American Water Works' (AWK) CEO Susan Story on Q2 2016 Results - Earnings Call Transcript

| About: American Water (AWK)

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

Q2 2016 Earnings Conference Call

August 4, 2016, 09:00 PM ET


Greg Panagos - Vice President of Investor Relations

Susan Story - President and Chief Executive Officer

Walter Lynch - Chief Operating Officer

Linda Sullivan - Executive Vice President and Chief Financial Officer


Ryan Connors - Boenning & Scattergood

Shahriar Pourreza - Guggenheim Partners

Richard Verdi - Ladenburg

Jonathan Reeder - Wells Fargo


Good morning, and welcome to American Water's Second Quarter 2016 Earnings Conference Call. As a reminder, this call is being recorded and is also being webcast with an accompanying slide presentation through the Company's Investor Relations Web site.

Following the earnings conference call, an audio archive of the call will be available through August 11, 2016 by dialoging 412-317-0088 for U.S. and international callers. The access code for replay is 10089150. The online archive of the webcast will be available through September 06, 2016 by accessing the Investor Relations page of the Company's website located at

I would now like to introduce your host for today's conference, Greg Panagos, Vice President-Investor Relations. Mr. Panagos, you may begin.

Greg Panagos

Thank you, Bianca. Good morning everyone and thank you for joining us for today's call. We will keep the call to about an hour. At the end of our prepared remarks, we will open the call up for your questions.

During the course of this conference call, both in our prepared remarks and in answer to your questions, we may make forward-looking statements to represent our expectations regarding our future performance or other future events.

These statements are predictions based upon our current expectations, estimates and assumptions. However, since these statements deal with future events, they are subject to numerous known and unknown risks, uncertainties and other factors that may cause actual results to be materially different from the results indicated or implied by such statements. Additional information regarding these risks, uncertainties and factors is provided in the earnings release and in our Form 10-Q each as filed with the SEC.

I encourage you to read our Form 10-Q for a more detailed analysis of our financials and other important information. Also reconciliation tables for non-GAAP financial information discussed on this conference call including adjusted return on equity and our O&M efficiency ratio can be found in the appendix of the slide deck for this call which is located at the Investor Relations page of the Company website.

We will be happy to answer any questions or provide further clarification if needed during our question-and-answer session. All statements in this call related to earnings and earnings per share refer to diluted earnings and earnings per share.

And now I will turn the call over to American Water's President and CEO, Susan Story.

Susan Story

Thanks, Greg. Good morning, everyone and thanks for joining us. With me today are Linda Sullivan, our CFO, who will go over the second quarter financial results; and Walter Lynch, our COO, who will give key updates on our operations.

Once again, American Water employees delivered strong results during the second quarter of 2016. We executed on fundamentals by investing in our water and wastewater system to ensure safe and reliable service. We operated efficiently to reduce cost impacts on customers field. We continue to grow our business based on our reputation and core competency and we worked to provide excellent service to all of our customers.

As you can see on Slide 6, we reported second quarter operating revenues of $827 million, a 5.8% increase above second quarter 2015. Earnings were $0.77 per share, a 13.2% increase above second quarter 2015. Our results reflects some timing benefits partially offset by some one-time expenses. For the first six months in 2016, EPS increased 8.8% and revenues were up 6.1%.

Slide 7 highlights, how we are executing on our strategy. Our foundation remains capital investment in our regulated operations. During the first half of the year, we have invested $552 million in capital including 24 million for regulated acquisitions. The majority of the remaining $528 million was in regulated operation primarily to improve water and wastewater system improvement for the benefit of our customers.

We plan to invest $1.4 billion to $1.5 billion for the full year, mostly for regulated infrastructure investments. That level of investment is balanced by our continued focus on controlling O&M cost as well as utilizing constructed regulatory mechanisms. Walter will cover this in greater detail, but we never lose sight of our customers and what they have to pay. This quarter was no exceptions and our employees continue to improve efficiency.

We had excellent growth during the first half of 2016. We have added approximately 7,600 new customers from closed acquisitions and 5,300 customers from organic growth. We have agreements in place, pending regulatory approval, which would add 47,800 more customers that include both the previously announced Scranton Sewer Authority, which led 31,000 wastewater customers as well as our recently announced acquisition of Shorelands Water Company adding more than 11,000 water customers in New Jersey.

I also want to mention acquisition activity that exemplify my earlier comment about growing our business based on our reputation and core competency. On Tuesday, the citizens of Blue Grass, Iowa voted in over whelming 86% majority to join the Iowa American family. Subject to a final agreement and regulatory approval, this 720 customer connections in Blue Grass would join this 730 new customers in yes community Iowa, which close earlier this year.

These two additions result in a 2.3% growth from acquisition over the 63,000 customer we had in Iowa at end of 2015. We are very proud of the dedication, reputation and customer commitment of our folks Iowa, as well as in all of our other state that we are privileged to serve.

In the market base businesses in the second quarter, we launched a municipal partnership to Homeowner services in George Town South Carolina. Our contract services grew kind of 10 year O&M agreement in July with the township of South Orange, New Jersey, which has 4,700 customers. Our Military services grew, began service to our Military and their families at Vandenberg Air Force Base on June 1.

As we noted in the first quarter earnings call, we continue to see headwinds in AWE for the remainder of the year. primarily due to lower fixed capital upgrade on our existing military installation compared to previous years. Linda will discuss this a bit more in her comments. Many of you know that drilling activity is picking up in the Marcellus and Utica formation where our Keystone Clearwater subsidiary provides water services.

As noted on the slide as of today we continue to see Keystone as being EPS neutral for the year. However, we will continue to evaluate the market and services demand and provide any update on our third quarter call. As noted on the slide our market share continues to increase and is now around 35% of the water services market in the Appalachian Basin.

As Linda will discuss in more detail we experienced an increase in our medical costs during the second quarter some of which we expect to impact us through the second half of the year, I would raise some of the more innovative ways we are looking to manage these costs in the future in my closing remarks.

As you can see on Slide 8, based on the results during the first half of the year we remain on track and we are affirming our 2016 guidance of $2.75 to $2.85 per share. We also continue our progress toward achieving our long-term goal of 7 to 10% EPS growth through 2020.

And with that, Walter will now give you his update on our operation.

Walter Lynch

Thanks Susan, good morning everyone. We are really proud of the results our employees have delivered this year. We had strong growth, we made smart investments, we meet or surpass all standards as shown in our annual water caller report and we continue to realize efficiencies across the business.

Through June 30 we have invested more than $535 million in our regulated business. Of that total, we have invested $511 million to maintain and improve the service we provide and another $24 million for regulated acquisition. As Susan said this investment is balanced by our focus on cost management, constructive regulatory mechanism, and legislation that enables us to assist communities with challenged water and wastewater systems.

Our commitment to invest in our infrastructure while focusing our customer affordability is clear in the rate cases filed and closed this year. In Missouri our rate case settlement was adopted and we received an order for $4.5 million of additional annualized revenue.

As part of the rate order the PSC further consolidated water and slurry to the geography regions, going from 19 water rate regions to three and 13 wastewater regions to two. This creates economies of scale by spreading costs over a larger group of customers, reduces company administrative costs and mitigates the volatility of our customers' bills.

During the second quarter, Iowa and New York requested an additional $13.6 million in combined annualized revenue and lowered operating expenses by $3.6 million collectively. In California on July 1, we filed an application that set new rates in each of our service areas for 2018 through 2020.

This application seeks a revenue increase statewide of $51 million over the three year period. Also the State Water Resources Control Board approved a five year time extension to California American Water to comply with a 2009 order to significantly reduce withdrawals of water from the Carmel River.

This action by the board recognizes our significant progress in building cooperative alliances among California American, local governments and communities and environmental organizations. With these alliances, we are pursuing projects in water recycling and reuse that augment our water needs both before and after completion of our planned desalination facility.

On Slide 11, you can see the success we have had in working with state governments and our commissions either in legislation or policy that enables water solutions for water in which would have chance. For example, the Pennsylvania legislature eliminated a consolidated tax adjustment in setting the utility rates.

The new law now requires a calculation of the public utilities federal income tax expense on a standalone basis. Separate from any gains or losses of unregulated affiliates. Prior to this law, Pennsylvania was one of our few states that had a consolidated fact adjustments.

In Illinois over the last several months, the Illinois American Water has worked to find solutions that help our customers having more reliable water system more quickly. The Illinois Commerce Commissions adapt with new roles in June, which removes the 5% cap between rate cases and instead permit rate that can increase in average of 2.5% a year with no year to increase more than 3.5%. This will be a big help in a state with big infrastructure challenges.

Finally in Kentucky, the Governor signed House Bill 309 into law. This law establishes a framework for public private partnerships in Kentucky. For the first time ever, the state and local governments can leverage private investment to complete necessary infrastructure projects to better serve to public. This law has been referenced as the most comprehensive P3 Legislation to-date in the nation.

As you can see on Slide 12, during the first half of the year. In addition to our organic growth, we welcomed about 7,600 new water and wastewater customer connections, which is about 20,000 people. We have pending acquisitions, which represented another 47,800 new customers. This includes the Shorelands acquisition, which is more than a 11,000 water customers. This is another example of how we are able to provide solutions.

Shorelands service area is in the part of the state that is designated by the New Jersey department and environmental protection as a critical area in terms of water supply. Once the purchase is approving close, we welcome our new employees and our new customers. We are also working to close our acquisition of the Scranton Sewer Authority by September 30. Here we will welcome 31,000 new wastewater customers who will benefit from our operational and engineering expertise and our commitment to make necessary capital investments.

You can also see in this slide how legislative efforts are helping us to provide water and wastewater solutions for people across our footprint. Out of the nine states where we have pending our close acquisitions, five have fair market value legislation. The importance of this legislation is evident when we look at the numbers. Nearly 97% of the customers we have closed or pending are one of these fair market value states.

Moving to Slide 13, we continue to improve our own and efficiency ratio achieving 35.2% for the last 12-months. We remain on track to meet our owned and efficiency target of 34% by 2020. It's a great effort by our employees across our business, and it's all about bringing value to our customers. As I did last quarter, let me provide you with you couple of examples of what we are pursuing to drive these results.

The first example is in our customer service centers, where we recently introduced new features to our customer soft service sight. These changes improve the customer experience by using easy and understand language for reoccurring payments and enabling our customers to change the bank account they use to pay their bills without the need to contact us.

For the month of July, more than 17,000 customers signed up for paperless billing and that's more than three times the amount of customers have signed up in a month of June. These changes are a true win-win to make it easier for our customer to do business with us and they enable us to drive down costs.

In New Jersey, in energy deregulated state, we have taken advantage of reverse auctions to reduce our electricity cost. We first did it in 2011 and completed another auction this past fall. To do this process, New Jersey American Water will save the total of $9 million for the next three year in energy cost, benefitting our customers.

When we reduce $1 in operation and maintenance expense, we can invest $6 in capital. The $9 million cost reduction would translate into an additional $54 million in capital improvements without impacting our customers rates.

Finally, we think our employees in West Virginia for the way they have responded to the devastating floods there this past June. Once again our team rose to the challenge, working safely and getting our service restored as quickly as possible. Additionally, they assisted statewide emergency response efforts.

For example, we loaned two water tankers to the West Virginia Department of Home Land Security and Emergency Management to provide portable water for flood devastated communities outside our service area. We also provided three large generators to run critical facilities in neighboring communities without power, it was a great effort by employees there and we are very, very proud of them.

And now, I’ll turn the call over to Linda for more detail on our second quarter financial results.

Linda Sullivan

Thank you, Walter and good morning everyone. In the second quarter of 2016, American Water delivered strong financial results and year-to-date, we remain on-track. Slide 16 shows the earnings per share contribution from each of our businesses. We reported earnings of $0.77 per share in the second quarter, up $0.09 or 13.2% over the same quarter last year.

Year-to-date, we reported earnings per share of $1.23, up $0.10 or 8.8% over the same period last year. For the quarter, the regulated businesses were up $0.08 and the market base businesses were up a penny. Parent which is primarily interest expense on parent debt was flat compared to the same period last year.

Turning to Slide 17, let me walk though the components of our quarter-over-quarter increase in earnings per share. The primary driver for earnings growth was in our regulated business, which was up $0.08. Regulated revenue was up $0.10 from authorized rate increases, infrastructure surcharges and the new revenue from recently completed acquisitions and organic growth.

O&M expense was down $0.01 per share, this represent continued improved O&M efficiency that Walter discussed and some timing impacts, including a one-time $0.02 benefit from settlement of the general rate case that will be offset during the remainder of the year. Largely offsetting these positive items were higher medical and prescription drug insurance cost of $5 million pre-tax that are managed through our [Aviva Trust (Ph).

These higher cost are the result of three items, first we have been managing down the over funded status of our Aviva Trust and this year the funded status went from been overfunded to been fully funded. Second, we are seeing an increase in claims cost; and third which would of our liability based on our claim experience.

As I mentioned, the second quarter impact was about $5 million pre-tax or $0.02 per share. For the remainder of the year, we estimate increase in claims will add another $3 million pre-tax, putting the full year increase at about $8 million pre-tax or $0.03 per share. America Water like other employers is challenged by rising healthcare cost and later Susan will discuss actions we are taking to manage this cost going forward.

Next interest expense was up a penny and depreciation expense was up about $0.02, both driven by growth associated with our regulated system investment. Moving to our market based businesses, quarterly net income was up $0.01 per share, primarily from a favorable contract dispute settlement of about $3 million pre-tax, which we had expected to receive later this year. Absent this favorable settlement, the market based businesses were relatively flat.

Increases in home owner services as well as the acquisition of Keystone last July were largely offset by lower capital upgrades in our military services group. As noted in our first quarter call, we expect lower capital upgrades in 2016 from reduced federal budgets and because these capital upgrades can be lumpy year-over-year. One of the biggest reasons capital upgrades were lower in the second quarter was the wind down of an $85 million three year project at Fort Polk.

Let me now cover the regulatory highlights on Slide 18. We currently have six general rate cases and one infrastructure surcharge request in process for a combined annualized rate request of a $113 million. For rates effective from July 1, 2015 through today, we received the total of a $102 million in additional annualized revenues from general rate cases, infrastructure charges and step increases.

As you can see on this slide, our requested ROE in our outstanding general rate cases is generally 10.75% to 10.8%, with recent authorization at 9.75% in several of our states. Overall our weighted companywide authorized ROE was 9.9% at the end of this quarter.

Looking at the change in ROE over the past three years since 2013, the company’s average authorized ROE has only moved about 10 basis points from a prior average of 10%, and during the same time period our weighted authorized equity ratio increased about 20 basis points. So even with sustained low interest rates over this period, changes in ROE have tended to be slow and gradual.

Slide 19 highlights our continued strong financial performance. We made total capital investments of $316 million during the second quarter of 2016 and $552 million year-to-date, primarily for regulated system investments, mainly for the replacement and renewal of transmission and distribution infrastructure. We expect total capital expenditures to be in the $1.4 billion to $1.5 billion range in 2016. Our capital expenditure range was updated to include our pending acquisition.

I would also like to point out that the Shorelands acquisition announced yesterday is a stock-for-stock transaction and the maximum number of shares to be exchanged at closing will be less than 500,000 with the final number of shares based upon American Water stock price. We expect to close the transaction in the first quarter of 2017.

For the second quarter of 2016 cash flow from operations increased $51 million or about 23% to $271 million mainly due to focused effort on improving the aging of our accounts receivables as well as the timing of account payable and accrued liability.

Our adjusted return on equity for the past 12-months was 9.55% an increase of 57 basis points compared to last year from continued execution on our strategies. We also announced in July a $0.375 common stock cash dividend payable on September 1, 2016 to stockholders of record as of August 8, 2016.

Turning to Slide 20, we are affirming our 2016 earnings guidance. I would like to point out a few items. First weather impacts in July are expected to be minimal as the hot temperatures across many of our states were also accompanied by rainfall. Second, our year-to-date earnings was strong across the business.

However, as I have noted they also include some timing related items including the favorable contract to receive settlement at AWV, which we had expected later in the year, and the $0.02 benefit from settlement of the Missouri rate case that will be offset during the remainder of the year.

Third looking forward despite the expected increase in group insurance cost and the headwinds we previously discussed at our military services group in Keystone, we affirm our earnings guidance range of 275 to 285 per share.

With that, I'll turn it back over to Susan.

Susan Story

Thanks, Linda. Before we move on to Q&A I would like to take a couple of minutes to talk about healthcare cost. Like other companies our healthcare cost are going up. This is especially true in utilities for we have been even more pronounced ageing workforce. We are currently partnering with our healthcare and pharmacy providers for better pricing, while strongly promoting a healthy and safe culture to our employees.

We continue to promote wellness and help management programs, preventative care screening and education for employees on being thoughtful consumers at healthcare, but were going a step further. Earlier this year, American Water was a founding member with 20 national companies, which you see on the chart to formed a health transformational alliance or HTA.

Since the initiatives we have kicked off in February and additional 13 companies have joined the alliance so within now 33 company representing more than 5.5 million people across the country. We are proud to be part of this cutting edge effort. The overall goal of the HTA is to create higher quality care by firs partnering with facilities and positions that have better outcomes, while also aggregating the purchasing power of all of the member companies to get cost down.

Additionally, HTA companies will improve our guidance without identifying individual information for better treatment options, better health outcomes and more reasonable and efficient pricing. The HTA is following a similar process for pharmaceutical purchasing and contracting systems.

The HTAs efforts have been highlighted recently in several media publications including the Wall Street Journal, Barron’s and the Boston Globe. This is just the start of an exciting collaborative efforts. We will keep you updates as we work with leading companies throughout the United States to improve the quality of healthcare and slow the rising cost for our company, employees, and their family.

So, in summary, our year-to-date financial performance reflects the successful execution of our strategies, investing in our system, off riding efficiently, growing our business and remaining stead fast in our commitment to the highest standards of customer service and water quality.

And with that, we are happy to take your questions.

Question-and-Answer Session


We will now being the question-and-answer session [Operator Instructions]. The first question comes from Ryan Connors with Boenning & Scattergood. Please go ahead.

Ryan Connors

Great, thanks for taking my question. I wanted to talk a little bit about the infrastructure surcharge and the new rates coming on to the P&L and if I read the slides correctly you have got more than $40 million worth of DSIC and other surcharges there. Coming on to the P&L in the first half which puts that DSIC revenue is my calculations are right, upwards somewhere around 1.5% of total consolidated sales, which is a pretty high number relative to the historical average.

So can you just talk a little about transitioning those rates across your system from the DSIC and surge charges over the base. as it's becomes the bigger and bigger part of the business, DSIC and surge charges, is that a seamless process or will that create complications that were are not there in a traditional set up of regular general rate case cycle?

Linda Sullivan

Ryan, this is Linda. Thank you for question, great question. This is actually a pretty smooth transition from the DSIC mechanism to general rate cases, because generally these types of mechanisms are really set up for the purpose that we will be able to continue to make these investments in an ongoing basis in our much needed infrastructure upgrades. So that’s really the purpose of that and then they roll into the general rate cases. It also allows us to spread up a time between general rate cases and smoothly impact of our capital investments on our customer rates.

Ryan Connors

Okay. And then I know that most of these DSIC type mechanism actually have a return in equity components to them, is that typically equal to what you expect to receive in a given state when you move from a surge charge over to a base rate?

Linda Sullivan

Typically it is, I mean every state is a little bit different, but typically it's the same.

Ryan Connors

Okay. And ten my other question was little bigger picture in terms of the new fair value legislation, obviously you have the Act 12 in Pennsylvania and Walter you mentioned five different states now. I’m just wondering, whether this is really catching on more broadly, I mean we just have the new summer meetings, I believe Walter you were there. And curious whether that’s something that’s getting a lot of play in the hallways and what not and whether we might see other states move in a similar direction and whether this will maintain a pretty snitch oriented?

Walter Lynch

Yes Ryan, thanks for that question. We are seeing this catching on in many of the states. And you can see that by each of the state adopting it and what it really does is providing a center for municipalities to look to monetize their assets. To be able to provide a fair market data systems and before this we could pretty much only pay original cost minus appreciation and then anything above that was risk for us getting in rate base. It just works for everybody and it is getting a lot traction in each of the states where we operate and you can see that from the slide that we had up there, five of our big states have Fair Market Legislation.

Susan Story

And Ryan, so the driver for this just like Walter and Linda said, the reason that this is for water is because there is a recognition that with every increasing infrastructure needs, every increasing retirement, smallest distance increase in water quality standard. There is a general concern, do we have the ability to meet the need of water and wastewater system. And Public Service Commissions also are residents of the state they are in.

So even if in many states municipalities are regular about the PSCs. The recognition of water and wastewater challenges is shared by everyone. So we do find in many of our states, vacations are concerned about water quality, water issue along with their governmental institute. And the whole point here is to offer optionality to municipalities so that whatever works for them and their citizens they have the options to do, and Fair Market Legislation just helps us that whole situation.

Ryan Connors

That’s very helpful thank you. And then one just last quick one is Walter you mentioned the Scranton acquisition, wanted to close that by the end of September. Is that pretty much buttoned up now or are there any lingering issues that could actually complicate that regulatory approval?

Walter Lynch

Well Ryan, we are working towards closing by September 30 and we will continue to work with the city on that.

Ryan Connors

Okay, thanks for your time.

Susan Story

Thanks Ryan.


Our next question is from Shahriar Pourreza with Guggenheim Partners. Please go ahead.

Shahriar Pourreza

Good morning.

Susan Story

Hi Shah.

Shahriar Pourreza

Apologize if this was asked already, I had to hop on a little bit late. But so on the Fair Value Legislation, Susan, is there any other states you are thinking about where we could see some sort of passage? And I’m thinking more like Illinois or New York, is there any opportunities there?

Susan Story

Actually Illinois was the first, when you look at the Fair Market Legislation at least in our service area it started with Illinois legislation, they were among the first to do that. The general question though is, I think today as you continue to see water and wastewater systems under distress across the country. This is a very viable solution that enables municipalities to benefit from water utilities like us and others to benefit and to solve - the main thing is to solve a problem for the citizens out there who are depending on the best water quality.

But also you have communities around the country who are doing an amazing job first of all, they have all of these different priorities. They have to provide for schools and for roads, and for parks, and you know the responsibilities that these municipalities have is so long and as we know a lot of the Federal funds aren’t there anymore that were there during the 70s and 80s and even 90s, and because they are trying the very best they can to serve the systems of their communities.

So where it makes sense and this is an option for them and they choose to put their systems up for sale, you know having this type of legislation takes an obstacle away from that. In the past we have had situations where a municipality or governmental entity wanted to sell a system we wanted to buy it but because of the way things work between the book value and what were able to put in a rate base that wasn't considered premium it's stopped a lot of deals before they ever took place.

So I think this is an effort by state to have a win-win situation but at the end of the day the people in those communities need to be better off and the municipalities are able then to provide the critical services that they are responsible for.

Shahriar Pourreza

Got it. That's helpful. Then just around obviously there hasn't been any issues growing, and you have got organic opportunities, you have got acquisitions opportunities. But when you think about the next leg of growth, is there sort of where we at with storm water? And is that something we can see as a potential driver of that growth maybe next year or the year after?

Susan Story

I think that is a big open question right now Shar, I think one of the things we know is that on some of the military installations where we served water and wastewater a question has come up about storm water so that we provide services for the whole water cycle. So that's really the immediate issue that we are looking at and clarifying in Washington in terms of the role of storm water in the privatization legislation which by the way is actually there.

So I think it's one of those that as the entire country looks at water supply challenges and we look at the entire water cycle. It's not you know in the past we tend to say it's the drinking water, it's storm water, it's sewer water where you have drought situations, where you have the need and we need to promote water recycling reuse, we are going to start everyone looking at the whole cycle. So I think it's very early in this space to do that, but it's something because it's part of the water cycle that we have to look at.

Shahriar Pourreza

Got it, it's helpful. And then just lastly on Keystone, obviously you reiterated the earnings neutral and I think I would assume cash flow positive up until the second quarter, but obviously do you highlighted that drilling activities to pick up a little bit and you sounded a little bit more constructive. So if we cannot continue with the fundamental we are seeing right now on joining your activity, is it something that is there the opportunity to look at that earnings profile this year or is it or it's too late in the year to revisit that mutual status.

Susan Story

Shar what we know so we like to base our guidance on what we know. So market conditions have stabilized we know that and they have began slightly improve so we have seen some increases as rig count currently pricing as you all know and some customers have risen completion and drilling activity, but were looking at capital spending, how much of it we will hit at the end of this year versus 2017.

So I think it's really a timing issue that we are looking at. So what we want to do is to look over the next few months to look at how that had stabilized, what that means for 2016 versus 2017. But the good news, as you said is that we are starting to see activity, it is nice spread, we are starting to see our growth in market share.

The last we had shared with you before this call was about 30% we are now seeing about 35% with some of the smaller players have fallen by the [indiscernible] during they really tough times. So our customers are steady, we are not seeing any further deferrals of completion activities, we are picking up some new customers but we just need to monitor over the next few months and see what we have got.

Shahriar Pourreza

Excellent, thanks and congrats.

Susan Story



Our next question comes from Richard Verdi with Ladenburg. Please go ahead.

Richard Verdi

Hi good morning everyone. Congrats on another nice quarter and thank you for taking my call. My first question kind of is a follow-up on Ryan's question about the DSIC. I had asked it to [indiscernible] on their Q1 call. And so in early Q2 I had a conversation with one of the more prominent members in [indiscernible]. He told me that the consumer advocates are basically we are looking conveniently push back on the DSIC and similar surcharges in other states. Because the group kind of feels that DSIC is being abused for one filing after the next. And so I'm wondering if America Waters hearing this expecting it and if so I'm wondering how it could impact the company's strategy?

Susan Story

Well Rich I'm not going to comment on this because they need to speak for themselves, but I will tell you from our standpoint, in fact here is what we know. there is a recognitions by the EPA throughout the country about the infrastructure needs that we have in the United States. Our plans are very open in our state, and our DSIC in any of our infrastructure surcharge we present plan, we also go in who we have either quarterly sometimes semi-annually filing where there is a close monitoring of the projects we are working on, what we are spending.

In addition to our O&M efficiency at least for American Water we also have several efforts in terms of capital efficiency. And what are we doing not only to spend every O&M dollar, but are we doing to show that we are actually even improving how we spend every capital dollar, because for us it's this situation. We are faced with years of investment, we want to be as efficient with every dollar as we can possibly be, because that needs we can put more on the ground, not in impact to customer bills and to be able to get the infrastructure replaced more quickly which still is a decade going issue. So that one thing we know.

I will also tell you with the recent I'll say attention to water quality issues in a time when you have infrastructure, but you also have emerging water quality issues and we have seen what happened in different parts of the country when we don’t invest in infrastructure. I’m not sure that there is risk that we are willing to take.

Richard Verdi

Great thank you Susan. That’s perfect. And then another question I have. I want to focus the rest of the questions on the Non-Reg segment. This kind of follows-up also on the last caller's inquiry. When you had laid it out to him, I just wanted to get some clarity though about the - let's call it, cautiously optimistic Q3 and Q4 for Keystone. I mean Oil is expected to pull back because of seasonality in late Q3 and into Q4. A lot of these guys go on vacation because of weather around Thanksgiving time and drilling activity dries up.

So I’m assuming you are optimistic, because Q2 was probably strong and Q3 probably followed that strength, but what keeps you cautious? Is that seasonality potential for an oil pull back keeping you cautious, or are you now seeing customer indications where they are keeping you cautious on Q3? I am just looking for a little more clarity on that.

Susan Story

Sure, so first of all, understand that our Keystone executive and management spend a lot of time with our customers. We share with them and they share with us some of their plans or drilling plans. So the cautiousness is not really related to timing of holidays or vacations. You are talking about an E&P industry that’s extremely cautious because of what they have gone through the past 18 months.

So you don’t have people that have gone from being so far down to think we are going to pull it out the stock and ramp everything up immediately. They have a cautiousness, so we have cautiousness. And it is a testing of the waters. The foundations are becoming stronger with the natural gas prices, I think NYMEX closed yesterday at $2.84, for example, just in April it was a $1.90 per million BTUs.

We are starting see better pricing as the supply has been drawn down because of the heat across the country in this summer. We are starting to see some activities where people had not been doing drilling and now they are, we are starting to see some more drilling rigs come up. So our cautiousness is the timing. It is the spacing, it is how quickly we will see this come up, how quickly we will see the supply that basically is being drown and being replenished. What are the forecasts for the winter months, how cold will the winter be.

So we try to base looking at objective, third-party data like, price projections, like drilling projections we look at all of that, then we also look at our internal discussions we have with our customers and what their are drilling plans are. So the cautiousness is what you don't want for people to flip back and forth to say, it's not good, it's great, it's not. We just want to be very cautious as we look at the ramp up in the continuing string of the natural gas drilling markets and make sure that we are very careful in how we look at that emergence.

Richard Verdi

Great. That's excellent color. Thank you, Susan. And then staying on the Keystone here, it is in the Appalachian footprint, it is in the Marcellus and it is in the Utica. So I’m curious, given market share the 35% market share you shared which I’m very thankful for. In what basin do they focus on more over the others, is it the Marcellus or is it the Utica?

Susan Story

You know really it's both, so they are so close, I mean basically it's three state its Pennsylvania, it's Ohio and it's West Virginia. And of course the formations are beside each other and also importantly as we mentioned on the first quarter call, you know Shell has announced that they are going to build a cracker plant there south of Pittsburgh, which is right in the heart of where the Marcellus and Utica and some of the formations are very close together.

So we are excited about that, because what that will do is if they start construction as they have said in 2018 and finish in 2020, you are talking about even more valuable natural gas drilling where you can get the NGLs along with the natural gas. So we just see that area and the intersection between Utica and Marcellus being very rich.

The fact is we know that it is the cheapest to drill, for the drillers and it also requires a good bit of water, because of the depth of the formation. So we think that's the right place to be and we've been asking. Also at this point we are not interested in going into other formations, because we think that the Utica and Marcellus is where we have the most key areas for production growth in the future.

Richard Verdi

Okay. That actually helped answer my next question then. And then of that 35%, does Keystone work with Ontario Resources?

Susan Story

We do, we have right now I believe in this space somewhere between 22 and 27 different customers.

Richard Verdi

Okay that's helpful. And I guess the last question is this. When I think of the Marcellus, there are 10 rigs there. Six of them are Ontario Resources, which then means that their midstream arm who has a water business, that that water business is going to the midstream arm. And so then there is the four other guys there, and then the Utica there is only one Ontario Resource rig there, and of the 13 remaining they are all other players.

And so of those other players - I understand that oil prices are supposed to decline because of seasonality. But they are also expect to decline following that. And in addition to that, if you look at any upstream player, they are all counting about how they are expecting to use - I think they were using something like 1,500 pounds of sand per lateral or somewhere around there. And it is expected to go up to 2,000.

And so I’m wondering if there is a potential to expand and capture more business in the Utica because it is open there? And then two, that increased sand it means increased needs for water there. So are you guys factoring that into your figures, and if so, how much of a positive impact? Because a year ago, that was a 1,000 pounds and now we are talking doubling that. So I mean that could be really meaningful for American Water.

Susan Story

Well a couple of things so Rich, in recent weeks the drill count has been about 36 in the Appalachian Basin and we are all natural gas by the way, we do very little to no support for oil actually for us it's mostly natural gas so that's one. Second thing you are exactly right, what we are finding is that in order to more efficiently utilize wells that have already been drilled, they are looking at higher pressure more sand, which does require more water, you are exactly right.

But those changes in the market and the efficiency are things that our folks at Keystone work closely with customers in terms of estimates of how much water we need. So you are right, there is changes, that's one of the reasons that the whales have become so much more efficient is they are doing the second third frac and they are also putting a lot more sand and lot more pressure with the sane when they go to those second and third fracs. So you are exactly right.

I would tell you there is a couple of other things we are involved in and one of them is we are working with a couple of customers on some automated pumping that really is not pretty standard right now. So we consistently look at working the A&P on how to make the production more efficient, how to get the most they can out of each individual well and to make sure that we are solutions provider on everything around water and water services.

Richard Verdi

Fantastic, and then thank you for that Susan that's great color. And then the very last question and I'll jump out and I'm taking up a lot of time. Last quarter I had asked Susan I think this is a great move on American Waters part, you know so I had asked this if American Water with the smart metering initiative that we are trying to team up with the electric companies, the user infrastructure and you have given some great color. I was just wondering if there is any sort of update on that if there has been anymore progress what have can you, just some color if there is an update?

Susan Story

Yes, we actually have an AMI team that we are working throughout the company to come up with a roll out unlike electric the water bills or so much like it's a business. Of course, we are looking at the ability to be able to justify them economically. One of the good things is we are seen a lot better technology with the meters that will allow us to actually put in AMR meters that we can then do software upgrade to actually make them AMI meters which is good.

We continue to work with some electric utilities on utilizing some of the same back haul infrastructure, so that our customers don’t have to double the cost of those investments, we are working with Edison ComEd in Chicago area as well as there is a couple of other utilities that have expressed an interest. And we were very excited about that, because it's really as the win, win to our customers where we put in a water meter.

But the one reason that does push us to do AMI is interestingly still a lot of water meters across our footprint are in people's homes. So the ability to put in AMI that we don’t have to actually send people out to peoples' homes. Instead of times to go into their home, is the real not just a efficiency improvement, but also a customer satisfaction improvement. So we are taking all of those factors, we have got a plan in place to roll out AMI over the next few years and where we can partner with electric utilities to offset some of that cost for our customers we are all for it.

Richard Verdi

That's great. Thank you, Susan, and congrats again on the success this quarter and moving forward. I appreciate the time, it's great color.

Susan Story

Thanks Rich.


[Operator Instructions] Our next question comes from Jonathan Reeder with Wells Fargo.

Jonathan Reeder

Hey, good morning all. I will try to be quick since this call has been extended a little bit recently. Could you give us an update on the military base RFP process? Obviously, your main competitor was awarded a pretty large base here recently, if you could just kind of say maybe what happened there on your end. And do you get the sense that any new bases are on the verge of being awarded?

Susan Story

Okay that's a great question, Jonathan thanks. It's that as we look at the military bases, there are several RFPs that are outstanding from the timely do and initial bid, it can be underground from three to five years before bases are awarded and we do have several outstanding bids. Again, we only bid on those basis that the 50 years contract value is from $250 million and above, because for us the normal base is - with the cost of bidding an all that.

So you are correct. The last one that was awarded was Eglin, and we did bid on it and American States Water did win that one and we are taking our lesson learned and seeing what we could do better next time. We do think that we know that there are others in the process, several we have already bid on, others that we think will come out for bid. It's an ongoing process and so we are just looking to get better every time we make a bid.

Jonathan Reeder

Okay. So no anticipation necessarily of any announcements in second half of the year at this point?

Susan Story

We don’t foresee any announcements in the second half of the year. With that said however, one never know. So when you got a bid out there, that’s going to out there for couple of three years depending on the particular installation and where the Department of Defense is. So it's very difficult to predict, but at this point we don’t foresee any further rewards this year, but we could be wrong.

Jonathan Reeder

Okay. Great. And then, Walter, did you say the Illinois infrastructure surcharge changes removes the total cap in terms of how much revenues can increase under the program between rate cases?

Walter Lynch

Yes, that’s right. It removes the cap of 5% between rate cases and it's allows us to increase rate no more than 3.5% a year. And it also includes a number of other things that we can invest in and get recovery not just pipes. So it was very favorable for the industry.

Jonathan Reeder

Okay. So a 3.5% annual cap, how does that impact the frequency of rate cases in the state for you now? Kind of stretch it out a couple more years given the broader application and the 3.5% annual cap?

Walter Lynch

It could lead to that, I mean we are going to continue work on our capital program to invest wisely within our systems and if that extends the rate cases that’s great, but we are going to continue to invest per our capital management program.

Jonathan Reeder

Okay. Do you think it expands the overall CapEx budget in the state, where it moved the needle at all on the consolidated budget going forward or too soon to say?

Walter Lynch

Yes, it's really too soon say, but it is favorable for us to continue to invest again at timely recovery. We will consider that as we are working for our capital plan for the next five years.

Jonathan Reeder

Okay. And then last question, and I think I already know the answer. But I guess year-to-date, weather hasn't really had a meaningful impact. Is that correct?

Susan Story

Jonathan that is correct. We have looked at the weather impacts through July across all of our state, and although we did see more heat in those states and hot weather, it was offset by also having rainfall in those areas as well.

Jonathan Reeder

Okay, great thanks so much for the time this morning.

Susan Story

Thanks Jonathan.

Walter Lynch


Linda Sullivan

Thank you.

Greg Panagos

Operator, I think that’s concludes our question-and-answer session for this morning.


Yes. I would like to turn the call back over to Susan Story for any closing remarks.

Susan Story

Well, thanks everybody for participating on our call today and as always if you have any questions, please give Greg or Melissa a call. They will be happy to help. We want to thank everybody for participating, look forward to see you in November. And thank goodness in one month, football season starts. So everybody have a great day.


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