play, to try to extend that contract life with those customers as well. But that's also a higher cost to renew customers where we don't have a bill mechanism.

Kevin Cole - Crédit Suisse AG, Research Division

And okay, I guess changing subjects a little bit. So I guess I'm hearing that you're playing more of an active role in New Jersey with the CTA conversation. And so I guess what are you expecting for the path in timing for resolution and how much of your rate base is at risk?

Jeffry E. Sterba

Well, CTA, consolidated tax, is an issue in about 4 of our states. In New Jersey has started a docket to investigate and it's going through that process. I hope, that we will hear an outcome in the not-too-distant future. It is a significant one for us because New Jersey is -- frankly, the whole notion of consolidated tax is odd, because it basically means someones getting a benefit for something they never paid for, that someone else paid for. But the -- New Jersey is, the way it was created, actually can never go away. In fact, it increases. So it's a somewhat just concerning mechanism. In total, the consolidated tax issue for us in New Jersey, I think we've disclosed this, is about $200 million of rate base. Because it's done on the rate base side. Now we have settled cases and so, within a black box, it's hard to piece apart it out. But it's about a $200 million rate base element at issue for us in New Jersey. And as I said, I really commend the commission for starting the process to look at this as to whether or not it's appropriate and I hope for a quick resolution to it.

Kevin Cole - Crédit Suisse AG, Research Division

And by quick resolution, do you mean like it's a 2014 resolution?

Jeffry E. Sterba

I look forward to a quick resolution to it. Kevin, that's all about all I can say. It's not -- there isn't a time clock on it. And our hope is that it can get handled. Because frankly, in telling it's resolved, how your file rate cases and all those kinds of things are kind of messy. So it would be good for it to get addressed one way or another and our personal view is it doesn't make sense to have. It should be eliminated. Because it effectively is giving someone a benefit for something they never paid for.

Kevin Cole - Crédit Suisse AG, Research Division

Great. And just one last question, just from a high level. So on Slide 21, you show how you reduced the average age of a pipe from -- by 100 years in the last 3 years. And so you're 50 -- I think you're currently now 50 years above your target. Now since you stepped up your 2014 to 2018 spending, how long will it take you to hit your target age of 100 years? And then once you hit that point, I guess where will your organic regulated growth be coming from?

Walter J. Lynch

Okay, well, it's 150 years through '14. So the remaining 4 years are going to be working down towards that 100-year mark. But there's a significant amount of capital. As I said, we have 46,000 miles of mains and collection pipes. We're going to get down towards it, the 100 years, but -- and approaching it. And we're going to continue investing in our systems. We still have a lot of water and wastewater plants we need to upgrade. That's a tremendous focus. And as I talked about, the 2 big projects in California are going to take an awful lot of capital. On the pipe issue, we are approaching the 1% of the 100-year replacement rate.

Jeffry E. Sterba

And it's not just putting more capital at it. This is where the effectiveness of our capital spend really becomes important. So little things like having all of our states go by a standard on pipe, as opposed to states doing different things because that's the way they've always done it. That's saving us, John [ph], $7 million? Over $7 million in pipe acquisition cost a year?

Unknown Executive

Yes, it's in excess of that.

Jeffry E. Sterba

And then, we start moving to, okay, how is that pipe laid? What's the most effective process used across our states and let's get that deployed across all of our properties. So we get more value for that same amount of spend. But even once we get down to 100 years, were still investing multiples 2x to 3x our rate of depreciation. So that rate base growth will continue. One of the things you might have noticed is that when you look at the triangles over time, the amount, the magnitude of growth that comes from rate base investment has declined. It was 8%, it's down to about 5%. Well, that's because while we're increasing our CapEx spend, our denominator has obviously continues to increase and so you get that divisor impact. There's also some issue, some impacts associated with what we talked about before, on the repairs maintenance accounting. And then, frankly, the other parts of our business are growing a little more rapidly than that is. So that's why those changes are occurring. But it's still, for as long as we can see, it will be the primary, fundamental driver -- foundational driver of our growth.

Walter J. Lynch

And just to put it in perspective as well. Our capital programs are bottoms-up-driven. So the states submit to capital programs, to Susan and myself. We take a look at them and we're well in excess of what we plan to spend over the next 5 years.

Jeffry E. Sterba

Who's next? Heike.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

Two unrelated questions for Walter. First, as we look at the 35% efficiency ratio goal, how are you going to do that while maintaining the corporate culture without hurting employee morale? And second, I believe you call them enablers. We referred to them as enhanced regulatory mechanisms. Is there something we should be paying attention to? Is there some type of legislation in 2014 that could meaningfully impact you in one of your operating states?

Walter J. Lynch

Okay. The second one first. There's nothing out there that's on the horizon that's going to meaningfully, I think, impact 1 state. We're working on it, as I said before, across a number of states. Enablers are going to enable growth, infrastructure investment, reducing regulatory lag. So -- and those, as Jeff said, are built into the performance metrics of each one of our states and our state leadership teams. That's great. On the first question, we're very cognizant of running our business for the long-term. We're not going to do anything that impacts the long-term sustainability of our business. Our goal to get down to 35%, we believe, is doable through a number of areas. We're looking at technology with which Jeff and Susan both mentioned. Skater systems where we can more remotely operate facilities, the water and wastewater plants. Automatic meter reading, so we can more efficiently read meters. Those are key things. I tell you, 1 example that we did about 1.5 years ago is -- and 1 of things I mentioned before is that we can learn from each other. So we looked at the different ways that our states were operating. I said, okay, if you look at the layers in the organization, we had, from Jeff down to the front-line employee, 11 layers in 1 state and we had 8 in another. And we looked at this and said, okay, we have a couple different operating models. Let's put this down so the states understand what the opportunities are to reduce their layers and let them make their decisions on what's the best way to run the company. Through that effort -- it was a couple of month exercise. Through that effort, we were able to eliminate 135 management positions in the business. And I can tell you after that, running the business right now we're more efficient and effective than we were before. That's another thing that we're looking at ways to learn internally not just from the external marketplace but internally in our business.

Susan N. Story

And Heike, also bring workforce planning with this, which is utilities have been saying for a long time, in the next 5 to 10 years, we may be looking at 60% of our employees who are eligible to retire to be able to be more efficient to use technology and automation do not have to fill those jobs one-on-one is a good thing. So actually integrating these studies into our workforce planning process is in looking at where we have more risk for people to lead and we have skills. And another thing is that, as we transform, we also create jobs that are more fun jobs come in some cases. You're doing for example, from manual data generation to value-added analytics, for example. So part of it is an opportunity for us to address another issue, not just us but the entire utility industry it's facing, which is the workforce planning and the aging workforce.

Jeffry E. Sterba

A good example of that is SCADA. SCADA is system control and data acquisition. And quite frankly, a lot of water plants are fairly labor-intensive. But the technology is there where they don't need to be. But the labor you do need is a much higher level of capacity. It's people who are instrumentation experts that know how to deploy and utilize SCADA systems. So may have fewer of them, but they're going to be much more valuable kinds of position.

Walter J. Lynch

And one other thing too, I always mention this, but our supply chain has done a tremendous job leveraging our buying power, in fuel, in power, in chemicals. And John and I spent a lot of time. We partner in ways that we can drive the cost structure down and by, as Jeff said, looking at pipe, let's [indiscernible] on the same pipe. Let's reduce the number chemicals that we have in our business so we can get better purchasing on those. It's a whole host of things that we've been working on that we're continuing to drive value.

Heike M. Doerr - Robert W. Baird & Co. Incorporated, Research Division

How should we think about -- Roger Lidell, Clear Harbor Asset Management. How should we think about newly recognized contaminants on the wastewater side? Western Pennsylvania bromine concentrations that are clearly traceable to drilling. Triclosan now getting attention. Pharmacologically active concentrations coming out of wastewater treatment plants. So I'm not sure how to think about that whether this is a significant opportunity with upgrading removal capacity in treatment plants, either wastewater or on potable side. And would this be an O&M issue or could there be CapEx-es? What's the magnitude of the opportunity, if there is one there?

Jeffry E. Sterba

Honestly, that plays to our strength. We're the only water utility in the United States that has its -- not only its own laboratory, but it's own research function. And in fact, half of all of our cost of our research function are paid for by grants given by other organizations to us to do research. So if you look in the drinking water side, there are 102 emerging contaminants. There's a whole set, obviously, also on the wastewater side. This is where a lot of our leading research is done, is what's going to be the best way to handle this. And in fact in many instances, we're providing baseline data to the regulators, particularly EPA, for what's the magnitude of this issue. Because we're the only one that spans as many states from Hawaii to New York. So I'll give you 1 example, chrome 6 -- Chromium-6, which has the tech -- California has now implemented a standard for Chromium-6. This will increase cost both on the capital and the O&M side because we will have to put in place new treatment regimens which will take additional capital, but then it'll also increase operating costs -- just not as much, but there will be capital that will need to be invested on chrome 6. So it really varies. I think the advantage we have is -- there's not one of those that were not looking at and figuring out what if, and when a regulation comes and what's going to be the best way for us to meet it. We also -- it'll vary by state. So even within California, probably, I don't know, 30% of our supply is going to have a chrome 6 solution. The balance -- it doesn't need it because it's way under. So you really have to go contaminant by contaminant. I think entities that are on more on the leading edge and have the capacity to both design and test have an advantage. Those that are going to have to always have that provided by someone else, they may not even be able to do the adequate testing, are going to have to buy that from someone.

Roger Lidell

And final question, is there any movement to remove or reverse the exclusion of the oil and gas industry from Safe Drinking Water Act and Clean Water Act?

Jeffry E. Sterba

That's for a group of people with a different pay grade than us. I'm not going to say if it's -- which way it goes, but that's really not ours to judge. We're -- we will -- our role is to take whatever the rules and regs are and make sure that we not only meet them but, in many instances, help shape them and help meet them. So the whole oil and gas question and whether or not -- what's done at the state level versus what's done at the federal level, we may have personal views, but those are frankly, not -- we're not going to have a major impact on that issue. I think you have 1 and this will be the last question.

Unknown Analyst

Hopefully, kind of easier ones. Hopefully this 2% to 3% growth in the market-based businesses through '18 assume that you win some of the outstanding RFPs for new bases? Or does it just factor in the price redeterminations and infrastructure projects?

Sharon C. Cameron

Are you speaking to 2014 or future --

Unknown Analyst

2015 period, '15 and beyond, the 2% to 3%.

Sharon C. Cameron

Our growth is based on both winning new awards and continuing to see those contract infrastructure projects awarded.

Unknown Analyst

All right. So you're embedding some of the 7 or less RFPs being won?

Sharon C. Cameron

Yes.

Unknown Analyst

And then, Susan, maybe...

Jeffry E. Sterba

It's not 100%, John.

Sharon C. Cameron

No.

Unknown Analyst

Susan, probably for you, the NOL balance, what's it going to look like at the end of '18? How much are you expecting to realize on an annual basis? And when do you think those will be fully utilized?

Susan N. Story

We do not believe that we will pay cash taxes until about 2021.

Jeffry E. Sterba

Okay. Well, I want to thank you, all for the time that you spent with us today. I think we got the snow stopped, so that's a good thing. I just would reinforce that as we've gone through this planning process, the level of comfort that we have with what we presented to you today, I'm sure it's probably also raised some questions that you'll think about and feel free to get hold of Ed or his team. Yes?

Susan N. Story

We have one more thing we want to show you.

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