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Aqua America (NYSE:WTR)

Q4 2013 Earnings Call

February 28, 2014 11:00 am ET

Executives

Brian Dingerdissen - Director of Investor Relations

Nicholas DeBenedictis - Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Member of Disclosure Committee, Chairman of Consumers Water Company, Chairman of Pennsylvania Suburban Water Company, Chief Executive Officer of Consumers Water Company and Chief Executive Officer of Pennsylvania Suburban Water Company

David P. Smeltzer - Chief Financial Officer, Executive Vice President and Member of Disclosure Committee

Analysts

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division

Operator

Good day, and welcome to the Aqua America's Fiscal Year 2013 Earnings Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Mr. Brian Dingerdissen, Director of Investor Relations. Please go ahead, sir.

Brian Dingerdissen

Thank you, Jason. Good morning, everyone. Thank you for joining us for Aqua America's Full Year 2013 Earnings Conference Call. If you did not receive a copy of the press release, you can find it by visiting the Investor Relations section of our website at aquaamerica.com, or by calling Alex Whitlum [ph] at (610) 645-1196. There will also be a webcast of this event available on our site.

Presenting today is Nicholas DeBenedictis, Chairman and President of Aqua America; along with David Smeltzer, the company's Chief Financial Officer.

As a reminder, some of the matters discussed during this call may include forward-looking statements that involve risk, uncertainties and other factors that may cause the actual results to be materially different from any future results expressed or implied by such forward-looking statements. Please refer to our most recent 10-Q, 10-K and other SEC filings for a description of such risks and uncertainties.

During the course of this call, reference may be made to certain non-GAAP financial measures. Reconciliation of these non-GAAP to GAAP financial measures are posted in the Investor Relations section of the company's website.

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

Nicholas DeBenedictis

Thank you, Brian. Good morning, everyone. Aqua's pleased to report this morning that 2013 was our 14th consecutive year of increasing earnings with a 10% CAGR over that time period, actually in excess of 10%. And 2013's 12.6% growth in net income allowed our board to raise the dividend in September of '13, 9%, that was our 23rd dividend increase in the past 22 years.

The stock performed well over the course of the year, returning to shareholders 19% shareholder value and it was complemented by a 5-for-4 stock split on September 1, '13, that was our seventh split in the past 18 years.

Now in '13, Aqua's management team was able to deliver the same consistent, strong financial results of an increasing shareholder value that our investors have come to expect as a slow-steady but profitable company.

As we look at 2014, that will be my 23rd year with the company, and I'm optimistic as ever about keeping the record of earnings and dividend increases intact. 2013 was one of my most satisfying times at the company after, as I said, over 2 decades, not only thanks to the strong financial results, but also due to the excellent execution of our management team, which we reorganized in 2012 and is now producing, what I would consider, stellar results. Let me give you a couple of examples.

This last year, we flawlessly executed on the $300 plus million CapEx investment program. And other than just the financial number, there's a lot behind that. One of the most important aspects of our continuing high investment level in our plans and infrastructure is the reduction of our environmentally driven expenditures to, today, less than 5% of our CapEx, it used to be much, much higher, so that we can almost exclusively focus now going forward, on the more discretionary infrastructure rehabilitation program we've started in all of our 8 states.

As we go forward, we will continue spending at these levels. I estimate $1 billion over the next 3 years, but the majority will be in infrastructure investments eligible for the applicable distribution system surcharges that we now have in 6 of our 8 states. The reality of this is that we'll keep our future rate request in the single digit, even though we're investing 2 to 3x depreciation versus the high double-digit ask and of course, there's risk with that, that we've been required to get to get our returns in the '08 through '13 time period.

And the positive effect of these infrastructure investments came just in time, as in January and February of this year, we have experienced one of the coldest winters ever and not to practice, I know a lot of companies are using what we call frozenomics excuses for things, but at Aqua Pennsylvania, we have concrete evidence. We have had 300 breaks just in the first 2 months versus 200 last year, but nowhere near what some of our large cities are experience or even closer to home. Just 10 years ago at the old Philadelphia Suburban, we experienced 600 breaks in January and February.

So as we keep investing infrastructure, again, $1 billion over the next 3 years, almost exclusively on pipes and transmissions, this hard-to-predict operating expense should be reduced further. But however, regarding the tough winter we've had this year and the increased breaks and, equally, snow removal costs, it could shave $0.01, maybe $0.02, off your first call projections for '14, which I'm still comfortable with.

Due to our continuing focus on expenses, again, this -- our management team really showing through on this year, we maintained an industry-leading efficiency record of 35%. Now I'm using the same metrics that you've been using when you compare the American Water, the largest in the our industry, and ours is 35%, if you want to use a comparable. But we're equally important, we're continuing to successfully recover our investment through rates. Thanks to the fact we've been able to lower the ask because of our most efficient standing in the industry.

In '13, we had $12.5 million in annualized rates and we have 2.8% already received and $21 million in cases pending. Now remember, in Pennsylvania, we have this unique repair tax policy, which has allowed us to continue investing record amounts in Pennsylvania infrastructure and not having to raise rates. Therefore, our rate requests are down year-over-year, but equally important, this slows down the revenue growth because even though we're producing record earnings, we are not using rates to get there in Pennsylvania and, therefore, revenue growth has slowed. I think to put it in perspective and well, Dave will explain much more to you if you have questions, I would say for '14, that 2% to 3% revenue growth will still let us achieve what we're trying to do with the earning side because of this very, very favorable repair tax policy for both the ratepayers and also for our shareholders.

Another aspect of what I would consider management's ability is the very efficient portfolio rationalization program that this year produced $89 million and a $14 million profit or $0.08 in the exit of our troubled Florida operations. And of course, in this sense, many times, when companies go discontinued and say, we're going to sell something off, it's usually not tracked as closely and, therefore, if you lose money on it or it actually hurts your GAAP earnings, it really -- most times, it's not noted by the analysts and the record.

In our case, both in '12, '13 and I would predict, in '14 with our Fort Wayne, GAAP earnings will actually be enhanced, not hurt, by the discontinued operations sale. And I think that's credit to management looking at every penny on the way out the door in our rationalization program.

And of course, when you consider that our record $221 million profit this year, when you roll everything else up, it allowed us to internally generate $60 million cash in excess of our CapEx spending. And that's the third straight year of this positive result, which obviously negates the need for any equity dilution in '14 or for the foreseeable future.

Interesting perspective, regarding our net income this year, it took Aqua and its predecessor companies 122 years to earn $100 million in net income, and it's only taken us 5 more years through 2013, to reach the $200 million mark. This is a stat we're very, very proud of.

2013, it was also a successful year for labor negotiations. We really don't talk about these things on the calls, but I thought it's important to see the fundamental operational strength of the company. We negotiated 4 contracts, allowing for some reductions and some benefit programs, while granting our average -- our employees a fair average wage increase of 2%. We have always had a good working relationship with our union membership, and that represents about 1/3 of our workforce and has never had a strike in the modern history of the company.

I would predict 2014 will bring no surprises in this area, as we only have 3 contracts up for renewal, which only represents 60 employees, so very low number.

Another area we never talk about on these calls are Aqua's record of having clean books and efficient information systems, which are the backbone of any public company. During my tenure, we have always received clean audit letters from the independent accounting firms, which -- our firm currently is PWC, one of the big 4. We have never had a SOX material weakness and we recently completed the upgrades of our financial information system and our customer information system and now, a brand-new purchasing system. And these upgrades were on time, on budget, and most important, they all work. We're optimistic in '14 and going forward that the new systems, especially the purchasing system, will allow our CFO, Dave Smeltzer, and our management team to enhance our industry-leading cost initiatives program.

Now when you're predominantly a regulated company, your customer service and reputation is the real value added as you execute your strategic growth plans through capital investments, cost controls and growth through acquisition, which has been our strategic direction for the last 20 years and continues today.

Tonight, we're honored as the Philadelphia region welcomes in spring, believe it or not, with 8-degree temperature, by the world-renowned Philadelphia Flower Show. Aqua is the honoree for this evening's event, and we're very, very surprised and honored about that. And the reason they picked us was for our efforts in tree planting as part of our watershed management program. These are the extra steps we take environmentally at the company that get us recognition but we very, very seldom talk about it.

We also received recognition this year for our solar fields, which we have 4 now, which steadily produced 4 million-kilowatt hours saving our electrical operating expenses. And we also got an environmental award for implementing a conversion to compress natural gas of our entire Southeastern Pennsylvania transportation fleet over the next couple of years. This is not only a money-saving project, but it also helps us reduce our carbon footprint.

And just this year, we received the NAWC award, and believe it or not, we're second to IBM in competition for the prestigious Platies Energy Award given at the Waldorf Astoria in December. And that was for our energy efficiency programs to reduce peak response and energy demand response on the PJM grid. We have experts in electric distribution and cost controls, and they are making a difference in our bottom line.

Now how do we do this? We do it predominantly through an investment we've made in standby generators, which have been installed throughout our system. These generators allow us to keep, especially during this last storm, they allowed us to keep 100% of our customers served despite up to 6 days of electrical outages in Pennsylvania and New Jersey during the recent snowstorm.

Now 100% reliability is something our customers and regulators expect take for granted, and we have to deliver and we're proud to say, we were able to do that during this storm.

One of the bright spots in '13's results, which I think bodes well for '14 and beyond, is the uptick in organic and acquired customer growth. We did 15 acquisitions in our customer growth group from under 1% over the past 3 years to 1.3%, still not back to the heydays of the '90s and early 2000s, but we're seeing an uptick in activity in both regulated and unregulated, and we believe we're going to grow 1.5% to 2% in '14.

Now, of course, acquisitions are only a growth engine if you can integrate them profitably into your operations. Our largest recent acquisition was mid-2012, and that was $125 million to expand our Ohio operations. The acquired operation that -- the one that we bought from America, was losing money in '11, and in '14, we expect to make $4.5 million in profit at a 7% ROE. Now there's still room for even further improvement, but we think this turnaround really has made a difference for current and future perspective earnings. This is a good example of the value added of our growth through acquisition program, which has produced almost 300 acquisitions over the past 15 years. It's just part of our DNA.

As mentioned in our release, the Aqua unregulated results generated $3.5 million in cash, but lost about $0.5 million in our net results. For 2014, we are comfortable with your first call of, I think it's $120 million or $121 million, it's somewhere between those 2 numbers, with the reduction in the first quarter '14 to our budget expense, if you can acknowledge that to the extreme weather. And this assumes, in our mind, in our budget, a contribution from the unregulated Aqua Resources of -- help me with that.

David P. Smeltzer

Flat.

Nicholas DeBenedictis

Flat in '14. And I think there's some upside on that because just in the recent 2 months, the gas prices have risen from $2 to over $4. And of course, Marcellus' problem is getting the gas out, not producing the gas -- Pennsylvania is now the second leading producer of natural gas in the country. It surpassed Louisiana this year. The problem is getting it out. The wells are more prolific and productive than they ever expected, but you have to get it to market. And with this recent run-up and usage of natural gas for energy, but also for heating in this cold winter, gas has shot up to $4. So we anticipate an increase in drilling, which is where the water is used in the process.

To wrap up, '13 was an exceptional year, financially, for us. But equally important was operationally strong with our very strong financial capabilities now built with our A+ rating and the cash generation. And with growth returning, it shall allow us to maintain our record of increased earnings year in, year out and dividend increases in '14.

Also, I saw an early headline on one of the services and I want to make sure I clarify it. The headline said that we, they acknowledge that we beat First Call and then they said that we're going to increase the dividend, at least I interpret it that way, and stock split. What we're talking about is the history of '13, obviously any stock split or more important, dividend increase is the board's responsibility, and we have not had our strategic meeting where we usually used to take the dividend increase up, but I assume -- you can assume it's a high priority when we've done it 23 times in the last 22 years.

We did issue a revised release to clear -- make it clear that we didn't raise the dividend yet at yesterday's board meeting.

I'll answer any questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Jonathan Reeder with Wells Fargo.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Could you clarify the expectations on the shale pipeline in '14? You said flat, did you mean just breakeven or still a little bit of a loss?

Nicholas DeBenedictis

About $0.5 million loss. But cash should jump up to about $8 million. That's what we're budgeting.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Okay. And then what was the gain on the Florida sale?

Nicholas DeBenedictis

$0.08.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

$0.08. And that was all in 2013?

Nicholas DeBenedictis

Yes. A little bit in the first quarter, that's why the first quarter was higher than most of the analysts' estimates, although here in this board meeting [indiscernible]. And then the last quarter, it was also in the last quarter, which we tried to true up on the -- in the quarterly and year-end analysis [indiscernible].

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Do you have the breakdown between Q1 and Q4, or no?

Nicholas DeBenedictis

I think it was $0.03 -- $0.02 in the first quarter and $0.06 in the third quarter -- fourth quarter. And remember, the other noise in the last year was that in 2012, all the repair was brought in, in the fourth quarter, but when you spread it out over the 4 quarters, which we tried to do, that's what we try to true up in the end and how we came up with the 26 versus 22. But still a healthy quarter.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Yes. And then on the customer growth expectations, 1.5% to 2%, is that driven more through M&A expectations, or is it strong underlying organic growth that you're seeing?

Nicholas DeBenedictis

We're seeing some strong organic growth now again, never really slowed down too much in Texas. A real rebirth in North Carolina. The rest are pretty standardized, 0.3%, 0.5% in some of the rust belt states. But we are seeing much more activity on the acquisition front. We just signed a deal with Chicago Heights doing O&M, which is hopefully a -- gets your reputation on and allows you to maybe do an acquisition later, although this is strictly O&M. But we are seeing some larger mid-sized municipal governments interested in working with us, be they regulated or unregulated.

Jonathan Reeder - Wells Fargo Securities, LLC, Research Division

Okay. And then, do you expect to file a K later today?

Nicholas DeBenedictis

Dave? Monday?

David P. Smeltzer

Yes, probably Monday.

Operator

[Operator Instructions] We'll go next to Jerry Swing [ph] with Bonnic [ph].

Unknown Analyst

Two quick questions, just on the repair tax accounting. Is there any way you can talk a little bit on the tax rate and maybe how we'd look at it on a go-forward basis, just on the modeling front, comfortable until we hit the tax line and then it -- that shifts around? And I know there's moving targets where you spend your CapEx during the quarter as to where it's been and how it falls into these buckets for the repair tax. So any comments on that?

Nicholas DeBenedictis

Yes, that's the real dilemma. Depending on what project gets done at what time, some are eligible for 100%, some 70%, some 0. And just saying, we're going to spend the same amount of capital doesn't necessarily mean you're going to generate less or more. It depends on what projects you can spend them on, and obviously, that's management -- the challenge of management. But Dave can express what is that, his assumptions were. You're talking about this year's tax line?

Unknown Analyst

Yes, this year, as in 2014? Yes. As much as you can.

David P. Smeltzer

Yes, well, when we look at the repairs, Nick said, it's a little bit hard to predict, right? It's based on specific projects that qualify and obviously, they have to get done during the year. But we actually see the repair being fairly consistent from '13 to '14. We saw a jump up in '13 over '12 and that was related to some new areas of deduction that we took, some of which were actually '12 portions that were booked in '13, that was about $0.05. We also saw in '13 the initiation of the catch-up deduction, amortization, right, so that started off and that will continue, we expect each year going forward. And in '13, we saw a greater percentage of our projects qualify because we began the year understanding what the rules were versus in '12 when we kind of worked up the rules during the year. So that explains the increase in '13. But like I said, we would expect, going forward, to be reasonably consistent in the level of deduction here, and therefore, our effective tax rate.

Unknown Analyst

Okay, that's helpful. And then, Nick, I think last time we spoke in terms of Pennsylvania, you were, at the earliest, you'll do anything [indiscernible] -- I know it's probably -- I mean, there's still some time off later in 2015, at a minimum. Is that accurate or...

Nicholas DeBenedictis

You faded out right when you said the dates.

Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division

Late 2015 is what I was looking at in terms of...

Nicholas DeBenedictis

Yes. We don't see, right now, the need for a rate increase in '14. We don't see the need for a disk in '14. Now that could change. But as of now, it looks like we'd go into '15 and if that's the case, the first step would be a disk. And that could be mid- to late-'15.

Operator

[Operator Instructions] And there appears to be no further questions at the time. I would turn the conference back to Mr. DeBenedictus for any additional or closing comments.

Nicholas DeBenedictis

Yes. Thank you, everyone, for attending the conference.

Operator

That does conclude today's conference. We thank you for your participation.

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