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Aqua America Inc. (NYSE:WTR)

Q4 2011 Earnings Call

February 28, 2012 11:00 AM ET

Executives

Brian Dingerdissen – Director, IR

Nicholas DeBenedictis – Chairman and President

David Smeltzer – CFO

Analysts

Michael G. Roomberg – Ladenburg Thalmann

Ryan Connors – Janney Montgomery Scott

Stewart Scharf – S&P Capital IQ

Michael Gaugler – Brean, Murray & Carret

Michael Roomberg – Ladenburg

Jonathan Reeder – Wells Fargo

Cleo Zagrean – Macquarie

Operator

Good day and welcome to the Aqua America Incorporated Fourth Quarter Full Year Earnings Conference Call. Today’s conference is being recorded. At this time I’d like to turn the conference over to Mr. Brian Dingerdissen. Please go ahead, sir.

Brian Dingerdissen

Thank you, Jeremy. Good morning, everyone. Thank you for joining us for Aqua America’s fourth quarter and full year 2011 earnings conference call. If you did not receive a copy with the press release, you can find it by visiting the Investor Relations section of our website at aquaamerica.com, or by calling Fred Martino 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 risk 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.

Nicholas DeBenedictis

Thank you, Brian and good morning, everyone. Very pleased this morning to announce Aqua’s 12th straight year of earnings gains for the year ended 2011 and a strong fourth quarter, beating consensus of – and our quarter was $0.24 versus $0.21, up 14% on 1% more shares outstanding.

For the year 2011, GAAP from continuing operations was $1.04 versus $0.86, up 21%. Our investors have come to expect consistency in our results and predictability in our business model of growth and efficiency and 2011 was no exception.

We had our 12th straight year of increased EPS for a CAGR over 10% over the 12-year period with 2011 rising on a GAAP basis, 14%, on a GAAP from continuing operations basis, 21%. It was our 20th straight year of dividend increases. We looked at a 20-year CAGR and it comes to 6.4%. This year, we raised the dividend 6.5%. So as you can see, pretty consistent.

We predicted at the beginning of the year a capital spend between $3.25 and $3.35 and we came in at $3.31, only the landing of the Space Shuttle was more accurate. However, one of the key items that I’m very proud of is that we’ve now addressed all our environmental issues and we’re investing in more green projects to reduce energy use and for reducing purchased water, which is an expense and turned it into a capital outlay.

We maintained and bettered our industry-leading efficiency ratio, lowering it again for the fifth straight year. In 2011, Aqua improved 70 basis points from a 38.7 – from 38.7 excuse me to 38, now that’s a non-GAAP measure and we’ve started tracking this 15 years ago and simply an operating expense or your operating expenses over your revenues, as you can interpret in a lot of different ways.

And once again for the 12th consecutive year, we’ve lowered our embedded cost of long-term debt to 5.30%, while Aqua Pennsylvania maintained its A+ rating, it’s – we are proud to say its ranked as the fourth highest out of 235 utilities ranked by S&P. So once again, 2011 was another predictable and successful year.

But 2011 was also an unpredictable and transformational year for Aqua. It was a year of very unprecedented weather to get into, it was a year of rapid rationalization of our regulated portfolios, something we’ve been talking again, but it really came thunderous in 2011. It embarked a venture into a burgeoning energy fields at Pennsylvania and Ohio, which three years ago we wouldn’t have even known existed.

And tax policies, which we’ve, obviously, accepted, but utilized and generated an unexpected additional cash flows and an additional $10.07 in earnings, which I’ll explain later in the call. The year ended with a major reorganization of our Senior Management Team to better align the team with our strategic planning and the extension of my employee contract for three additional years to ensure a smooth management succession.

When we ended last year, we had 14 states and we were suggesting over the last couple of years a pruning, which is another word for rationalization program, that was needed to maximize our earnings potential, and honestly management did not believe it would have happened as quickly as it has. Within months, we’ll be operating in four fewer states and expect to continue increasing our net income as a result of this rationalization. We work very hard and very closely with our other water industry peers to do some transactions, I think that truly make sense for both parties. And let me take a minute of your time to just summarize them.

Late in ‘10, we sold a very small operation and money-losing operation in South Carolina. In May of ‘11, we sold our Missouri operation, which was only 3000 customers to American Missouri. And over the years, eight years, we owned and we lost an average $200,000 annually to maintain that property into run at rate. 2011, we expand in Texas through the purchase of number of systems and 5000 customers from American as part of the trade and I can tell you after six months we’re already earning the same ROE as the rest of Texas because we initiated and implemented our program immediately and in just six months, so you can normalize this, we earned over 200,000 in that six-month period, turning a loss from Missouri into a gain in Texas.

We announced in July and sold in at the end of December or the first day of January for official purposes. Our main operation to Connecticut Water, once again I think it’s a win-win, six months is a remarkably fast time to have a franchise transfer, I think that’s credit to Connecticut Water’s reputation but it’s also a credit to our main operations reputation. We sold the operation for 37 million plus assuming all debt. After taxes on the profit we will have 26 million in equity cash to invest in our other state operations and we will increase the earnings power to Aqua from the roughly 1.5, 1.6 annually we used to make out of main to about 2.8 million annually by reinvesting it in the higher earning states.

We expect the trade of our Aqua New York operations 51,000 customers to American for America’s Ohio properties at 57,000 to occur early in the second quarter and both companies are confident that the current profitability will be enhanced by both of us improving economies of scale. New York is currently 5% of our customer base, but only 2% of our net income and the earned ROE in New York is underperforming the rest of the company’s overall performance by as much as 40%. Ohio’s current performance is similar and we’re optimistic that we can improve the performance of the systems that served the 57,000 customers we’re buying to the same levels we experienced for the 90,000 current customers we have in Ohio.

So transformational year in our portfolio of our regulated companies. Now weather was truly erratic in 2011 versus much more favorable normal I’d call it 2010, revenues were reduced to approximately 2% due to the reduced consumption chiefly in the Mid-Atlantic region, we’re flat in the Midwest down significantly in the Mid-Atlantic and actually up in the southern states with Texas experiencing a drought, but the Mid-Atlantic region which is more than half our customers had the wettest year on record.

Now as I mentioned, some of the negative effect was mitigated by record sales in Texas, but not enough to offset what we believe to be as much as a $0.02 difference from a normal weather year. Most people fear the tax spend, but in 2011, we welcomed as we explained in our three prior earnings calls, for 2011, we tried to explain it, not all the GAAP earnings were coming from operations and some were from tax policies.

At the end of the year, the analysis shows that 10.7% of our GAAP earnings came from this one-time retroactive policy to grand 100% bonus depreciation and for one of our key jurisdictions to allow a flow-through of that. This policy was retroactive, I think it was in February or March of ‘11 that was enacted retroactive to September of ‘10. So the first quarter was affected even greater than the other quarters and on the addendum sheet that we added to the press release, hopefully it’s on our website and people have seen it, we put by quarter the amount that we got from these taxes of $0.107 for the year. And the first quarter as you can see, if you were looking at it, was the highest of the four quarters at $0.031 and that was because of its retroactive status all the way to September of ‘10.

Now, the most recent tax package that was passed by Congress on the payroll tax, there was an attempt, but was at sale to put bonus depreciation and again for ‘11 – I’m sorry, for 12, the 100% bonus depreciation expired at the end of ‘11. It goes to 50% this year, which is still more than normal and all our planning for 12’s budget and cash flows and capital spend is based on that 50% and the fact that the first tax bill that went through and I’m not sure there is going to be many more tax bills to pass this year, it did not get into that bill. So if anything, it looks like it’s late in the year and who knows it will be retroactive and all that, but we can’t plan for possibilities. We are planning for the 50% bonus depreciation this year. But it was nice while we have it in ‘11.

Now other than the actual help to GAAP earnings, which we’d like to at the end of the call, explain what the one-time effect was, therefore you can judge how you want to go forward with comparisons. The good news is that our cash flow in ‘11 was over 365 million, actually 367 to be exact and it well exceeded our capital outlays and allowed us to reduce our ‘11 and actually into ‘12 planned borrowings, so it’s actually reduced our overall debt load there for our interest.

But – and it also significantly increased our net income in 2011. However, I’d like to also say that since 2006, we looked at the last five-year period, we’ve more than doubled our net cash flows from operations, but that all didn’t come from this one-year tax advantage, deferred taxes are only part of the story. When you compound net income at 10% a year and depreciation at about 7% a year, they are also big factors in why we had become much more cash self-sufficient to support our capital programs and that’s why therefore we do not need as much debt floating as we did in early part of this decade and also the last decade, excuse me, and also we have not had an offering for, I think it’s 40 years and we don’t anticipate any equity offering from our – for our current operations in ‘12.

Now, the difficult part, which is to try and take what is generally all good news and explain four different sets of numbers that various analysts are tracking and looking at. And I’ll give you my opinion. On the website, you’ll see a pretty detailed sheet by quarter over the last three years that shows the – what the effect of the loss of New York and Maine will have to our continuing operations. This does not include the Missouri sale or the Texas purchase, which I gave you a little bit of granular data on earlier.

Personally, I believe the appropriate analysis for the future would be our adjusted GAAP from continuing operations to predict the future. But you could use GAAP, but I do hope that you’ll take note of the four quarters this year, where we had the $0.107 of taxes and we would – for projections, we’re adjusting them out.

So let me just throw some numbers at you. If you want to do just GAAP, I’ll start with ‘07 through ‘11. So you’ll have a five-year comparison. ‘07 GAAP was $0.67 and $0.69 in ‘08. $0.74 in ‘09, you can see how we started to assimilate all the Heater properties and the AquaSource properties. $0.86 in ‘10 and $1.04 – again this is unadjusted GAAP in the ‘11, so that was 11.5% CAGR.

‘07 was a good year to start to, not constantly the five-year period, but we really grew quite a bit in the 456 time period when we bought AquaSource Heater, New York Water and Florida properties and that was a 25% gross spread in two years and we had to assimilate that and that’s really ‘07 was start of the assimilation, you can see how by rationalizing and improving the capital structures and getting rate cases in all these states and fixing them up, we’ve been able to get back to the old Aqua America Philadelphia Suburban, which was just a steady 10%.

Our GAAP from, I’m sorry I gave you the first one was GAAP from continuing, so that was the 11.5 CAGR. If you take GAAP, straight GAAP numbers, which were on the sheet also, they were 71 in ‘07, 73, 77, $90.03 and that was a 10% CAGR. If you take GAAP from continuing, which should mean New York and Maine or out and roughly $0.03 a year they threw off, but not equally in every quarter, New York lost money two quarters and then would make money in the last two.

That GAAP from continuing and I’m going to adjust this for the $0.107 in ‘11, and you can see that’s right up top of the sheet where 1.44 was the real number four GAAP continuing 10.7 paying the 93.7 rounded up to 94. The numbers will be 67, 69, 74, 86 and 94 which comes to just over 9% CAGR and if you want to say that the 94 was may be a penny or two late because of the fact that we had abnormal weather this year, you’re right back there to 10%.

And I’m very comfortable that we’ll continue whichever number you want to use as long as you adjust the continuing for the one-time effect of the tax benefit that we’ll ‘12 will look just like the rest of the years and we can continue with the 10% growth, either GAAP from continuing adjusted or with the GAAP Itself.

Now the reason the GAAP itself would be different is that Maine in the first quarter this year could throw off as much as $0.06 to $0.07 to $0.08, $0.07 to $0.08, yeah. Now, it will look good on the numbers, but obviously it’s a one-time sale and I’ve tried to adjust that and it would be adjusted out of the continuing. But it’s real dollars and it’s going to be earning in the future at a much better pace than if we had kept main for the rest of the company.

So kind of a confusing, but I thought if I gave you all these numbers, you could better judge the past history but also the future potential of the company.

I think, I’ll stop there and open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll go to our first question from Michael Roomberg from Ladenburg Thalmann.

Michael G. Roomberg – Ladenburg Thalmann

Hey, good morning, Nick. Thank you for the very detailed update there, I appreciate it.

Nicholas DeBenedictis

Good.

Michael G. Roomberg – Ladenburg Thalmann

I just had a quick question on your Texas operations. It’s often difficult for us to get a real-time perspective on developments from there. And I’m just wondering, if you can kind of give us a general overview of your operational footprint there, current regulatory proceedings that are in place and your growth plans there?

Nicholas DeBenedictis

Sure. We seem to be one of the few companies that like be in Texas. And we’ve had success in Texas, we’re the largest, we are in three basic regions, we have an O&M contract all the way out in West Texas.

But most of our regulated operations are in the three areas Dallas Fort Worth, which we call our north division, the Southeast which is Montgomery County and the suburbs of Houston, and third would be in the Austin to San Antonio area. All three are consolidated, but within the region, so we don’t have one rate structure in Texas, we have three, actually six, water and wastewater, but they’re all consolidated.

We have a settlement in our most recent case, the Southeast case, which is well described in the K, you read it. In our mind it was like any settlement, both sides feel like it did well and we do, and that one is now behind us.

We have two active cases, where there has been very little controversy or opinion. We filed these cases in late ‘11 and will be ready now for the process in Texas, which is – they allow what they call interim rates, Michael and then you to then prove the case and after the interim rates, you need to give back or you get more at the end when they finally rule and that’s the process we’ve always been treated very fairly so we’re comfortable with that process.

Okay. It’s one of our fastest growth states, the recent we have economy of scale there and American didn’t, we’re no better managers than they are, just that we were able to take their operation basically cut 30% to 40% out of the cost structure, put it into our existing structure, pick up some of their employees who are good employees and one as a manager and we were lucky enough to get a hot summer, but I normalized that 200,000, we actually earned well in excess of 260 on a six-month basis that would be 0.5 million. So you can see it, it’s we’re very pleased with the transaction and we’re continuing to look in Texas and expand in Texas.

Michael G. Roomberg – Ladenburg Thalmann

Okay. And in terms of the interim rates that you mentioned, can you give us an idea of the magnitude and when they went into effect?

Nicholas DeBenedictis

Well, the interim rates do not go into effect until the commission approves that and I got to get back to you rather than give you – I think it’s March or April, but I’m not positive and then usually they rule later now, one time, we had four years before we finalize the case, and I don’t want to, that was the first one, the second one was much quicker, it’s only been a year on the settlement, the one that settled, which is the Southeast, we anticipate hearing at some point from the official commission ruling even though their staff has agreed to it, sometime maybe as early as end of March. And that would finalize that case.

The other and there is a lot written in the K and if you have questions after you read that, go into much matter detail. The other two cases were filed, were not collecting any revenues yet. We sent all the notices out having hearings and so on and I think it’s April before we start charging interim rates. And I just don’t remember the percentages, but I think they’re well in excess of the teens to 20%.

Michael G. Roomberg – Ladenburg Thalmann

Okay. All right. That’s helpful. Thank you. And then just real quickly on the non-reg side, it’s good to see the progress on the Marcellus pipeline and just trying to get an idea if you might be able to handicap the number of wells that could be serviced or drilled based on the water supply that could come through that pipeline over the life of the region?

Nicholas DeBenedictis

Yes, sure. The way I look at it as we fill impoundments and then well – the Rangers and the EXCOs in the southwest all take the water from their impoundments and take it to their various well sites, that’s really, I don’t know how many wells they’ll do off of each in impoundment, but we just keep filling impoundment with a spigot basically.

The impoundments are at least 5 million gallons each, big pretty big, big swimming pools. And a typical well can take up to 4 million gallons, typical truck is about 4,000 gallons, so that’s why 1,000 trucks for every well, and that’s what’s causing the environmental degradation. So this way they would take the trucks only or maybe they have an overlying pipeline from their impoundment to their well pads, and so it would be much less truck traffic.

We will be able to pump if we get the permit and it’s not final yet. Up to 3.5 million gallons through this one pipeline that we are working on now.

And the 3.5 million, you could argue a day, would cover – let’s say it’s 3.5 million gallons per well, that’s really only one well a day that we’d be able to sack to do, but it doesn’t work that way, but I’m giving you that example. So we think that once we get the pumping station build and the pipeline build, it will be in constant use, because it fills up a pond of 5 million and as their work in that on, we’re refilling it and so on, that’s like our tanks would be on a normal system.

Michael G. Roomberg – Ladenburg Thalmann

So, I guess, just to be clear, even with the collapse in natural gas prices recently, I mean you still feel fairly confident that the pipeline will be utilized in a pretty short order here and on a continuous basis?

Nicholas DeBenedictis

We will know within a month. The companies that have signed on to us are bugging us when it’s going to get done. So that tells me they’re still drilling. But you’re absolutely right, gas price cut down as low as $2.10, there is a point where it doesn’t paid to drill, I assume, by – on that net business, but we think they’re still drilling.

Michael G. Roomberg – Ladenburg Thalmann

Thanks, Nick.

Operator

We’ll take our next question from Ryan Connors from Janney Montgomery Scott.

Ryan Connors – Janney Montgomery Scott

Good morning, Nick.

Nicholas DeBenedictis

Good morning, Ryan.

Ryan Connors – Janney Montgomery Scott

I wanted to – first-half just tackle Michael’s sentiments and thanks for the detailed walkthrough the numbers, I mean that’s very, very helpful, and the different ways to look at it. But on that note, clearly the swaps are creating complexity in the financial results and in the reporting, as you know, just in terms of first call that sort of thing.

And I know you’ve got to negotiate separately with the Connecticut Water on Maine, but with your largest peer there, they’re talking about more of the swaps and most people believe that will continue and why not just get it all done in one sellthrough, everybody in the room talk about what makes sense where and to get one big deal done instead of having potentially two or three years of these types of discussions on the complexity that this introduces into the results?

Nicholas DeBenedictis

I mean we’re always open and constantly looking. There is also capacity issue as to how many you can do at this facility here. I mean I don’t want to under estimate the time it takes regulatory wise, planning wise, new employees, we have 80 employees who are leaving us and 80 new coming, training, pension benefits that are different and so on. And I’d love to say we can do everything at one-time.

That’s what we tried to do at AquaSource and Heater and we ended up getting in to (inaudible). So if there are more out there, I’m sure they’ll happen if they make sense, but I don’t – we’re not in discussions right now – serious discussions on anything else until we get Ohio up and running and Maine is almost done, we’re doing the final numbers now and New York sold at which point we’re ready to go back in and look at some more.

Ryan Connors – Janney Montgomery Scott

Okay. Fair enough. And then in terms of – just want to get your update on regulatory developments, most of all belief for you in Pennsylvania but also elsewhere, I mean what are the three or four regulatory changes you see on the horizon, whether they be the D6 or future test years or whatever, which states do you see a significant change for better or worse on the horizon here in terms of regulation?

Nicholas DeBenedictis

Three pieces of legislation that are very positive for us. One is in New Jersey. There appears to be at least support at the commission level for a New Jersey styled disc and we’re happy with that if it happens and we will immediately shift our capital programs and increase our capital spending in New Jersey, especially on the infrastructure if it occurs and we are planning and are – we have two budgets for New Jersey, one with and one without the disc for ‘11 – for ‘12, I’m sorry.

In Pennsylvania, a bill was passed that actually helped the gas companies because we had two very unfortunate explosions in ‘11 to address their deferred maintenance problems and we were able to make sure that water wasn’t forgotten in that bill. Two things occurred, first of all, it allows for future test year, which is even clearer than the current modified future test year we have in Pennsylvania for all utility electrics or utilities electric gas and water.

Second, it allows water companies to have wastewater in addition to water, which is fairly new for ourselves and American and New York and I don’t think New York has any wastewater nor does United and Pennsylvania, they may, I don’t know – Pennsylvania, American and ourselves did get into wastewater in the late 90s.

A very small piece of our business and it is an administrative burden on everybody because these are small systems and small cases, they’ve allowed for the consolidation of those, a consolidation of the rate base between water and wastewater and therefore a modifying effect on some small water source systems whose prices would become unaffordable if you fix them the way EPA wants you to fix them.

So that’s a positive plus we’re allowed now to apply for a sure disk, which will be called a Sisk, I don’t know why it’s called a Sisk but that’s what it’s going to be called which we plan in due course. In Ohio, there is a bill right now that was passed for gas and there is one being considered for water to allow for future test year currently Ohio is a historic only test year.

Ohio has good regulatory climate, they have it as they call it a sick surcharge improvement charge or something like that and it allows for 3%, so you can get upto 12% in between rate cases. And but they have a historic test year, which causes lags, so therefore nobody can stay out for years. So that’s being looked at and there is at least legislation sponsored to possibly give water the same future to – and gas – same future test year as gas just got last year.

Ryan Connors – Janney Montgomery Scott

Okay. That’s a great update. Thanks, Nick. And then finally this seems like an issue we discussed almost annually now, but now we’re hearing again about a potential increase in the tax rate on dividends and some of these tax plan get floated in the last cycle. What are your current thoughts on that and if you – we did see a dramatic bump up in dividend taxation rates, would that at all impact your capital deployment priorities, payout ratios, et cetera?

Nicholas DeBenedictis

Well, it clearly would affect companies that are trying to sell stock, which we’re not and I think it will affect the utilities more, it will affect all every dividend paying stock, it will affect the utilities for higher yield (inaudible) and you can see our industry has traditionally been lower than 3%. So we have a little bit of growth aspect to the valuation of our stocks versus strictly on a yield basis, like, some of the more older mature or less growth oriented electric utilities.

Now having said that, the last – when it dropped the last time, it dropped from ordinary, Ryan, which was at that point over 42.15.

David Smeltzer

I think it’s 42.50.

Nicholas DeBenedictis

Yeah, 42.50, 42.50. And that was a dramatic drop and I think you’re exactly right, it was a nice jump, and I think it was during the Bush year’s, so it was early 2000s just when they did this. It’s been around for 8, 9 and 10 years. The risk – I haven’t heard the latest of the President’s proposals, but I’m not sure where his budgets going anyhow. But the rumor is possibly gone up to 20 or 25.

Wrong direction, but not at the speed that it came down, and we’re going to, obviously, have be here and we have a couple of members on ways it means I’ve already started loving them and explaining to them and I’ll glad offline to share some of the ideas we’re talking to them about to basically earmarked utilities as companies were absolutely going to invest in America, our money is not going to go overseas.

And as long as the money is being used, utilized to invest here, you don’t want to hurt capital intensive industries, which need investors to continue to grow in America. And some way to reward them, whether it’s a – and there was this back and only one old enough to remember this. Back in 79 there was a bill, which was passed, that allowed reinvested dividends, which I’ll share with you and I’ve already shared that with some of the members.

That would really make sense and you treated as a lower capital gains, at that time it was 12%, I’m not sure we’re going to get there, but it worked and it kept people investing and keeping reinvesting dividends into utilities, which had to invest at least that much in capital, so that all the money was going back into the ground in the U. S.

Ryan Connors – Janney Montgomery Scott

That’s a great point. Thanks for your help, Nick.

Nicholas DeBenedictis

Okay.

Operator

And we’ll take our next question from Stewart Scharf of S&P Capital IQ.

Stewart Scharf – S&P Capital IQ

Good morning.

Nicholas DeBenedictis

Hi, Stewart.

Stewart Scharf – S&P Capital IQ

Hi. How are you? Could you talk a little about your acquisitions and your strategy. I know, several years ago, some of the larger acquisitions, like, AquaSource and Heater, it took time to bring up the ROEs pretty weak and it seems like now, with some of the deals, you are able to get the ROE up to your traditional levels quicker than your smaller deals, so are you focusing more on the deals that you’ve been making now in your strategic or critical mass states or is it just based on opportunity where you would seek a similar deal like a few years ago?

Nicholas DeBenedictis

Right. The question – the AquaSource, nobody expected and it just came upon and we’re one of the few companies ready and waiting to do the deal and we know it was a troubled company, but it did take us longer than we had anticipated to invest and capitalize and then get fair rate cases and that catch up period is now still happening, but it’s come from the basement I guess, we’re up – halfway up the office tower now, whereas some of our more traditional states, Ohio, Pennsylvania and New Jersey are more mature and by managing correctly, avoiding regulatory lag and then of course with the disc, you are able to almost fully earn, which is exactly what the system says you are supposed to do, so that you’re getting a fair return for your investor’s dollars.

Regarding the concentration, we are very pleased with the three big states that we’ll have and we’re hoping that with organic growth coming back, we’ll see some rapid growth in two of the southern states, North Carolina and Florida. But the Texas, Ohio and Pennsylvania are being helped by the energy issue of the gas and it’s creating a new wave of growth in certain areas that we hope to capitalize on.

So I would say the more likelihood for ‘12, ‘13 will be, you will see a rush of what we call, small, middle sized, but that’s all that is out there other than one or two systems that may be sold of these small systems whether it’d be municipal or private.

We just got approval just the other day for three in Pennsylvania, which are the typical size that we’re looking for and we re-organize and have now a Senior Executive Vice President doing nothing, but development, which could be regulated or unregulated with a hint towards the energy side and I’m going to be spending a lot more time of my last three years on that part of the business. Now that the other part of the business seems to be humming.

Does that answer your question? I mean I don’t – there is only three or four publicly traded that are of size that would be a possibility and these are like collectors cars as what we said, they are not for sale unless this owner decides to sell them.

The smaller private companies that are private equity owned or we really don’t have access to the public figures, but I know that the pension funds love the water business. So as you can see from some of the last transactions and rightfully so because it was pretty much – if you look at our numbers whether it’s five, ten or twenty years, it’s about a 10% CAGR and I don’t know that how many pension funds our earning that. So there is a lot of interest in the field, but not a lot of interest in the 10,000 customer system in Idaho where you have to do a lot of work to get it. Everybody wants the 0.5 million customer system that’s already fixed.

Stewart Scharf – S&P Capital IQ

Right. Okay. That’s helpful. And on your rate requests, how is that going – is it generally – you’re basically getting your historical percentage on the rate?

Nicholas DeBenedictis

Yeah. We’ve been doing pretty well. We get our normal – as you know, we always feel we should get more investment – return on the investment we’ve made than the regulators finally decree, but and that’s usually the biggest part of the difference, we very seldom lose any dollars on operating costs of significance and that’s because our operating costs are so low compared to all the other water and electric companies, it’s hard to cut from the best in the field.

Regarding the current cases, the big ones are in New Jersey, where we’re having hearings as we speak and we have not had much controversy and we anticipate early summer for settlement and in Pennsylvania, which is always our biggest every two years and we’re starting our hearings and so far the comments have been very, very constructive. So it’s an ROE case and a capital case and capital is spent and there is very little prudency challenges.

I’m feeling pretty good about them.

That’s the bulk – in the release, I put in there Stewart how many cases we’ve already gotten this year and what the annualized return is in Pennsylvania is in there for 36 million and we did ask for 11 – I think 11.75 ROE, which would be – we’d love to get it, but I – we don’t think we’ll get 11.75 and when you take 25 basis points off of the ROE allowed, it drops millions at a time. I can’t give you the exact number, but maybe Stewart, call Dave Riley or we can figure it out for you.

Stewart Scharf – S&P Capital IQ

Okay. And you said that the organic growth is picking up, where are you seeing and how much new housing units –

Nicholas DeBenedictis

Yeah. We’re seeing – yeah. Little bit hope Pennsylvania permed up a little bit, but I think a lot of that again is the energy related. Texas slowed down, but never to the point where it stopped, still was 2% last year, which is still pretty good.

Texas is still importing people and we’re starting to see some stabilization in North Carolina, which is the state we have the most potential because in North Carolina we’re the developer of the communities outside the cities and we’re not a builder goes in and plots 500 lots and then starts the development, they lay all the pipe and maybe they sell 30, 40 houses at which point we give them so much per house as it’s sold, but we have accessed in that example to 470 more homes and they’re just winning to get build and most of the building will occur where you already have the infrastructure roads and a reason to be there because there is already some people being there versus expect development, so we’re optimistic, it’s not going to be overnight, believe me, but I think in the next five years we’ll see a return to organic. And we dropped almost 100 – we were growing 100 let’s say – 1.5%, 2%, last year it was 0.3% I think.

So we dropped 100 basis points to more on the growth rate organically and that would make a big difference in getting rid of lag if we can get that back.

Stewart Scharf – S&P Capital IQ

Great. Thank you very much.

Nicholas DeBenedictis

Is your electric back on Stewart?

Stewart Scharf – S&P Capital IQ

Yeah. The winds are pretty high the other day but these data –

Nicholas DeBenedictis

Good.

Stewart Scharf – S&P Capital IQ

Thanks.

Operator

And we’ll go to our next question from Michael Gaugler from Brean, Murray & Carret.

Michael Gaugler – Brean, Murray & Carret

Good morning, everyone.

Nicholas DeBenedictis

Good morning, Michael.

Michael Gaugler – Brean, Murray & Carret

Congrats on a nice quarter Nick.

Nicholas DeBenedictis

Thank you.

Michael Gaugler – Brean, Murray & Carret

A lot of my questions have been already been answered, do you have to – in your comments this morning you kind of highlighted improvements in O&M and where those trends are headed and you guys have certainly done a nice job there. This is an area we’re seeing other companies like AWAK focusing on as well in their presentation and we do get questions from investors on it as well. I guess my question we’ve got given now that you’ve got some non-regulated business and some non-regulated business coming on AWAK has some as well. Are the metrics there fairly comparable across most of the water utilities or does some of the non-reg kind of flow into that?

Nicholas DeBenedictis

The way we did it was everything. In other words we just took a simple line off the P&L of operation and maintenance, which we give you and provided in whatever the reveries regulated or unregulated and that’s the number. If – but I did see American, and rightfully so, if they’re going to – they are looking at the regulated group and they’re looking at not all the O&M, but one of big elements purchased water, which truly is part of our core business, but we had to taken out. So if you – I felt apples-to-apples, I did do that calculation if I have I mean ours is on everything and if you took out that purchased water and you took out the O&M expenses from our unregulated, which are very much higher, I mean nobody has margins like the water business, right.

I mean the trucking business, where we have the except the trolling, the margins are 12%, so it’s 88% O&M, but it’s not a big part of our business. But if you took all that out and just for purchased water, we’d be around, let’s say, just excluding about 35, it looks like about 35.5 (inaudible) apples-to-apples comparison. I still think we’re 800 to 1000 basis points better than anybody else in the industry, but we’ve been working out for 20 years, it’s not easy to get down.

Michael Gaugler – Brean, Murray & Carret

Understood. That’s helpful too when – as we look out towards the California Utilities given the volumes of purchased water they have. And then the kind of – I’m going to kind of follow-up here on the non-reg side, the Marcellus pipeline. I saw on your release, that’s coming online shortly, I would guess that that’s going to have some kind of an impact on 2012 EPS and would appreciate any guidance you could provide if not earning, perhaps, sales, so we could at least put a margin on that business?

Nicholas DeBenedictis

Absolutely. Right now, the budget assumes nothing, right Dave. A little bit in bulk water sales from our – we did last year matching that. That’s a filling stations we have around the state for the trucks. And I’m comfortable without any thing up or down from Marcellus with the 10% projection, I said, I was comfortable with on the adjusted continuing ops. Then, if you want to do GAAP at another whatever $0.08, $0.09, the – $0.07 or $0.08, I’m sorry, for main. The outlays – I think, what I’d like to do is – have you ever been up there, Michael, looking the (inaudible)?

Michael Gaugler – Brean, Murray & Carret

I have not yet, but would love to go.

Nicholas DeBenedictis

Maybe that’s the best way to show you and it have to be springtime when we’re doing our Phase II, where you could see that where the line comes in. These are – this is no small engineering fee, I mean, we’re pumping at 1,000 psi, we had to get numerous permits. When you see them constructing this pipeline, you realize it’s mountains, putting in holding and then having bacos hold up the bigger equipment that’s digging the (inaudible) I mean it’s not (inaudible).

So – but once it’s up, we think that it’s so competitive to the trucks that even at the price we’re selling, which is almost a multiple of what we get for regulated water, it’s still competitive with the trucks, and I’ll show you some of the numbers and then you can do your own projections. But the key will be, if they are drilling or not and like going up there and flying up there, maybe you’ll get a feel for the – all the pads and what these impoundments look like.

Michael Gaugler – Brean, Murray & Carret

Okay. Thanks, Nick. I appreciate the offer.

Nicholas DeBenedictis

Good.

Operator

And we’ll take a follow-up question from Michael Roomberg from Ladenburg Thalmann.

Michael Roomberg – Ladenburg

Thank you. Nick, I just wanted to follow up on something that you brought up a few minutes ago, which is the influx of private capital, the appeal of water utilities to private capital and pension funds and so on. For us, it seems as to kind of present it a 2x short on the one hand, it seems like there is a bit of a crowding out or a competition for attractive assets between you and the private guys, but on the other side, with evaluation multiples that these guys are paying, it would seem to suggest that the entire sector is undervalued and I’m just wondering if you can comment on that in terms of how you see these guys approaching the industry, whether at a certain point, whether or not they look to guys like yourselves to acquire?

Nicholas DeBenedictis

Well, the last time I’ll call them big players and these are big players, these are the big Canadian pension funds, the Australian infrastructure funds and of course Citi, JP and so on.

So it’s the biggest of the big players. The last time that happened to our industry was in mid part of the last decade when GE came into the market and Siemens and the evaluations ran probably a little bit ahead of themselves, but we were trading above 40 on forward earnings, based on the fact that GE was going to – they’re going to buy everybody out or somebody missed something and since we’re already in the business, our earnings will be work more. We’ve now settled back to in the 20 range, 20, 21 depending which one – which one of the numbers you want to use. But I think that is warranted based on the consistency, the EBITDA, the revenue numbers are close to 60%.

The dividend yield, which you could do away with immediately if you went private, all those considerations I mean these are truly unique encompassed and the fact that some of them like the bigger ones who are publicly traded or well run and don’t bring within lot of risk, I think it garners that premium, whether we should trade at 20, 25 or higher who knows? So I think it does put a floor on the stocks as to dividends eventually. But I’ve always believed that these are I call them collective cars, they’re all Bugatti’s or all the Packard’s or whatever in the sense that you can’t create one and they’re not making any more and they’re only for sale when somebody wants to sell them.

Now the ones that have been bought at huge multiples to EBITDA, which I think they’re even getting huger at the continuing operations. Our companies that were I would argue not the best of the group when they were part of the 20 or so that were around at the time. So there is something to be said for once you pay for these things, you have to run off. And I think that is my bigger fear of value destruction than we’re overpriced. I think there is an under evaluation here, but we also want to make sure that the private equity people who are buying some of the other ones run them well because it will hurt all of us in the long run, but also hurt valuations. I don’t know if that was too philosophical or –

Michael Roomberg – Ladenburg

No, that spot on. Thank you so much.

Operator

We’ll move to our next question from Jonathan Reeder from Wells Fargo.

Jonathan Reeder – Wells Fargo

Hey, good morning Nick I won’t keep you long, just a couple of quick questions. I just want to make sure the bonus depreciation that you’re talking about the 50% in 12, you’re talking on the federal level not Pennsylvania?

Nicholas DeBenedictis

Yeah the state of Pennsylvania will do nothing unless it’s 100 and even if it’s 100 I talked to the secretary revenue even if it’s 100 now that the governor’s budget has been proposed and it’s another tough budget, very little likelihood that well no likelihood if bonus isn’t passed retroactive before June probably. I don’t know that the state would retroactively do it because it costs state budget money. I’d say the chance of that 10.7 reappearing in 12 is very, very slim.

Jonathan Reeder – Wells Fargo

Okay. And then second, just a little bit of clarification, the adjusted EPS and earnings that you’re talking about that does not I guess exclude any of your like sale gains over the last couple of years, is that correct like, I think in 2010, you guys have like a penny investment sale gain?

Nicholas DeBenedictis

Yeah. Yeah. No, because, I’m not saying they’re continuing ops, but every year, we have something we sell land or stock in somebody we bought, like the Southwestern, which was a penny in whatever year. So rather than try and go back 12 years and figure out what they all were, but they are pretty consistent.

Jonathan Reeder – Wells Fargo

Okay. And was there something remind me in 2011, like in Q1, was there a system sale.

Nicholas DeBenedictis

Yeah. You’re exactly right. 2010, when was southwest, ‘11 or ‘10?

David Smeltzer

‘10.

Nicholas DeBenedictis

In 2010, there was a penny or penny and a half gain, in the first quarter, we had the Southwest properties.

David Smeltzer

I guess it was ‘11.

Nicholas DeBenedictis

We want to make sure.

David Smeltzer

(Inaudible)

Nicholas DeBenedictis

And in ‘11, this year, we budgeted and told you we budgeted a condemnation sale in Texas.

Jonathan Reeder – Wells Fargo

Okay. And now it’s like a penny or something around?

Nicholas DeBenedictis

Yeah. Little under a penny I think. But they are all, whenever you sell a system, it’s usually three quarters of a cent or cent and a half.

Jonathan Reeder – Wells Fargo

Okay. All right. Just wanted to make sure.

Nicholas DeBenedictis

Yeah. So that first quarter of 2012 will not have like that 19 adjusted, it was 22, I’m glad you brought this up because let me just give you, 22 was the GAAP. If you take the $0.03 off, $0.031 of the state tax, that was 19. Included in that 19 last year was a penny, which we – it should be included, but I mean there was a penny in the first quarter, not in all the other quarters of a land sale.

Jonathan Reeder – Wells Fargo

Okay. Yeah. That’s what I was thinking and I just want to make sure I was thinking about it correctly.

Nicholas DeBenedictis

If you’re purest, we are up against 18 last year.

Jonathan Reeder – Wells Fargo

Okay.

Nicholas DeBenedictis

I mean taking all the noise out, if you want to take that $0.01 off of (inaudible)

Jonathan Reeder – Wells Fargo

Yeah. (Inaudible) stripping out a lot of those noise, you will get it all right?

Nicholas DeBenedictis

You’re right.

Jonathan Reeder – Wells Fargo

All right. Thanks a lot. I appreciate it.

Nicholas DeBenedictis

Okay. Good.

Operator

We will take our next question from (inaudible).

Unidentified Analyst

Good afternoon, guys. And that was after ‘12, but a quick question, yes, I hope I’m the last guy for you, but quick question, you did mention, I guess some of the waste water, the ability to consolidate some of the rate cases there as well as the sewer disk or a sic that’s coming down the line, would that change or alter your thoughts or change your thoughts in any way in terms of acquiring some more sewer systems, I know it hasn’t been a large piece of your business, but that’s definitely a positive regulatory improvement as here in PA?

Nicholas DeBenedictis

Absolutely, in Pennsylvania. Texas, we look at – I mean, in some of our southern states, Gary, wastewater is 35% to 50% of our business. So there is no reluctance to – we already have it consolidated. In New Jersey, we only have two or three, so consolidated rates in the sewer would be a big plus if we could get it. And in Pennsylvania, the reason we didn’t do more wastewater was consolidated rates were not available, now they are. So absolutely you hit the nail in the head.

Unidentified Analyst

Okay. And then, not to be labor, some of the Marcellus stuff, just a couple of quick questions. The pipeline, is that – where is that located, is that up in the Northern tier, at the part of (inaudible)?

Nicholas DeBenedictis

Dry gas.

Unidentified Analyst

Yeah.

Nicholas DeBenedictis

It starts in a place called Jersey Shore, which is little bit West of Williams Fort on the west branch of the Susquehanna like Cuming County.

Unidentified Analyst

Yep, I know it. And 18 miles long, and you’re still working on the premise, correct?

Nicholas DeBenedictis

No. Phase I, 18 miles, should be completed by March, early March, we should be completed.

Unidentified Analyst

I’m sorry. Okay, go ahead.

Nicholas DeBenedictis

$24 million total cost. We’re starting Phase II shortly, which will be another 25-mile run to the river, so we can get to the access to the water. Right now, we buy water from a reservoir up in Jersey Shore.

Unidentified Analyst

Okay. Got it. And then, on the permit side from I guess from the SRBC. Are they four-year permits or would that – are they longer?

Nicholas DeBenedictis

At least five.

Unidentified Analyst

Okay.

Nicholas DeBenedictis

But I think they’re evergreen, but I’ll get an exact answer and get back to you on that.

Unidentified Analyst

That’s fine.

Nicholas DeBenedictis

If you have a chance, come over one day, we’ll show you the whole map and explain it to you.

Unidentified Analyst

Yeah, I love to. I’ve spent more time than I tier up actually up in Williams Fort recently, but –

Nicholas DeBenedictis

Okay.

Unidentified Analyst

– it’s rather amazing. I don’t think it’s definitely slowing down there, but drilling still going – on a relative basis it still going to stay?

Nicholas DeBenedictis

That’s right.

Unidentified Analyst

And then, on the pipeline, is that take or pay, the contracts you know?

Nicholas DeBenedictis

The two of them are take or pay.

Unidentified Analyst

Okay.

Nicholas DeBenedictis

One of them is a guarantee to buy all the water from us assuming they’re pumping, which we felt it was due risk and they’re paying a higher price per gallon for that, in fact that they’re not a 100% take or pay.

Unidentified Analyst

Okay. And then, obviously you said, in the next couple of years you’re going to be focusing a little bit more on the energy side back. Have you given much thought as to what’s next. Obviously, there are some, I guess, sourcing pipeline opportunities not only in Pennsylvania, but as you look to develop couple of those key – key counties in Eastern Ohio, but curious if you’ve given any more thoughts where you can broaden it out or if you’re in a position to discuss those?

Nicholas DeBenedictis

No, no. We have already a plan and we are in discussion and we’ve already started a station out in Western Pennsylvania to serve Western Pennsylvania, Eastern Ohio mainly Shell.

Unidentified Analyst

Yep.

David Smeltzer

Little bit Chesapeake and we’re basically, we’ll be the only water company in Ohio at the end of May, excuse me at the end of the March. So we are looking at Eastern Ohio, Western Pennsylvania as a center of operation and then the (inaudible) Bradford areas similar in Pennsylvania in the Northeast.

Unidentified Analyst

Okay. But right now just focusing more on sourcing of water?

Nicholas DeBenedictis

Yeah. We’re eventually looking, but right now, there is not much of a market as to the treatment. That’s how we got started treatment and then we get morphed in to the water supply and the water supply is more immediate and something we feel very comfortable with. We haven’t given up on trying to get to the treatment side.

Unidentified Analyst

Got it. Yeah. I may take you up, I’ve spent a lot of time out in southwest looking at some private companies as well, so I know there’s a lot going on there.

Nicholas DeBenedictis

Yeah. I already talked you.

Unidentified Analyst

All right. I appreciate it. Thanks a lot.

Operator

(Operator Instructions) We’ll take our next question from Cleo Zagrean of Macquarie.

Cleo Zagrean – Macquarie

Good afternoon. First question, could you please give us more insight into how the organization of management helps promote your strategy? And then second, if you see more opportunities in the municipal areas than you might have in the recent past? Thank you.

Nicholas DeBenedictis

Right. The – one of the concerns was the fact that I’m nearing retirement age and where would the company go under new direction and we’ve started strategic planning, we’ve decided that we had great executives here that we could groom in to the next CEO. We’ve organized so that the succession plan would be inevitable that one of the three people that are Executive Vice Presidents now will be the next Chairman and that to use my years, which are now three left, 3.5 left, would be to gear the strategic plan so that we’re growing the company at the kind of pace we’ve been growing.

It’s not easy to keep growing 10% a year, year in, year out for 20 years. But we think the potentials here one of the earlier questions about the uniqueness in the earnings powers of these investments and we just want to make sure that I spend most of my time in the last three years to worry about the future and the growth. Does that sort of address it?

Cleo Zagrean – Macquarie

Yes, I was just wondering if the specific position assigned (inaudible) signals an increased focus towards those as a good business and –?

Nicholas DeBenedictis

Absolutely.

Cleo Zagrean – Macquarie

And if you could comment on the long-term potential of those areas, a little bit now would be appreciated.

Nicholas DeBenedictis

Well, the issues that will affect the (inaudible) (inaudible) are going to be the technology advances that are occurring the fact that the EPA will start enforcing, whether or not low cost financing stage for ever, at which point the (inaudible) would be at a disadvantage. And just the practicality of size many of the municipal governments, I’m not talking city of Philadelphia, city of Boston, but the one that we just bought or announced that we’re buying Mifflin to Pennsylvania, 500 to 700 customers don’t even have $1 million in revenues. How can you sit on top of all the rules, regulations. It’s the small municipal and the small privates, which I think the demographics are inevitable that they have to be combined with something there.

Cleo Zagrean – Macquarie

And you said significant opportunities to integrate efficiently into your system or there are limits for the margins at which those smaller acquisitions ca operate?

Nicholas DeBenedictis

No, no, it’s a good point. The reason one of the earlier questions was we’re looking everywhere for opportunity I think Steward asked that, we were going to concentrate in the states where we’re in, which is quite a bit of in California the nation’s top population states and use them as and therefore you can get immediate synergies by tucking them into your existing organization in that state the overheads are covered and the management is covered. That’s the highest priority.

Cleo Zagrean – Macquarie

Thank you very much.

Nicholas DeBenedictis

And there is 20,000 plus small systems municipal and private in those states just not like there is no inventory.

Cleo Zagrean – Macquarie

Thanks.

Nicholas DeBenedictis

Okay.

Operator

That conclude today’s question-and-answer session. Mr. DeBenedictis at this time I’d like to turn the conference back over to you for any additional or closing remarks.

Nicholas DeBenedictis

Thank you very much, and thank you for the questions.

Operator

That conclude today’s conference. Thank you for your participation.

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