American Water Works Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 15, 2024

There are 11 speakers on the call.

Operator

Good morning, and welcome to the American Water's 4th Quarter and Year End 2023 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 website. The audio webcast archive will be available for 1 year on American Water's Investor Relations website. I would now like to introduce your host for today's call, Aaron Musgrave, Vice President of Investor Relations. Mr.

Operator

Musgrave, you may begin.

Speaker 1

Thank you, Dave. Good morning, everyone, and thank you for joining us for today's call. At the end of our prepared remarks, we will open the call for your questions.

Speaker 2

Let me first go over

Speaker 1

some safe harbor language. Today, we will be making forward looking statements that represent our expectations regarding our future performance or other future events. These statements are predictions based on 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 as well as a more detailed analysis of our financials and other important information is provided in the Q4 earnings release and in our 2023 Form 10 ks each filed yesterday with the SEC.

Speaker 1

And finally, all statements During this presentation related to earnings and earnings per share, refer to diluted earnings and diluted earnings per share. After our prepared remarks, we'll then close by answering your questions. With that, I'll turn the call over to American Water's President and CEO, Susan Hardwick.

Speaker 3

Thanks, Aaron. Good morning, everyone. As we announced yesterday, we finished 2023 with very strong financial results that were right on plan. As shown on Slide 5, earnings were $4.90 per share for the year, which included $0.13 per share of favorable weather, most of which we discussed earlier in the year. Excluding the estimated weather impact earnings of $4.77

Speaker 4

per share,

Speaker 3

we're at the midpoint of the guidance range we shared originally back in November of 2022. I'm very proud of our company's ability to stay focused on serving our customers safely and reliably through numerous economic events this past year, which gave us the ability to confidently execute on the plan we had for 2023. I'm also proud of the resilient service we consistently deliver and especially over the past few months during a cold January and active storm season across the country. I want to thank our employees for safely providing reliable service to the 14,000,000 people we serve in their homes, businesses and communities. Can see here on Slide 5 an abbreviated list of some of our key accomplishments in 2023, and John and Cheryl will add to these in their remarks.

Speaker 3

Overall, we believe the takeaway today for investors is that our strong execution in 2023 Amid the challenging macro backdrop, coupled with our clear top tier growth plan demonstrates American Water's ability to deliver on our long term plan. I'm very confident we will execute our plans in 2024 and beyond with the great momentum we have from 2023. Turning to Slide 6, as you can see, we have delivered an excellent total shareholder return over the past 5 10 years, including our growing record of significant dividend increases. We're proud of this history, which compares very favorably to other utilities. I want to acknowledge though that our stock and utility stocks in general did not perform nearly as well as the S and P 500 in 2023, which dampened the outperformance we've had versus the S and P 500 over the last decade or so.

Speaker 3

Relative valuations of utility stocks fell without regard to specific performance. All of that while we continued our very strong performance. I'm confident our company's fundamentals and the execution of our strategies will continue to produce superior shareholder value and very competitive total shareholder returns for years to come, which takes us to Slide 7. That we'll share today are largely an affirmation of the financial plan, long term targets and guidance we laid out last November, highlighted by 7% to 9% EPS and dividend growth. Later, John will recap the drivers for our growth in 2024, including the increase to our EPS guidance range that we announced yesterday.

Speaker 3

Big picture though, we believe the combination of our EPS and dividend growth, Our low risk capital plan, our ESG leadership and the affordability of our service continues to be rewarded by investors and distinguishes us from other utilities in the sector. I'll remind you that we believe the runway for our growth and for achieving these targets is very long, certainly through 2028 in our 5 year plan and beyond that. This of course is driven by significant investments and acquisitions coupled with our track record of constructive regulatory outcomes, all with a keen focus on affordability. And on top of all of that, we continue to grow organically, including in our military services business that successfully serves 18 military installations across the country. One final thought I want to leave you with as we begin 2024.

Speaker 3

American Water continues to receive tremendous support at the state and federal level for the work we do across the country. The impact we are making in communities across our 14 states to improve water and waste water service is critical to the well-being of the citizens we are proud to serve. As we've told you many times, we are committed to solving local structure issues, while at the same time driving efficiencies in our business to remain very affordable to our customers. Policymakers frequently encourage our leadership to keep growing, keep investing and keep solving problems in their states. This includes Pennsylvania, where we applaud the Public Utility Commission's proposal on February 1st to enhance the process around the implementation of fair market value legislation.

Speaker 3

We believe the spirit of the enhancements is to increase public awareness and establish greater procedural consistency, all in support of much needed consolidation of the Commonwealth Water and Wastewater Systems. While the business of providing these critical services can at stakeholders as we pursue our company's mission. With that, I'll turn it over to Cheryl to talk more about rate based growth, a regulatory plan and some recent news around lead service lines. Cheryl?

Speaker 5

Thanks, Susan, and good morning, everyone. Let me start by turning to Slide 9, where these graphs that our continued successful execution of our capital investment plan is succeeding and growing regulated rate base consistent with our long term rate of 8% to 9%. Rate based growth, of course, will drive earnings growth. We believe the high degree of visibility to our capital investment plan, combined with the low risk nature of the plan, uniquely positions American Water in the utility sector and is fundamental to our investment thesis. Turning to slide 10, I'll cover the latest regulatory activity in our states, beginning with our most recently filed cases.

Speaker 5

In Pennsylvania, we filed a general rate case in November and are seeking recovery of $1,000,000,000 of investments. The case is proceeding as planned, including testimony and evidentiary hearings that are scheduled for February March, with rates still expected to be effective in August. As a reminder, Pennsylvania uses a forward test year for rate making purposes. In New Jersey, we filed a general rate case in January and are seeking recovery of over $1,300,000,000 of investments through December 2024. This case includes, for example, infrastructure improvement projects at all 7 of our surface water treatment plants in the state.

Speaker 5

We expect the New Jersey case to be completed sometime later this fall. We also filed a general rate case last month in Illinois, we have invested over $550,000,000 since our last case. Our general rate cases in California, West Virginia and Virginia are all progressing well and as expected. In California, we reached a partial settlement in the case in November related to the revenue request. We will prepare to implement the new rates retroactively to January 1, 2024, upon receiving the CPUC's decision on the settlement agreement and outstanding topics related to rate design and revenue stabilization mechanisms.

Speaker 5

Our request for a 1 year extension on the cost of capital was also granted, pushing the next filing out to May of 2025. In Indiana, we received a final order just yesterday and it looks very constructive. We are currently evaluating it and we'll share key takeaways in the next day or but overall, we're generally pleased. And finally, in Kentucky, we expect to receive a final order very soon. As a reminder, we expect to file general rate cases about every 2 years in our larger jurisdictions.

Speaker 5

Because we make investments and have skilled and dedicated employees working on these cases, we're very confident in obtaining constructive outcomes again in 2024 as we did in 2023. On a legislative front, in New Jersey, new legislation supporting capital investment was passed and was signed by the Governor in January. The resiliency and environmental system investment charge or RIFIC for short establishes a new regulatory mechanism that will enable water and wastewater utilities to recover in a more timely manner, capital spending related to investments in resiliency, environmental compliance, safety and public health. This includes capital related to PFAS remediation. In fact, most of our states where PFAS is present, There are either existing environmental mechanisms that we believe PFAS investments will fit under or we're proactively advocating for such mechanisms.

Speaker 5

To show the magnitude of our regulatory execution efforts, you can see on Slide 11 that we have $390,000,000 annualized new revenues and rates since January of 2023. This includes $273,000,000 from general rate cases and step increases and $117,000,000 from infrastructure surcharges. We also have $670,000,000 of total annualized revenue request pending. As a reminder, American Water recovers about 75% of our overall capital spend through infrastructure mechanisms or forward test years, which greatly reduces regulatory lag. Alongside all of the investments we're making, We remain extremely focused on customer affordability and operating efficiently.

Speaker 5

We are continuing to evolve our strategies around rate design and programs to assist our customers who are challenged with affordability. We are also continuing our focus on technology, efficiencies of scale and cost management to deliver on customer affordability, especially as the regulatory demands such as the proposed PFAS rule and lead and copper rule improvements drive increases in on our capital program. On Slide 12, I'd like to cover our recent announcements regarding the U. S. EPA's proposed lead and copper rule improvements.

Speaker 5

Like PFAS, we think clear rules are important and should be enforced for all providers. American Water consistently meets water quality standards related to the lead and copper rules across our footprint and believes removing the risk of lead service lines over time is the right thing to do for the health and safety of our customers. But also like PFAS, we believe all stakeholders must understand the costs associated with the proposed improvements to the lead and copper rule and that the EPA estimates are likely understated. The cost to identify the material of all unknown service lines and replace all lead service lines, including the customer owned lines and galvanized lines where needed by 2,030 7 will require significant investment for all water systems. We are currently developing preliminary estimates based on the proposed rule.

Speaker 5

Unlike PFAS though, the expected timeline for complying with the lead and copper rule improvements is much longer, so the impact on capital spend will be more gradual. Providing safe, reliable and affordable water is American Water's business. We continue to work with the EPA, Congress, regulators and policymakers to ensure that the implementation of any final standards protect customers, communities and the general public. As I close on Slide 13, you can see that our 5 year capital plan, which unchanged from November has $1,000,000,000 for PFAS and approximately $500,000,000 for lead service line replacements. We have been proactively investing about $100,000,000 per year to replace lead service lines for several years now and expect to continue that level at least through 2,030 or beyond.

Speaker 5

Depending on the EPA's requirements in the final lead and copper rule improvements, such as for customer owned service lines, our annual investment level may need to be revised and likely over a longer period of time. Also, we are still awaiting a final rule from the U. S. EPA on PFAS. We continue to expect that there will be no material changes to the proposed rule And we have not changed any of our announced plans or estimates last November related to PFAS compliance.

Speaker 5

We continue to treat for PFAS in compliance with state regulations and we continue to prepare for full compliance with the new federal rule once released. Previously, we have disclosed that we are a party to the multi district litigation or MDL lawsuit in U. S. District Court for the District of South Carolina against manufacturers of certain PFAS like 3 ms and DuPont for damages. In early December, there were deadlines to decide whether or not to remain party to the 2 potential settlements with manufacturers, and we did remain a party to both settlements.

Speaker 5

We believe this is the optimal path to recouping the most dollars possible from PFAS manufacturers in an expedient manner for our customers. On February 8, the MDL court issued its final approval of the DuPont settlement. We will now begin the process of our claims under this settlement within the time period provided by the MDO. A fairness hearing on the 3 ms settlement was held on February 2. This matter remains pending.

Speaker 5

In closing, it's important for investors to understand that the ever changing regulatory environment is leading significant industry challenges, including those related to lead and PFAS, but also with issues like cybersecurity, for example. Each change on its own is significant, but the layering effect of all these changes is even more dramatic. The expertise we bring to the table to solve these challenges is well recognized across the states where we operate and sets us apart from others. It's a privilege a great responsibility to deliver safe, clean, reliable and affordable services to our customers and communities. With that, I'll hand it over to John to cover our financial results and plans in further detail.

Speaker 5

John?

Speaker 6

Thank you, Cheryl, and good morning, everyone. Turning to Slide 15, let me provide a few more details on financial results for 2023. The appendix also has details of 4th quarter EPS. Consolidated earnings were $4.90 per share in 2023, up $0.39 per share compared to 20.22 and up $0.32 per share on a weather normalized basis. Increased revenues were driven by general rate cases we completed in late 2022 and early 2023 in our larger states.

Speaker 6

These additional revenues are driven by the significant investments we've made and continue to make in our systems. As noted, earnings were higher in 2023 by an estimated net $0.13 per share as a result of weather in the second, 3rd and 4th quarters due to warm and dry conditions, primarily in Missouri, New Jersey and Pennsylvania. This compares to net favorable weather in the Q3 of 2022 of $0.06 per share, which related mostly to warm and dry conditions in New Jersey. And looking at operating costs, higher pension expense of about $0.13 per share and increased chemical costs of about $0.11 per share including inflationary pressures are being recovered in large part through higher revenues we proactively sought in general rate cases we completed in the last 12 to 18 months. In the Q4, we also had higher costs of about $0.10 per share related to waste disposal, equipment repairs, tank painting and other maintenance costs across our footprint.

Speaker 6

Supporting our investment growth, depreciation expense increased $0.24 per share and the cost of additional long term financing increased $0.38 per share, primarily related to share count dilution. As I have mentioned all year, the EPS impact of the higher share count from our equity issuance back in early March was offset by voided interest on the year. An additional benefit realized this year from the equity issuance is the interest income we have been earning from the cash balance held since March. Other reflects primarily post closing acquisition adjustments in 2022 from the sales of HOS in New York, which added to EPS. Turning to Slide 16, you'll see that we continued to be set up for strong growth through acquisitions.

Speaker 6

We closed on 23 acquisitions totaling $77,000,000 across 8 states in 2023. We also 25 transactions under agreement across 7 states at year end totaling $589,000,000 $88,000 customer connections. This total includes both the Butler Area Sewer Authority wastewater system in Pennsylvania and the Granite City wastewater treatment plant in Illinois. We are very close completing the Granite City acquisition where we already provide wastewater collection service for approximately 12,000 customers. In Pennsylvania, as Susan briefly discussed, the regulatory environment relating to acquisitions is undergoing change, which we think is ultimately necessary and positive, but will take a period of time to sort out.

Speaker 6

We are very confident that Act 12 fair market value legislation will remain in place and continue to have strong support. As is often the case, implementation of legislation needs to be worked through in the regulatory arena and that is what is happening now. In the meantime, closing of our current pending transactions will likely take more time than usual, but to be clear, we are confident that the previously approved Butler acquisition will close soon. We are continuing to invest in regulated acquisition opportunities in Pennsylvania driven by the continued need for system consolidation and upgrading for the benefit of communities in Pennsylvania who deserve safe and reliable water and wastewater service. As you know, we have a strong track record of closing acquisitions.

Speaker 6

Over the past 5 years, we've closed over 100 acquisitions across 12 states totaling nearly 200,000 new customer connections. Of course, as we close transactions, the work to build and refill our acquisition pipeline is continuous. Our pipeline of more than 1,300,000 customer connections with meaningful contributions from across our platform continues to be a strong leading indicator that supports this piece of our rate based growth outlook. As you recall, in November, we introduced our long term target of 2% annual customer growth from acquisitions as shown on Slide 7. This equates to about 70,000 acquired customers per year based on our current customer count of approximately 3,500,000 customers.

Speaker 6

We are proactively investing in our capabilities across our platform to bolster our system wide contribution to acquisitions to support this growth and are confident in meeting our 2% long term target. Turning to Slide 17, here we show the buildup from 2023 weather normalized actual to the 2024 EPS guidance range of $5.10 to $5.20 that we introduced last November, which reflects 8% growth at the midpoint of $5.15 Working from that same buildup, yesterday we announced an increase of $0.10 per share to our 2024 EPS guidance range, which is now $5.20 to $5.30 per share. The increase is due solely to additional interest income We will receive in 2024 and expect to receive annually through 2026 from the amended terms of the secured seller note from the sale of HOS. As we described in the 8 ks we filed on February 5, the note balance has been increased to $795,000,000 from $720,000,000 which satisfies payment of the contingent consideration owed to American Water of $75,000,000 triggered by the extension of HOS's service agreement with the New York City Water Board. In addition, reflecting current market interest rates and removal of American Water's option to require prepayment of the note At a future date, the annual interest rate on the note has been increased from 7% to 10%.

Speaker 6

American Water is pleased to see the continued growth of the HOS business under its new ownership, including the service contract extension with New York City as well as the acquisition recently announced by HOS, which will be funded with new equity from HOS's owners. As it relates to future earnings guidance, it will be important for investors to be able to track the ongoing growth of American Water from its core regulated strategy before this additional interest income. Therefore, when we provide forward year EPS guidance each November, we will be sure to note the EPS associated with the additional interest income from the secured seller note in that guidance. To wrap up, Slide 18 is summary of our continued strong financial condition, which we further solidified in 2023. Just last month, Moody's affirmed our solid Baa1 investment grade credit rating and stable outlook and noted our improved FFO to debt ratio.

Speaker 6

We are confident our FFO to debt ratios will continue to support our current credit ratings. Our total debt to capital ratio as of December 31, Net of our roughly $330,000,000 of cash on hand is 55%, which is comfortably within our long term target of less than 60%. While having moderated somewhat, the current higher interest rate environment continues to be challenging. As I said in November though, We are in a position of strength on a number of fronts in dealing with this challenge. Our strategy of issuing debt at the holding company level allows us take advantage of our scale and pricing debt issuances and we will remain proactive in managing risk and achieving a low cost of capital to and shareholders.

Speaker 6

With that, I'll turn it back over to our operator to begin Q and A and take any questions you may have.

Operator

Our first question comes from Shahriar Pourreza with Guggenheim Partners. Please go ahead.

Speaker 7

Hey, guys. Good morning.

Speaker 3

Hey, Sean.

Speaker 4

Good morning. Yes, I don't usually Susan, I don't usually lead off with Sort of an M and A question, but I know John loves talking about M and A and we saw that in the prepared remarks. And obviously, it's Timely given the Eversource news yesterday where they essentially put acquiring on the block. Can you speak maybe to your appetite for larger inorganic opportunities and specifically any geographic versions to the Northeast in light of the developments yesterday? Thank you.

Speaker 3

Yes, Shar, I think it's a great question. Obviously, we saw the news As well, and John certainly can comment more. I'd say, 1st of all, of course, we don't comment on any activity in the M and A space of that nature. I think for us, it continues to be our standards that we've shared. We have to be confident in the ability to grow.

Speaker 3

We have to have confidence regulatory environments, confidence in policy in any jurisdiction that we're currently in or other jurisdictions we may be looking at. So I think that's always the gate at which we evaluate opportunities. So I'd probably just say that John, any additional comments from your side?

Speaker 2

Well said.

Speaker 4

Perfect. And then just a follow on, I know you're still kind of working through some of the ins and outs of the lead and copper rule. Is there Even a general CapEx upside amount you could give us to think about with the spend sort of be additive in your view to the current plan or would it out some spend out like we saw with obviously with PVAS spend on the last update? Thanks guys.

Speaker 3

Yes, sure. Let me again sort of generally answer and then Cheryl can add to it. I think it's, 1st of all, sort of too early to be able to give any additional guidance around impacts to our overall plan. I think the important thing to remember here is it is over a much longer period of time than what we're seeing with the PFAS rules, for example. So it will give us more time to figure out what the Actual impacts are to the plan give us more opportunity to look at opportunity to move other projects around to sort of accommodate whatever spend we think may be incremental here for us.

Speaker 3

So we just probably need a little bit more time to sort through it and then we can give a clearer guidance. Again, as Cheryl said in her prepared remarks, We know it will be significant. I don't think it will have the dramatic impact on our plan for shorter term windows we saw with PFAS, for example. Cheryl, anything you want to add to that? Yes.

Speaker 5

The only thing I would add, Shar, is just that we have been making really good progress in that space And we'll continue to be focused on removing our lead service lines and the customer led service line where they exist. But this is a more inclusive rule that as Susan said is over a longer period of time. So we'll continue to look at how we can layer that in.

Speaker 3

Yes, I think just to sort of punch line on that one and Cheryl again made the comment in her prepared remarks, this is about unknown service lines unknown material and it is about customer owned. So as we've been working through our own program of replacing bigger. And then again, the long term time horizon to deal with it, I think is also important to keep note of. Fantastic.

Speaker 4

Thank you, guys. I'll pass it to someone else. See you soon.

Speaker 3

Thanks, Sean.

Operator

The next question comes from Durgesh Chopra with Evercore ISI. Please go ahead.

Speaker 2

Hey, good morning team. Thanks for giving me time. Hey, just

Speaker 3

Good morning.

Speaker 2

Hey, good morning, Susan. Just I hate to go back to the M and A. I know you're You can be very limited in what you can say, but we've been getting a ton of questions on this. So I just want to be clear about something. In your seat, Your peers generally describe M and A as a high hurdle rate, right, with the organic growth opportunities that they have as a company.

Speaker 2

How would you characterize the Connecticut water assets? Are these once 1 of a kind assets, large assets that don't often come to markets extremely attractive. Would you say The M and A opportunity is still high hurdle rate versus the organic CapEx that you have. I don't want to put words in your mouth, but I just want to see how you're thinking about it?

Speaker 3

Yes. Durgesh, I'll tell you at the outset, you're not going to be happy with my answer because I'm not going to sort of go into a whole lot of detail here. I think our focus continues to be on the communities and the states that we currently operate in. As you know, we're in 14 different states. We think there are just a significant number of opportunities in those states, and we're going to continue to focus on that.

Speaker 3

As you would expect anyone to do, we'll take a look at this kind of an opportunity as everyone would. But I think again, our screens are the critical thing you should focus on regulatory environment, legislative environment, business climate and the ability to grow, and that we're always going to look at opportunities from that perspective.

Speaker 2

Understood. Thank you, Susan. I appreciate that. Maybe then switching gears, can you just update us on the Pennsylvania rate case? The commission, I think, came out in December.

Speaker 2

I think they may have suspended the rate case schedule. Maybe just talk What does that mean? What are the next steps there, please? Thank you.

Speaker 3

Yes. Cheryl, I think you laid out the details around timing. We've the size of the case, etcetera. Sort of big picture for me on this case, as is the case really with all of our general rate cases we have in progress, it's all about investment. We're not trying to do anything That's what this Pennsylvania case is about, and we'll continue to work through the process.

Speaker 3

There are no indications of any issues associated with this case as we work through the process and we'll continue to stay on that path. I'd say that's generally the case on all of our jurisdictions, all the cases that we have on file today. We've been signaling this, I think, for quite some time that The expectation to be in for general rate cases on this roughly 2 year cycle, we've been saying that probably 2, 3 years now. And this is just the continuation of that program. And it's all really driven again by our investment, the pace of our investment, we've been increasing our capital spend plan for a number of years now to really address The needs that exist in the communities that we serve, and I think our regulatory strategy is consistent with that approach.

Speaker 3

So Pennsylvania is no different than any other state in terms of our approach to it. And we'll continue to work the process there like we always do. And we think Pennsylvania again is a very constructive state, and we're confident in our ability to work through that case.

Speaker 2

Got it. Thanks. Just a quick follow-up there, Susan. Like do does the procedural like the steps the rate case in terms of testimony, intervenor testimony and all that stuff, does that go along as planned with the suspension or is that on pause? Might have seen something that you may be on pause.

Speaker 2

I'm not sure if

Speaker 3

No, no change. Yes, no change. Yes, it's on schedule and on the normal process.

Speaker 2

Thank you.

Speaker 7

Yes.

Speaker 3

Thanks, Durgesh.

Operator

Next question comes from Angie Storozynski with Seaport. Please go ahead.

Speaker 8

Good morning. I'm going to ask about Illinois first. I mean, we had some very bad outcomes, regulatory outcomes on the electric and gas side in the state. You have a case there where we're already seeing some noise around it. So I'm just wondering how if there's any lessons learned from what happened in December, and if you've incorporated that into the current timing?

Speaker 8

And then secondly, on PFAS, We're seeing some lawsuits against investor owned utilities on the back of PFAS. I understand that you've mentioned that And compliance and going beyond the requirements, but I'm just wondering how you manage this risk?

Speaker 3

Yes, again, let me sort of start off here. On Illinois, I would take my answer to Pennsylvania and insert the word Illinois. We are proceeding there as scheduled with no significant issues in that case. It is about investment, and we'll continue to process that case like we always would. Certainly, there is noise around, the electric and gas cases there.

Speaker 3

We think again our cases are different in that they are about investment only and we're confident in our ability continue to work through that case as well. On PFAS, Cheryl, you might just actually want to comment on Illinois if you like. And then on PFAS, there's obviously a lot going on here too. I think the litigation environment around this is probably not surprising. There'll be all sorts of Plaintiff's attorneys looking for an angle here and I think that's probably what mostly you're referring to and what we're seeing.

Speaker 3

But Cheryl, anything you want to add on either of these topics?

Speaker 5

Yes, I would just say, Susan, you were completely accurate on Illinois. We've built a really strong case based on capital investment, And we feel good about that case and the process. We're just going to go through the process there, the way we normally would. As far as the stuff. I do believe that, there we've seen some lawsuits out there, Angie, as you mentioned, But we've been working really hard both to make sure that we're in compliance with all the rules that are out there, that we're being proactive in our approach, But we're also working with EPA on the CERCLA designation and working at the federal level to try to get protections for water utilities all across the U.

Speaker 5

S. Because we believe that we shouldn't be held accountable for polluted waters that are coming to us and we're doing everything we possibly can to treat for that pollutant. And so we think that we should be protected from that. So we're going to continue to work in And in that space and, being part of the MDL, that's one step in that process to get recovery from the people who caused the pollution in the first place.

Speaker 8

Great. Thank you.

Operator

The next question comes from Julien Dumoulin Smith from Bank of America. Please go ahead.

Speaker 7

Hey, good morning team. Thank you very much for the time. Appreciate it. Nicely done on the guidance here, I got to say. Maybe actually to that point on guidance given the bump here, just with respect to resetting higher the CAGR going forward, I just want to recognize that this goes through 'twenty six.

Speaker 7

Implicitly, could we say this is a statement of confidence through the forecast period? Or is this more nuance to the specific 3 year forecast period 'twenty five 'twenty four to 'twenty six year, if you will?

Speaker 3

Yes. I think we've tried to be clear, Jillian, on the sort of duration of this additional interest we'll have on the note. But John, you want to comment on this further?

Speaker 6

Yes, I think you've got it right, Julien. It's think of this is an increase over our ongoing guidance for that period through 'twenty six. And that's but we've not made changes as we tried to describe in our comments from our original guidance on the regulated strategy from back in November.

Speaker 7

Right. Yes, understood. I just wanted to clarify that extra clear. With respect to Illinois here, obviously, you've got this case out there, there's a certain degree of attention. Can you comment a little bit about maybe some of the rate mitigation factors?

Speaker 7

What other pieces could help offset some of the rate increases to customers in Illinois and any other mitigating factors and circumstances around that case that we can speak to here for

Speaker 3

Yes, I'll comment on sort of overall strategy on that point. I think we Illinois the same as we do our other states. I mean, we've been very focused on mechanisms or approaches to regulatory solutions that will help lessen and mitigate the direct impact of inflationary cost pension and other things. We've done that via trackers. We've done that via deferrals.

Speaker 3

We've done that sort of across many of our jurisdictions. And we have a good amount of those costs Actually, frankly, already sort of dealt with and embedded in rate structures across our territory. Illinois really no different than that. And as Cheryl said, we're just not experiencing other issues currently in that case. Now we obviously have to finish it.

Speaker 3

We have to get through the rest the procedural schedule and work through any issues that may come up, but we're not anticipating anything materially different there.

Speaker 7

Yes, excellent. Thank you. And then lastly, just going back to the M and A point you're making earlier, I thought you're pretty clear about this. It needs to be accretive and or provide robust visible growth. I just want to make sure I'm hearing you right about the growth piece there in terms of a key element in Ingredient?

Speaker 3

Well, I don't know that I said it has to be accretive. Are you talking I guess you're talking about the M and A piece. I think again, I'll just repeat it. I think our view is that, for us to look at new jurisdictions, it has to be productive regulatory legislative business environment. And the opportunity for growth, And I really, I guess, was referring to sort of footprint growth there.

Speaker 3

And obviously, you would apply It's the same dialogue we've always had on potential expansion into other territories. I don't think this particular situation changes anything about how we feel about growth in other jurisdictions.

Speaker 7

Got it. And just going back to lastly on that FMV piece, you guys commented extensively here, but just the timeline on getting that clarity there. And You talk about being a little bit more protracted. Just how does this cut sort of at least from a process perspective finally get to some resolution as far as you guys are concerned? And then prospects on expanding it even from there given where we stand?

Speaker 3

Well, Julien, you're going to have to help me. On the first part of your question, I'm not sure what you're referring to.

Speaker 7

Well, just on fair market value, just in terms of Yes, indeed.

Speaker 3

Got you. I just didn't hear the first part. Yes, I think that, as I said in my remarks and John expanded on a bit, I think that what the PUC has done in Pennsylvania is actually quite helpful. And I've got a lot of experience in The regulatory world over the last 40 years or so, I've seen many pieces of legislation enacted and I've seen many situations where Commissions have to work through the implementation of that legislation. And I think that's exactly what we're doing here.

Speaker 3

And as we said, we applaud commission for taking this approach and really being thoughtful about it and understanding the importance of this legislation to the larger strategy in the Commonwealth. So I think the steps that are being taken make good sense. Now Having said that, we do have to continue to work through how those guidelines ultimately may be employed. But we think it's just helpful and will give a framework for all of us to be able to work more productively in. Now having said that, also we do have to sort out what it means in terms of timing and we've got a number of cases, acquisitions that we're working on in Pennsylvania through the regulatory and approval process and it's obviously impacting that a bit currently, but we expect that to clear soon and be able to get back on our way here.

Speaker 7

Great. Excellent, guys. Thanks for the patience.

Operator

Next question comes from Anthony Craddell with Mizuho. Please go ahead.

Speaker 4

Hey, good morning. Just a quick housekeeping question After Julian, you talked about the HOS note and the income and you're very clear about that, that that's more or not much of an ongoing earnings number. I think you talked about maybe it rolls off in

Speaker 3

2026. When we move forward

Speaker 4

to post-twenty 26, should we think about additional rate base that maybe backfills that on a more linear growth rate or And I know $0.10 of a $5 number is very small, but just there's something backfilled out to keep their earnings trajectory pretty linear.

Speaker 3

Yes, I think you hit on it, Anthony, there at the end. It's not terribly material. We think this is a great benefit from a cash flow The additional interest is nice to have. We think the certainty associated with That contingent payment we had on the New York contract extension is quite helpful now to have that secured. So we think there Just a variety of things about the restructuring that made a lot of sense for us that don't necessarily translate into any material impact to our overall plan.

Speaker 3

So long answer to your question, we would not expect there to be a need for finding additional capital to sort of fill in that very minor hole that this Tencent will create.

Speaker 4

And just if I could squeeze one more. And it's to Cheryl's comments earlier and unfortunately, It looks like most of the Q and A has been sidetracked by Eversource questions. So I'm not asking an Eversource question. Just When Cheryl talked about the increased needs on water systems, cybersecurity, you just think of that. Is that maybe a foreshadow to that Maybe the smaller bolt on acquisitions may come at a greater frequency because of the requirements that are being the compliance requirements that are being put on these smaller systems.

Speaker 4

I mean, was that where that was headed?

Speaker 3

Yes, I think this is an area we've tried to signal, I think, for the last several discussions we've been having. And I think really probably what prompted that even was PFAS as an example. We see that as just another area that may be difficult for some of these smaller systems to be able to manage, both from an investment standpoint as well as an expertise standpoint. Cyber is another great example. Interest rates is another great example.

Speaker 3

I mean, the list just gets longer, not shorter for these communities to sort of have to deal with. And from our perspective, we have always been very focused on trying to define what the need is for a community and helping satisfy those needs. And again, from an M and A perspective or an acquisition perspective, as that list gets longer, it creates more opportunity for us to have that dialogue and work with communities to solve those kinds of problems. So yes, we think it does have upside to Our acquisition strategy, it's probably not a tsunami though, to use Water term, it's probably a much sort of longer term impact. I think it takes a bit of time for communities to sort of wrestle with these issues and determine impacts to them before they're ready to make a move.

Speaker 3

So again, we use these kinds of issues in our discussions. I think it'll take some time before we see any measurable impact directly related to these issues.

Speaker 4

Great. Thanks so much for taking my questions.

Speaker 3

Sure. Thanks, Anthony.

Operator

The next question comes from Steve Fleishman with Wolfe Research. Please go ahead.

Speaker 9

Hi, good morning.

Speaker 7

Good morning, Steve.

Speaker 6

Not an M and A question. So the Couple of

Speaker 9

things on the HOS changes. So just the thinking about the shift in the interest rate on the note, 7%, 10%, which is great. I mean, that's a pretty high rate to pay for the seller and I guess soon to get rid of the prepayment. And so I guess I'm just wondering How do I think about just making sure that that seller in terms of getting paid back,

Speaker 6

Getting paid. Yes.

Speaker 3

It's a great question, Steve.

Speaker 9

Are they set up and pay you?

Speaker 3

Yes. John, do you want to take

Speaker 6

this question? Sure. Good morning, Steve. From a credit perspective, We stay very close to the HOS business. We're in fact a partner and as lender, we're constantly in touch with the business.

Speaker 6

As the company has evolved, the credit has improved. Extending the New York contract is a significant positive credit move. And as I mentioned in my comments, the company is currently making an acquisition with new equity funding from their owners as well as cash on their balance sheet. So We do have covenants. They've remained in compliance with the covenants.

Speaker 6

And in fact, we've taken the opportunity to tighten covenants as well. But when you look at the underlying business, it's frankly doing better than it ever has. So we feel very, very good about the underlying credit here. Okay.

Speaker 9

Does the owner, does the private does the firm back it up too or is it just the business backs up paying the rest?

Speaker 6

Yes. No, the owner backs it up and that's what I was trying to say. So when there's fresh equity coming into the business to make this acquisition. That's coming from Apex, who owns the business.

Speaker 2

Got it.

Speaker 9

And then just I know you had that sharing mechanism too for the business. Could you just maybe let us know kind of how much income you made on the sharing mechanism part in, let's say, 2023? Or yeah.

Speaker 3

Yes, Steve, I don't know if we had that disclosed. Is it separate in the 10 ks? Yes, Steve, we can point you to it. I'll have Aaron follow back up with you to point you to it. But I think it is in the 10 ks, which obviously we filed last night.

Speaker 3

This is the revenue sharing mechanism you're referring to where we collect a share of the revenue that's generated from The warranty work that they're doing in our various state jurisdictions where we have contracts.

Speaker 2

And that's right.

Speaker 3

Yeah, Yeah. So Aaron will, direct you to that. Okay, great. Thanks, Steve.

Speaker 2

Okay.

Speaker 9

On the Pennsylvania case, I think 2 of the commissioners sent a letter at the beginning of the case just kind of framing it. I'm not sure is that abnormal, would you say or is that normal for your Pennsylvania cases? How would you characterize that?

Speaker 3

Yes, I would say it's probably not necessarily customary. But Again, we think that this case is proceeding as it should. We don't really see again any issues here. It's a big case. I mean, it's $1,000,000,000 worth of investment.

Speaker 3

And we were in just a little under 2 years ago on this case. So it's certainly material. And again, solely driven by investment in the jurisdictions that we or the communities that we serve there.

Speaker 1

Yes. Understood. Thanks for your time.

Speaker 3

Yes. Thanks, Steve.

Operator

The next question comes from Jonathan Rider with Wells Fargo. Please go ahead.

Speaker 10

Hey, good morning team. Just wanted to come back

Speaker 6

to EA

Speaker 10

and the fair market value stuff. Do you anticipate that all the changes to the fair market value will come via the commission process or do you think some of the bills in the legislature will make it across the finish line?

Speaker 3

Yes. Our view is that this is the best path and the likely path to sort of resolve issues around fair market value in Pennsylvania. Again, I think this is normal practice, And I'm not speaking specific to Pennsylvania. I'm just saying normal in my 40 years of experience. This happens fairly regularly where commissions You know, are charged with interpreting legislation and applying, the provisions of it.

Speaker 3

And that's what I think this commission is doing. And I think they took a very proactive, step here to do exactly what you're talking implement the legislation. I think there's no one, well, I shouldn't say no one. There are a few probably that have conceptual problem with what fair market value legislation was intended to do. I think there There's a good understanding of the need for consolidation in the state and this is the mechanism to allow for that to occur.

Speaker 3

So I think it stands and I think the commission will do the work necessary to make sure that the legislation is effectively and acted and implemented.

Speaker 10

Yes. So I mean, you're saying PA is, in your opinion, very much fully behind continued promotion of consolidation?

Speaker 3

Yes, I think as a state, as a commonwealth, I believe that is a true statement, yes.

Speaker 10

Okay. What sort of impact do you think it will have the deal activity and would you say the proposed RRR will make it tougher for AWK to deliver on The M and A CapEx placeholders?

Speaker 3

I think we'll have to see how it plays out and how Ultimately, it gets worked from a procedural standpoint. But I'd say generally speaking, no. We do not see it having a material impact on available opportunities and then ultimately the outcomes on transactions.

Speaker 10

Okay. And then last question for me. I saw that in at least the PA in New Jersey rate case filings that revenue decoupling requests were made, Possibly it's in the Illinois case too. Do you typically make those decoupling requests and just don't get them or is that something new that you're

Speaker 3

Yes, it's a good question. I'd say it varies across jurisdictions. And again, part of our job here is to really understand what each commission is comfortable with and what mechanisms work or don't work in a particular jurisdiction. And it's also part of our responsibility to educate and to inform commissions and their staffs about how various mechanisms can work and what the impacts are. So we do that across our jurisdictions and I think we have really been more proactive in that regard over the last couple of years.

Speaker 3

And so I think as we do that education and that dialogue, it will inform where we propose what mechanisms. So I wouldn't necessarily say it's a broad application that decoupling is always on our list in every jurisdiction. I think it's all circumstantial what mechanisms work best in what jurisdictions and we work accordingly.

Speaker 10

Okay. But for PA in New Jersey, are these new proposals or have they been there in say your most recent case too?

Speaker 3

Yes, I'd have to go back and look to see if we had them specifically in those cases. I don't actually recall, but again, I wouldn't necessarily think this is breaking new ground on either of these proposals.

Operator

The next question comes from Greg Orrill with UBS. Please go ahead.

Speaker 10

Yes, thank you. Just a question on the PFAS Settlements, just sort of your expectation on the outcome following up on the 3 ms settlement there. And thanks for the additional updates. I'm just curious if anything's changed around your view of the company's sort of legacy liability to

Speaker 3

On the first question, Greg, around just settlement expected outcomes, obviously, that process is proceeding. And we had one settlement approved and the other one, fairness hearing has occurred and we would expect it to ultimately get approved. And then the process begins of claim submittals and really going through the settlement allocation process. So obviously, It's too early for us to be able to give you any indication of what we think the outcomes will be financially. But as we've said all along, these will be cents on the dollar in terms of recovery.

Speaker 3

We don't expect obviously for it to cover the full cost of exposure here. But The amounts to be recovered through the settlement, we think is quite important and the best avenue, as Cheryl said in her remarks, to collect dollars on behalf of the customer to reduce the overall obligation the customer has. So, it's a good process. We've been happy to be involved in it. Our team, I think, in a lot of ways is leading much of the effort around getting this work through the courts and getting here that are quite favorable.

Speaker 3

To your second question on how do we view sort of legacy exposure here, I don't think our view changes. As we said earlier, this will be an environment like all where there will be plaintiffs attorneys that are looking for an opportunity here and how that ultimately gets worked through the larger process around the MDL, the multi district litigation is yet to But in terms of our exposure, we don't have any different view than we've had from a legacy Again, as Cheryl said, on a go forward basis, we are treating and we're preparing to treat and we're confident in our ability to do that on a go forward basis.

Speaker 4

Thank you.

Speaker 3

Sure. Thanks, Greg.

Operator

This concludes our question and answer session.

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Earnings Conference Call
American Water Works Q4 2023
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