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OPERATOR: Thank you for standing by. Welcome to the Aqua America
fiscal year 2007 earns conference call. Today's conference is being
recorded. At this time, it is my pleasure to turn the conference over
to Kevin Brophy. Please go ahead.
KEVIN BROPHY, DIRECTOR, IR, AQUA AMERICA: Thank you, Duane. Good
morning, everyone, and welcome to Aqua America's fourth quarter and
year end 2007 earnings conference call. If you did not receive a copy
of the press release, you can find it by visiting the Investor
Relations section of our website website at www.aquaamerica.com.
There's also a live webcast of this event available on the site.
Presenting today is Nicholas DeBenedictis, Chairman and President of
Aqua America, along with David Smeltzer, the company's Chief
Financial Officer.
As a reminder, some of the matters discussed during this call may
include forward-looking statements that involve risks, uncertainties
and other factors that may cause the actual results to be materially
different from any future results expressed or implied by such
forward-looking statements. Please refer to our most recent 10Q, 10K
and other SEC filings for a description of such risks and
uncertainties. During the course of this call, reference may be made
to certain non-GAAP financial measures. Reconciliation of these
non-GAAP to GAAP financial measures are posted in the Investor
Relations section of the company's website. At this time, I would
like to turn the call over to Nick for his formal remarks, after
which we will open up the call for questions.
NICHOLAS DEBENEDICTIS, CHAIRMAN & CEO, AQUA AMERICA: Thank you,
Kevin. Good morning, everyone. The -- we'll start with a broad
overview and get into some specifics regarding the year end quarter.
I would characterize '07 and a good year, not a great year. Despite a
rapid slowdown in, probably the second half of '07, provides us some
of our organic growth towards our 4% goal.
Somewhat erratic weather this year. Good weather in some of the
states, heavy rains in Texas, great weather (inaudible) was declared
in Texas (inaudible) North Carolina, Florida, which cut sales where
we had an inordinate amount of maintenance with a colder than usual
winter it is the biggest disappointment that affected earnings and
affected us and reorganized the rounds (inaudible) disappointing rate
case in Florida that was somewhere between $0.02 and $0.03 to our
earnings. Overall we earned 71 versus 70, once again slowing
delusion, net income was up 3%, up a penny 71 versus 70. Slowed down
to now about 1.5% and we expect that to continue to go down as I'll
get into later into the presentation.
The quarter was actually a solid quarter if you take out some of the
what I'll call noise and this is a non-accountant speaking so forgive
me but in '06 we had nearly two-one cent gains that were one time,
one was regarding our Texas rate case, and that was based on the fact
that the ALJ decision came out in late '06. The case is still not
finalized but the preliminary decision came out and the accountancy
of it -- reserving and felt that the -- the revision of the estimates
should be accounted for and that came about a penny, again obviously
one time.
And the other was another penny that was reduced because we switched
the way we did insurance from a quarter to a quarter to a more
levellized system so there wouldn't be as much variability and that
actually added a penny and we looked to the reserves we had already
accumulated. This year, we had a penny for the fact that we sold an
investment--a company called (inaudible)actually, we invested in a
company called--based on the order, we moved the money and they gave
it (inaudible). And the IPO traded well above the price and we
decided to take that investment and that was about a penny and so you
can add -- subtract two for one -- or one from the other and you will
get a better feel, and so that resulted in a fairly solid quarter.
Looking at the year in general, our growth in customers was just shy
of 20% of the quarter. Disposition of some property which I'll get
into under a new policy we've adopted so not our normal 4%, not as
rapid as it has been in our major acquisitions of either the Florida
Water, New York Water and-- four years out of the last five but it
was a year of digestion and we were just shy of 3%. Our dividend was
9% because of some strong cash flow which we're seeing, EBITDA was up
over 9%. (Inuadible) And you'll see that is closely tracking the same
-- we're making to our rate-based, basically we're about $2.5 million
in rate base and we're spending about $250 million a year in capital.
The disappointing area was expenses. And across the board, I mean
overall O&M expenses were up 15%. Interest was up 15%. Local
taxes because of the New York acquisition, which obviously was not
there the year prior, other states, 36%. And depreciation was up 17%.
And so, we had a lot of head wind in the expense side this year,
which I'll go over for '08 and what we're projecting which is going
to be much more contained. Take the 15% in the O&M increases,
over half of that 7.5% was from acquisitions, New York Water. 1% was
the writeoff we had to take of legal expenses and rate case expenses
in Florida. Another 1% was accounting accruals regarding retirement
in the Pennsylvania which will get back into rate case or we're
asking to get back in the rate case and also the -- there were some
other help and pension-type things that had to be trued up. And the
other was 1% of the expense increase because of an increased writeoff
in bad debt and I attribute back to not the economy as much as it is
the (inaudible) new customer information system which basically now,
is part of the automatic New Jersey (inaudible). (Inaudible) bills
that are over a certain number of days and we had a number of states
rendering their own systems, used a lot more discretion before they
would try to basically shut people off for nonpayment and this system
was a little bit more automated and there is therefore always a
washout of bad debt in the reserve side, we (inaudible) collected,
when we start shutting people off if we find that out.
So overall I would say we had, in that regard, biggest challenge in
-- in '07. Now we had a lot of non-financial issues that I'd like to
take two minutes and go over with you. First of all, I mentioned
earlier the organic growth being down considerably, about half of
what it normally is. And it all happened in the second half. And I
attribute that basically to the mortgage rates going up and the
surplus of housing that was already built when the crunch hit.
We're starting to see an uptick in the existing stock and although
prices are not as high as they were a year ago, that doesn't affect
us because people buy water whether they pay more or less for the
house. And we're starting to see a little bit of recovery in the
housing, new housing, based on the fact that interest rates are down,
people are looking again and that the inventory is going down so the
builders will start building again. Obviously, going back to the
building business and that is my assessment looking at numbers, you
will have to talk to the -- to get a more accurate perception. That's
where we see it. That put more pressure on the fact that the only way
that you -- if you don't have organic growth to get to the 4%
(inaudible) acquisition, the flurry of activity at year's end, is we
did 26 acquisitions. And we did pretty close, as I mentioned, to the
3% range and so we're pleased with that. And we do think that the
slowdown in the economy, which also forces austerity on municipal
governments with revenue slowdown, we think we could open that door
up a little more with municipal acquisitions in '07 and we're looking
at more municipal acquisitions in '08 and remember, 85% of the market
is all municipal. We're -- we are a small 15% of the private sector
of the overall water market.
The second thing that happened in '07 is we instituted a major
customer information system. As anyone who has gone through a major
system change, we went from 35 separate systems in all of our regions
and states to one centralized system -- double the estimate that the
I-S people tell you is going to happen and that is exactly what does
happen. It does -- we worked ourselves through it, I think we're
beyond it. Even our bad debt was up because the computer now kicks
out the reserve versus discretion at the rate local, state level. We
had to ramp up expenses to fill up three call centers and have people
get onboard at the call centers during the transition. The training
of those people, getting more and more efficient but until they're
more efficient, we had extra people and basically we had the typical
growing pains which I think are now stable and we're ready for
improvement and I think that will (inaudible) in comparison '08 '07
but with a big comparison '06 to '07.
Again another solid capital spend, $236 million which, as I
mentioned, is about 10% of our rate base. We're going to probably up
that next year to 250 plus based on the projects that we have in the
pipeline now. And the fact that we're seeing a lot more cash
generation. I mentioned earlier that our EBITDA was up over $300
million. I'll get into that in -- and the fact that the new tax law
which is called The Economic Stimulus Act actually gives a huge tax
rebate for improvements made to water systems, and that is going to
mean our systems -- light up our capital and the fact that for one
year you will get a tax break and generate more cash.
If we take a look at where we are, I think that the biggest
accomplishment on our capital spend in '07 is we completed all of the
fixups that had to be done in the new system, small systems we bought
from the former electric company, Elite and Aqua source where they
had not fixed the problem therefore we couldn't pay for rates until
the problems were fixed, whether it be (inaudible) arsenic, leaky INI
system, sewer plants, malfunctioning waste water and -- (inaudible)
We put a lot of money into systems and I can tell you that I'm very
proud that we've now fixed them and at this point in time looking
back five years and forward five years, obviously we've ramped up our
capital spending from the mid-150s to now a quarter billion a year
which we intend to stay at. If you take a look at the mix of that,
probably the 50% five years ago was you have to do this to meet the
current environmental rules. In '07 30% of our spend is to meet
compliance not only visiting compliance but also the fact that we're
trying to build in advance of the next set of EPA rules that will
come into effect in two years and we're well on our way to already
accomplishing that.
As we look forward five years I would estimate more than 20%,
probably 10% of our spend would be for compliance this year, whether
it be needed attention to the plant or--or fixup of some
environmental rule that was just passed. On the other side, pretty
steady 28% of our capital spend meaning if you buy a system and it
needs work or meaning that the system has grown to the point where
you have to expand the water or waste water plant or build a new tank
and that should -- that should go from 20 to maybe a little less five
years out but we spend about 20% of our money on half this year, do
that for 50% for infrastructure, infrastructure is probably 30% five
years ago, infrastructure is pipes, tanks, things of that sort,
meters. That drops to -- that goes up, excuse me, to 50% in this
budget, '07, and probably when you get to five years out, 10, 11, 12,
it may be as much as 70, 75% of our spend and that is much less risky
capital design-wise, fitting-wise, more standardized.
And it is also very discretionary, the EPA will not force you to
spend the money but spending it is encouraged by the EPA and also by
the regulators under the surcharge program I'm shouting. I do not
know what else I can do. Are people having a hard time hearing me?
OPERATOR: This is the operator. It is just -- the MIC, if you would
move it closer, it might be a little clearer, but we are hearing you.
Please proceed.
DAVID SMELTZER, CHIEF FINANCIAL OFFICER, AQUA AMERICA: Can you hear
me better now?
OPERATOR: Yes. Thank you.
DAVID SMELTZER: Okay. So on the capital side, I'm very, very pleased
with the climate we've built, stable climate we've built. And I think
that bodes well for the future and for the controllability of our
program going forward. Now the next major thing we did this year, we
changed out some people in our organization. We built a whole new
treasury department. And I would say if there was one major
accomplishment, this was our major accomplishment for the year.
First of all, we've -- we had a number of offerings, and in those
offerings, S&P reaffirmed the fact that we had an AA minus
secured debt rating. They said that our senior secured first mortgage
Bonds are one notch higher than the corporate credit rating, which
would be an A-plus and that we have a recovery rate of one-plus,
which means that you are pretty sure of getting your money back if we
borrow money from you. The other, is our risk profile which ranges
from a low of one to a high of ten for corporations, we're ranked at
two. So I think we're very pleased with the stability, especially for
our -- our debt lenders, our -- our interest -- excuse me, our debt
holders, the fact that we're secure and we're running this business
in a secure way. We had a -- an enormous year of refinancing to
financings to get it started and to give you an example, this year we
did over $205 million in new debt. The average price using tax-frees,
using low interest state loans came to 4.92%. That allowed us to
lower our embedded cost of debt on $1.2 billion, I think is our total
debt now, from $5.72 billion to $5.58 billion.
And so we are clearly for the next decade or two in great shape from
the standpoint for shareholders, and for ratepayers in getting a low
interest rate for -- at 50% of our money that's invested in -- with
debt on this capital. We also assumed another $23 million in debt on
the New York Water at 565, which isn't bad. And our average -- this
is the biggest part of the variation between seven and eight, we had
100 million-dollars always outstanding and an average balance during
the year at our various states for short-term to carry the capital
program. And the average interest rate for '07 was 6.11 to carry that
100 million.
We have done two things: First, consolidate all those lines we are
paying a lot higher rate with smaller lines in some in some of our
smaller states, one line at the parent, we anticipate our cost being
under 4% for all of '08, and we anticipate our average balance in '08
probably being in the $80 million range, we'll be borrowing less,
having less on the line at a much lower interest rate and that should
be a help for '08 versus '07 where we had such an increase in
interest rates.
In '08 our borrowings at this point based on our quarter billion
dollar estimated capital budget and the cash that we're generating is
-- basically we're taking $24 million out of REFI that is coming out
at 6.5% average and we think we should be able to do better than that
and we have another $80 million in tax-frees and regular ventures
that we're going to borrow to support our capital program so you're
seeing $100 million versus $200 million last year, obviously less
interest rate risk. We're very pleased with the status of our -- our
program and of course the cash is helping. We -- have -- I think
we'll be up another -- I think we were up 9, 10% this year in EBITDA
with some of the system sales next year. Should have no problem
beating that. And this year we went up to $307 million of EBITDA.
The real story this year, however, was rates. Both good and bad. I
mentioned Florida earlier. That was a shock to us. And of course a
shock to our shareholders, because we had to take some writeoffs.
We've completely reorganized our rates department. We have
decentralized the rates departments so the presidents have much more
responsibility in getting their rate cases filed and through. We've
brought in five new employees that are seasoned veterans, state
agencies, other utilities. And we've worked very hard as a team. And
basically had some immediate successes.
We've got a 70% rate increase in Kirkwood's division, which is about
10% of the state of North Carolina, a huge rate increase, but
deserved. Hadn't -- we hadn't -- heater had not been in for rates
there since 1996, so it's a pretty old rate case. And also picked up
-- already cast in on $3 million worth of rate cases already --
that's an annualized figure in early '08, so we're already off to a
good track.
On the other hand, we have $67 million in the pipeline. These are
major cases that have been filed and -- and of course this new team
had to do all of this work over the summer to get them ready. Most of
them were filed late summer to fall. We have the Pennsylvania case,
which is our largest case. New Jersey was filed in December. And
Sarasota in late August. We have five cases filed in Illinois in --
late in the year, two in Ohio which are in the process. And we're
expecting two other major filings over the next couple months, 2 Q in
North Carolina and -- and Florida. And, of course, we still have the
decision in Texas, which we're hopeful will be forthcoming sometime
in the second quarter. And so you can see we have a lot of rate
activity.
Now to put this in perspective, in our 4-7-10-5, 4% customer growth,
7% customer growth we usually say 3 to 4% in rate relief is part of
that 7% revenue. If you take the six new -- new run rate of $600
million of revenues that we have, that would be $18 to $24 million
and you can see we filed for $67 million. So this is truly a slug in
the pipeline, this is what we call regulatory lag. We much rather
would have spread it out over a number of years but it was impossible
to do because we could not file the cases until we had all of the
meters in place and all of the environmental problems solved and most
of this back log are -- other than Pennsylvania, which is pretty
steady every two, 2.5 years, has been in states where we had a
backlog of environmental improvements we had to make. So that's going
to be our big task this year in rates. And also the-- and also
obviously the generation of cash and how to use that cash to support
our big capital program.
The new item that we've added to basically our strategy, which will
be ongoing now, when -- when we accumulated, we've begin it up pelled
in size in the number of customers in the last ten years and
collected a lot of systems, although we say we've done about 200
deals, some of those deals included 50, 100, 200 systems so we have a
lot of systems out there probably over 500 individual-type systems.
And not all of them -- of them are performing to the standards we
want. And we've listed some of those. We're continually reviewing the
portfolio. We did sell one towards the end of last year, and I think
it is a great microcosm example of why we would sell it. We had a
county willing to buy a facility where we had 13 of 14 small systems,
all in one county, all on need of major capital and in Northworth
county. The county needed it for other reasons to accumulate their
assets and they paid us a fair price. We booked a gain which is in
the numbers. And it is one less major capital draw, major management
attention draw without much in the way of future potential growth or
future potential -- potential growth in customers or in net income.
Looking at a number of other ones like that, there are two in
Illinois we're looking at and one that is in our 2 -- or, sorry, in
our K and that is the Fort Wayne situation which we've been talking
about for quite a while, a lot has happened on that in the last two
months and at this point we have the north part of our system, which
is about a third of our customers, has been taken by eminent domain,
I guess you could call it, called a quick take. We did show and in
settlement of the suit two issues, one, we're going to run it for the
next three to six months under an interim contract to give us a
steady transition period. We have appealed the price that they -- the
Fort Wayne government has given us $16.9 million for what they think
the assets are worth. We obviously disagree. We've also agreed to
allow us to continue as a -- has the commission with a rate case
which had been 100% request for both the north and the south. We've
revised that only to the south now, submitted that last Friday and
asked for 75%. Obviously the -- you can see the south was more
profitable than the north and in need of less rates so that's good
for our customers also in the south. But it also means that we still
have out there a finalization of the price in the north to resolve.
And then the two Illinois cases will probably generate in the
neighborhood of 15 to 20 million of new cash that we will put right
back into capital, but that means that we don't have to borrow it and
of course some of that is equity and so some of it would be -- to
reduce our future equity needs because we're getting equity from
selling these systems at a profit.
So I think that is a major new issue, it's part of our program and I
guess if this was a REIT that you were listening to they would be
telling you that they were selling this building, buying that
building and continually moving your portfolio around, I think you
can look at that way versus when we were a single state. (Inaudible)
we did not have that opportunity to look at it that way. So I think
what we can control we are really in good shape on.
Our capital spend is now mostly discretionary. We don't have any
major environmental issues we're building for. We're staying ahead of
the curve with the EPA. We're looking at the tax policies of The New
Economic Improvement Act and trying to see if we can gain for the '08
time period if permitted for water utilities a major part of our cash
needs. That could be in excess of 30 to a -- maybe as high as $40
million. We are -- I think expenses we have our compliment now is
under control, we have the -- customer information system behind us
and less inflationary risk, which nobody can predict. I think our
expenses are going to be back in the, you know, three to four range
versus the four to five core and then 15 overall last year.
Our interest is going to be under control, depreciation will probably
be up less than 10% and interest probably low single digits, and I
think our organization and our systems are in place which all
occurred during '07. Now what is not under our control, it could be a
major must or a major minus through '08 and '09, '08 for weather. So
far a good start, main breaks last year at this time were 450, this
year they were about 150. And in '06 what we compared to the prior
year they were only 75 and so you can see it had a big, significant
difference in the weather this year. And the success of our
acquisition and disposal program would mean a lot to our core
earnings and our total earnings next year. That's a pretty broad
summary to answer any questions.
OPERATOR: (OPERATOR INSTRUCTIONS) Our first will come from Heike
Doerr with Janney Montgomery Scott.
HEIKE DOERR, ANALYST, JANNEY MONTGOMERY SCOTT: Hello, everyone. Can
you hear me okay.
NICHOLAS DEBENEDICTIS: Yes, I can.
HEIKE DOERR: I'm hoping that maybe this is a question for Dave
Smeltzer. If we can iron out what the impact of the Fort Wayne
condemnation would be on PT and E and revenue and operating expenses,
what percentage, you know, of revenue we could see a decrease, how
much the operating expenses were relative to the base, can you put
some numbers around this for us, Dave.
NICHOLAS DEBENEDICTIS: I will give you a general answer and Dave can
either give you a specific or call you back, Heike. The Fort Wayne
north system was losing money. And so it tells that you we're going
to do better without it until we got rates than before. We had put a
lot of capital in. We were arguing over how much we owed them for the
sewer. Disposals. Because we used their plant for our customers. We
told them we felt we owed them 300, they asked for for 2 million and
we settled at 450 which was reserved. So it takes a lot of those
question marks out. Now, so for '08 it is going to have a positive
effect because -- we're basically getting money for a O&M
contract which is break even at worst. And we also don't have the
losses incurred through '08. On the other hand, if we had gotten 100%
rate increase then it would have been making money. But they will
give you the specifics for '08 and really it is irrelevant for '09
because they've taken it and Supreme Court ruled three to two in
their favor.
DAVID SMELTZER: Yes. I don't have -- don't have handy the revenues or
expenses.
HEIKE DOERR: Okay.
DAVID SMELTZER: But actually improves the results when that case --
but I can get you those details.
HEIKE DOERR: Okay. We can handle that offline. And, Nick, maybe as a
bigger picture customer growth question I know that the target had
normally been 4-7-10-5, as the company gets bigger and 4% customer
growth is difficult to attain, do we scale back and think maybe 3% or
2.5% is a more realistic annual run rate?
NICHOLAS DEBENEDICTIS: Well, it -- it is the IBM problem, although
we're nowhere near the size of IBM, it is tougher it continues to
grow on a bigger base. But I'm still optimistic, Heike, that there's
so many out there and I think that the new part will be the fact that
municipalities are going to be tighter now and maybe be looking again
at selling their systems, when interest rates were so low on
tax-frees and revenues were coming in because of tax revenues and
property tax increases they were less willing to look at, you know,
where they should trim costs and of course that is one of the areas,
asset sells would be one of the areas. I do any that you are correct,
if I'm wrong and the housing market stays in the tank for a
year-and-a-half, different story. Because, I mean, we did depend on a
percent, the 2%, actually more in North Carolina and Texas, of our
growth being organic growth. So I'll answer it with -- if we can get
the housing market back to where it was in, you know, even '06, not
even the the '05 peak, I'm comfortable with the four. If it stays
down consistently for a couple of years, probably will be tougher to
hit four.
HEIKE DOERR: Okay. That's helpful. And one final question, when we
look at the $250 million CapEx that you look to spend next year and
now all of the cleaning up of the systems is taken care of, how does
that break down regionally?
NICHOLAS DEBENEDICTIS: Well, regionally it is mostly in Illinois,
Pennsylvania, New York, and North -- and New Jersey. Ohio's pretty
steady. We have a plant to build in Ohio and some pipe but it is not
excessive in infrastructure, although they do have a disk-type
program, it's called sick in Ohio but if the place where the capital
spend slows down is in the south because we've fixed things now and
it -- there was an inordinate amount of capital spent in the south
over the last three years that we're not getting any return on, and
that's our goal. Go in and get return in the south.
HEIKE DOERR: Okay. Great. Thanks for your help.
OPERATOR: Our next question is from Jim Lykins with Hilliard Lyons.
JIM LYKINS, ANALYST, HILLIARD LYONS: Good morning, everyone.
NICHOLAS DEBENEDICTIS: Hey, Jim.
JIM LYKINS: First of all with Florida, the rate case that you're
going to file down there, would that be for the same amount as the
one that you withdrew last year? And I'm wondering, I know there are
issues with the regulators down there, just curious as to whether
you've been able to make any inroads with the regulators in that
state?
NICHOLAS DEBENEDICTIS: Well, we did successfully -- I would say we
have been in constant contact, and we're working with all of the
parties this time. Last time we had not touched base with everybody,
meaning the people for and against this. And we're at the very final
stages in the withdrawal of the case. It wasn't just as easy as just
dropping the case. We actually had to give refunds back, which was
not an easy task with the new customer information system.
We also committed to public meetings and public phone calls, buy
we've accomplished, and now we're doing some town meetings which have
been very helpful for us because we're hearing what's on people's
minds and that all has to be done and that should be done shortly
before the old case can be shut down. We hired a person who actually
came from The Florida Commission who's now our rates person in
Florida. He has given us a lot of insights and a lot of experience
that we're going with. And we think that we're going to come up with
an acceptable rate plan when we file in the second quarter to come up
with a way so we don't have 82 different systems we have to file for
each time, which would make investment in Florida very difficult
because the accounting and administrative costs overwhelm the great
case needs for, you know, service and for capital needs.
So we're a lot more optimistic and probably know a lot more this time
around and it was about this time last year we were filing the case
that was ill-fated. And so we're a year behind in Florida. Any your
first question is what will we be asking for? I -- I can't imagine it
will be any less than last year because we actually -- that last year
was 7 million, as we've put more capital in Florida, all automatic
metering in and everything else so we can improve service to the
customers, and we -- we could justify the 7 million last time and so
I can't believe it would be any less. I think probably before a final
decision is made though, it won't affect '08's earnings, it will only
affect '09.
JIM LYKINS: Only '08 earnings, not '09?
NICHOLAS DEBENEDICTIS: We'll file it in '08 but it's going to take at
least six to nine months, I do not know what the rules are in Florida
specifically, how many months during a process they take but I can't
imagine it having any effect on '08 earnings, so it is all back-ended
loaded into '09.
JIM LYKINS: Okay.
NICHOLAS DEBENEDICTIS: As are by the way many of these cases. The 67
cases, the biggest one -- 67 million cases in nine out of our 13
states, the biggest being Pennsylvania, none of these would be
actually coming to fruition before probably mid-to-late summer, most
of them late in '08. And so the biggest impact of this bulge that's
gone through is still going to be late '08, early and mid- '09 for
your quarterly modeling I mean it's you'll going to happen in over a
year period but where it bulges in in the quarters, is all dependent
on the litigation time period after you file. And we can give you
that specifically for your specific model we can tell you when to
anticipate that them.
JIM LYKINS: Okay. That would be helpful. Regarding acquisitions, I
know that you mentioned something about some opportunities with
municipals and -- and what you're going to need to do there to make
up for the customer growth but I'm just wondering if you could give
us a feel for what you are seeing out there right now and if you
think that at least in '08 it will be similar to what we've seen
historically on the acquisition front?
NICHOLAS DEBENEDICTIS: Well, we'd like to do fewer but bigger,
because some of these systems have been very small and it takes a lot
of work to do any of them. You have closings and you have to go
through the regulatory approval but you take them as they come
because it is not like we can say we're ready to buy you now it is
when they are ready to sell. So it is not completely under our
control. But we just had a meeting with our corporate development
company the before our board meeting yesterday and they feel that the
pipeline is full and they have this time a little bit larger and now
sometimes they are harder to close but they are pretty confident that
we can keep up the pace, like Heike asked about the 4%. Usually that
is 2.5, 2, 2.5% of -- of acquisitions and 1.5 to 2 every organic
growth. We're asking our team now to come up with over 3% so the bar
actually went up. So we need some bigger deals.
JIM LYKINS: Okay. And one last thing and then I'll let someone else
ask questions, the economic stimulus act that you mentioned, can you
maybe give us some color and what you think the impact will be for
that.
NICHOLAS DEBENEDICTIS: For your '08 capital spend in the water
business if you are a private utility, a tax rebate for -- so 35% is
our federal taxes, Dave, I guess?
DAVID SMELTZER: Yes. It is actually bonus depreciation.
NICHOLAS DEBENEDICTIS: Bonus.
DAVID SMELTZER: Not unlike that that was enacted after 9/11.
NICHOLAS DEBENEDICTIS: So if all 250 would be eligible.
DAVID SMELTZER: Yes.
NICHOLAS DEBENEDICTIS: Multiply 250 by 35% and that's the amount of
cash we would get by not paying taxes.
JIM LYKINS: Okay.
DAVID SMELTZER: 250 times the 15% bonus depreciation then times the
30%.
NICHOLAS DEBENEDICTIS: Oh, I'm sorry.
DAVID SMELTZER: And that would only be reduced by some, you know, 30,
40, 50 million of the 250 that may be financed by the low interest
tax freeze and therefore may not be eligible for the bonus
depreciation.
NICHOLAS DEBENEDICTIS: Right. So if it is 250 you would multiply 250
times 50% times 35%? -- so 125 by 35 and so you can see it is pretty
healthy though, it is 30, in the 30, $40 million range.
JIM LYKINS: Okay.
NICHOLAS DEBENEDICTIS: The fact at that we're generating more cash
with the EBITDA really means that we'll be able -- and, Dave, that --
because you are paying less taxes falls to the equity side, retained
earnings.
DAVID SMELTZER: It is not an income item.
NICHOLAS DEBENEDICTIS: Okay. Just cash.
DAVID SMELTZER: (Inaudible) in payment of taxes.
NICHOLAS DEBENEDICTIS: Okay.
DAVID SMELTZER: Yes.
NICHOLAS DEBENEDICTIS: So we're -- we're seeing less need for equity
too, Jim, in our analysis than we did a year ago at this time with
the five-year plan.
JIM LYKINS: Okay. All right. Thank you, gentlemen.
OPERATOR: Our next question is from Tim Winters with Smith Moore.
TIMOTHY WINTERS, ANALYST, SMITH, MOORE & CO.: Good morning, Nick.
NICHOLAS DEBENEDICTIS: Good morning, Tim.
TIMOTHY WINTERS: Just a couple of questions on the O&M expense
line. You talked about a, you know, new computer system and three new
customer information systems and kind of a washout with the bad debt
reserve, can you quantify, at least to some degree, how much that
impacted the O&M line?
NICHOLAS DEBENEDICTIS: Yes. I can give you exact. We'll call you
back. $1.7 million? That was the bad debt. Yes. Bad debt was $1.7
million more. But we also have to quantify the increased operating
expenses year-over-year which we'll call you back on, Tim, of the new
call centers versus how much we had to staff at the old and the --
the hidden dollar in there is the fact that we couldn't reduce the
local staff until the new staff overlapped with them and -- and was
trained. And so here's the example, we had people in our Canca key
office, in our Danville office and in our -- in our Wood Haven
office, in Illinois, we probably had 10 people, answering phones and
we beefed up a call center in -- and it happened to be in Canca key,
one of our three regional call centers where we hired 25 people.
They're handling the whole country, all 13 states. But we couldn't
reduce the ten people that were local until the others got up and
running and the system got up and running and so we had that overlap
for probably two quarters which it will go away also.
TIMOTHY WINTERS: Okay. And then as far as this pruning process goes,
did you take a gain on the Virginia sale and, if so, how much? And
what is roughly the price to book that you are selling? That you sold
Virginia for and what the $16.9 million represents as price to book?
NICHOLAS DEBENEDICTIS: Okay. Well, let me start with the Virginia,
because the 16.9 is Fort Wayne. In Virginia we sold for a little
under $1.5 million that was the purchase price negotiated. It was 2.5
times our book vault value, if not more, almost three times. And
therefore that difference at we expensed the lawyers and all that was
put as part of the way the accounting system does it is you take it
as a, what, deduction from O&M.
DAVID SMELTZER: Yes. Since it's a sale of an operating asset it needs
to appear in the operating section of the income statement up top and
since it is relatively immaterial we incorporated as the deduct in
line of O&M expenses.
NICHOLAS DEBENEDICTIS: That's about 2.5 times book.
TIMOTHY WINTERS: Okay. So it's not on that item on the press release
that's gained on sale of other assets?
NICHOLAS DEBENEDICTIS: No, it's not. That's the security sale.
TIMOTHY WINTERS: All 2.5 million of that is basin water?
NICHOLAS DEBENEDICTIS: Basin water, yes.
TIMOTHY WINTERS: Okay.
OPERATOR: And Mr. Winter, any follow-up question?
TIMOTHY WINTERS: Right. And then Fort Wayne --
NICHOLAS DEBENEDICTIS: Oh, Fort Wayne, the way -- because we're still
in court debating what the final cost is.
TIMOTHY WINTERS: Right.
NICHOLAS DEBENEDICTIS: It's impossible to book the gains. I can tell
you the $16.9 million covers our book value and we think it's worth a
lot more.
TIMOTHY WINTERS: Okay. And can you give any kind of time frame? I
mean, could this go on for years?
NICHOLAS DEBENEDICTIS: The court, the Supreme Court ruling was about
six months in waiting for the hearing, the briefings, and then it
took them a year to rule it three to two. This is not a Supreme
Court. This will be an Alan-County court. But if either party, us or
Fort Wayne disagrees with that court, then you have access to the
Supreme Court. So I cannot tell you what the final is going to be
settled, whether we'll both agree with what the jury says, the judge
says so, you know it is a guess. I would argue probably a year
though. Okay. Thank you.
OPERATOR: Our next question is from Steven Gambuzza with Longbow
Capital.
STEVEN GAMBUZZA, ANALYST, LONGBOW CAPITAL: Good morning.
NICHOLAS DEBENEDICTIS: Good morning, Steven.
STEVEN GAMBUZZA: If you were to receive 100% of your requested rate
relief that you have pending right now, just curious if you could
give me an approximation for how much would know through for '08
based on the timing of expected decisions?
NICHOLAS DEBENEDICTIS: Well, it would be half of Pennsylvania. You
want 100%.
STEVEN GAMBUZZA: Just, like, if you've got the amount that you
referenced in the press release.
NICHOLAS DEBENEDICTIS: Sure. 67. I would say 40 of it, be half a
year, 20. And 65% of 20 would be 12. And so 12 million in top line
revenues.
STEVEN GAMBUZZA: Okay. Is that -- so is that just for Pennsylvania or
is that the total amount.
NICHOLAS DEBENEDICTIS: 12 million in net income, Dave, because I
already took the 35% off.
DAVID SMELTZER: Yes, you asked for 100%, Pennsylvania we asked for
40, assuming we get it sometime this summer, I just made the broad
adjustment, half a year, and since all the expenses that we asked for
are already been expended there's no more expenses when we get the
case so it falls on the bottom line of today's run rate.
STEVEN GAMBUZZA: Okay. And what about the other $27 million outside
of Pennsylvania.
DAVID SMELTZER: New Jersey we probably won't see until late fall,
maybe winter, and so maybe a month. New Jersey's filing was for $7
million. And the Illinois ones are due in 11 months, filed in
December. And so they won't be out until November.
NICHOLAS DEBENEDICTIS: And the Illinois ones totaled about $4
million. Takes one month, 4 million times 35% off for taxes and that
gives the bottom line. In is going to roll into next year for 11
months then.
STEVEN GAMBUZZA: Okay.
NICHOLAS DEBENEDICTIS: That's how it works. Now most of this revenue
from REITs are going to really come a little bit -- not a little bit,
a lot, half a year of Pennsylvania is a lot for us but the rest is
all going to be really back and loaded into '09 with the two big
cases still to file in Florida and North Carolina, definitely won't
show up in eight. They will all be in nine.
STEVEN GAMBUZZA: Okay. And I was just wondering if you can comment on
the outlook for O&M expense in '08. I think that you mentioned
that you expect some moderation, back towards the three to 4% growth
rate. I'm just wondering if you can make talk about risks and
opportunities associated with that given, you know, the potential
opportunities to do better or given the inflation trends that
everyone in the industry has been feeling broadly where some risk to
the upside might be?
NICHOLAS DEBENEDICTIS: Yes. Well, the risk to the upside is more
people needed than what we've said. We think we're going to be flat
to down in number of -- this year we were up considerably based on
what Tim Winter asked me about, which was how many people did we add
for the customer service and in our I-S department, so we'll get you
that. But that should not be -- and that's the biggest part of our
factor. I mean, people is 40% of the budget, O&M budget.
Healthcare we've locked in pretty good rates for all of '08, so there
shouldn't be a major increase in that, maybe 3, 4%. And we've had
people pay to their benefits which is not normal in the utility
business but to cut back on the -- moderated the increase. Pension is
hard to figure at this point. That's really based on how well the
stock market does. But, you know, at this point pension could be --
could be good, could be bad. We already are putting money in each
year for expensing pension increases. Insurance is always a risk will
now we're on an accrual basis for a rolling 12 moments so it won't be
as radical quarterly. We don't have any major litigation that we've
noted in the K but we have trip and falls every day, that kind of
thing, a car accident, you know, something like that, what it could
be.
And then power. Texas is very volatile in power prices. Obviously
we're big power users everywhere. Most of the states we've figured
increases.
And on the positive side, as we sell these systems I think you'll see
that those systems have higher expense to revenue ratios than the
systems we're keeping. Ability so that could be a moderating force.
STEVEN GAMBUZZA: The $250 million of CapEx and those--I'm shifting
gears from talking about CapEx versus the operating costs but I would
imagine that a substantial portion of that is capitalized labor
associated with the pipe refurbishment and other activities. Is that
fair?
NICHOLAS DEBENEDICTIS: That's fair. We try and keep that pretty
steady, so it's not one that -- as long as the total spend is steady,
the amount of capitalized labor is steady.
DAVID SMELTZER: I don't know what the exact percentage is, probably
in the teens but, yes, we use our own workforce to do some of the
work on labor which means that their labor gets capitalized on that
project and then it is recovered in the next rate case.
STEVEN GAMBUZZA: Okay. Thank you very much for your time.
OPERATOR: Our next question is from Ryan Connors with Boenning and
Scattergood.
NICHOLAS DEBENEDICTIS: Good morning, Ryan.
RYAN CONNORS, ANALYST, BOENNING & SCATTERGOOD, INC.: Good morning.
Yes. I wanted to go back to the topic of CapEx budgeting for a minute
and just kind of more conceptually get your thoughts on the strategic
outlook for capital deployment. You know, you talked, Nick, about
this analogy of with the REIT where you are now sort of in a mode
where you are evaluating and prioritizing among your different assets
and territories, and what I'm wondering is in some of the states
where there's at least some uncertainty as to whether you can get a
decent return on capital in a timely fashion, how do you manage the
process of capital deployment there as it pertains to capital
improvement projects. In other words--
NICHOLAS DEBENEDICTIS: Great question.
RYAN CONNORS: In theory, you would want to invest where you know that
you will get a good return and you have great confidence that can you
do that in a timely fashion and so do you hold back on some of the
more proactive projects in the states where you have concerns about
the regulatory climate?
NICHOLAS DEBENEDICTIS: As of '07, your answer is yes, and that was
one of the issues both with our new computer system and with the
reorganization of rates and spreading the responsibility of trying to
tie your capital spend into what you can recover in rates and putting
that responsibility on the president of that state, IE measuring
ROE's so you don't get too much lag was a major organizational shift
that we made. Dave now has a program that -- we call it The QWAC
Analysis what does that stand for, Dave?
DAVID SMELTZER: Can We Afford the Capital.
NICHOLAS DEBENEDICTIS: Can We Afford the Capital on every system that
has a rate base so that we decide, okay, you want to spend this money
as part of the 250, when will you get the money back and what kind of
rate case will it need, and if it doesn't seem realistic, we cut back
spending.
And so in some of our states for the -- there has been a shift in the
'08 capital budget, although you are seeing the same number, 250,
that we told you about for a couple of yearings, more of it has been
shifted to states where we are ready to go in for rates or states
that has a surcharge program.
RYAN CONNORS: Okay. So when you look at the states where you laid out
and there is going to be a lot of spending, Pensylvannia, New York,
New Jersey, Ohio, those seem to be states where the regulatory
climate is favorable so you are saying that that is not a react to to
some of the issues that you are seeing in the south it is more just
that the improvements have been made in the south and there is not a
lot more to do there.
NICHOLAS DEBENEDICTIS: Both -- because I will tell you the engineers
in the south have plenty of projects for us.
RYAN CONNORS: Right.
NICHOLAS DEBENEDICTIS: I'd say, and not Ohio it is Illinois where
we're putting the -- more money. The south has fixed their immediate
problems where -- whether we can get it back in rates or not, we have
to spend the money, because the environmental agency would have sued
us and service was down and now we're into more the discretionary
phase where we're now saying we'll give you the latest spend if you
can show that you will get quick return and the regulators want you
to do this.
RYAN CONNORS: Okay. That's helpful. Thanks.
NICHOLAS DEBENEDICTIS: Okay.
OPERATOR: And we do have one question remaining it is star 1 for an
initial for follow-up question. Our question is from Ajay Jain with
UBS.
AJAY JAIN, ANALYST, UBS: Hi, good morning. Maybe I'll address my
first question to Dave. Could you just confirm how much cash you have
on hand right now and what the remaining proceeds are on the -- the
forward purchase agreement, how much of that is available for you to
draw down on at this time?
DAVID SMELTZER: Yes. Cash at the end of the year you will see on the
balance sheet when we file today is about $13 million and the funds
restricted from construction activity, which is the undrawn portions
of the tax-free debt that we've issued in the last year or so is
about $77 million.
AJAY JAIN: Okay. So.
DAVID SMELTZER: We expect to bring a large portion of that down
during 2008 as part of our financing.
AJAY JAIN: Okay. So on that basis, and I guess taking into account
your CapEx budget for this year, I mean, do you feel like you may
need to raise any additional equity in 2008? I mean, can you comment
on that at all?
DAVID SMELTZER: Yes, we -- we don't have any new equity planned for
2008, other than the standard equity that we bring in as a matter of
course with our drip program.
AJAY JAIN: Okay.
NICHOLAS DEBENEDICTIS: This is Nick. We may look at all the
alternatives provided under that forward equity provision because you
know that is such a flexible provision. It says that, you know, could
be put to us this August. We don't have any feel that that's the case
but if also gives -- it also gives buy back provisions and everything
else and obviously the value of the stock that UBS is holding in our
account is, what, $23, $22.30 which under the current market
conditions we're in the money, I guess you could call it.
AJAY JAIN: Got it. Okay. And Nick, can you give any more specificity
on some of the drivers behind the revenue deceleration last year in
'07? It looks like sequentially the top line growth decelerated
pretty consistently each quarter and obviously, you know, you've got
the regulatory setback in Florida and you talked about the impact of
housing and erratic weather and I know there are always a lot of
moving parts with the results but are there any major issues based on
what you are seeing in terms of underlying consumption trends?
NICHOLAS DEBENEDICTIS: Yes. The acceleration, you are looking at the
slope of the increase more than the total so let me qualify it that
way. Your acceleration was more in the first half than the second
half because Pennsylvania got their rarity case in June or July or
August I guess it was of '08 -- excuse me, '06. So your first two
quarter comparisons in '07 were huge. 11, 12% on our biggest state.
Add to that New York Water, which was an additional 8%, 7% right off
the bat, New York Water we did a run rate of $23 million in revenues
on a 500 base and there they were heavy in revenues up till the
fourth quarter, so that was one of the reasons for the decelerations
in the fourth quarter.
The third I would argue is that the -- most of the acquisitions that
we did came in very late in the year, so there was really no --
unlike other years where it has been an if he a steady -- you know,
you could average 4%, 2% over the whole year, we didn't have that
advantage in '07. As a matter of fact, we did not get Sea Quest until
probably -- I forget what it was, until mid-year and that was our
biggest one and Mantino was late in the year. It wasn't really as
much comparison-- next year will be a better comparison than that.
AJAY JAIN: Okay. And just in terms of the situation in Florida, you
know, assuming the discussions are back on track, and, Nick, you
mentioned that '09 is your anticipated recovery period, I just wanted
to clarify if there's a retroactive component to that or should we
expect that the writeoff is basically permanent as it relates to '07
and '08.
NICHOLAS DEBENEDICTIS: Very seldom do regulators ever go retroactive.
They call it retroactive rate-picking. We could argue it is fair but
I do not think that you would get it anyhow so I do not think we're
asking for it so I think that that is lost forever.
AJAY JAIN: And just lastly, Nick, I think you mentioned in your
prepared comments you characterized the tax provision as a little bit
of a headwind and that was based to large degree on Sea Cliff maybe I
misinterpreted -- but it looks like the tax rate was actually lower
in '07 and it was materially down year-over-year in the fourth
quarter to 36%. Is there anything I'm missing in terms of the
implications of --
NICHOLAS DEBENEDICTIS: How about the federal tax? Federal tax.
RYAN CONNORS: Yes.
NICHOLAS DEBENEDICTIS: Maybe you'll have to help me with that.
DAVID SMELTZER: Yes. The federal -- federally enacted tax credit for
the exact term escapes me right now, for the production credit, it
was enacted a couple of years ago and at 3%. And it doubled now in
2008. So you'll find that -- the biggest chunk of the reduction in
our effective tax rate is related to the doubling of the federal
production credit.
NICHOLAS DEBENEDICTIS: Okay. That's another cash generation for us.
DAVID SMELTZER: Yes.
RYAN CONNORS: Okay. Thank you very much.
NICHOLAS DEBENEDICTIS: Should go into the cash business, gee.
OPERATOR: Our next question is from Selman Akyol with Stifel
Nicolaus.
SELMAN AKYOL, ANALYST, STIFEL NICOLAUS & CO.: Thank you. A couple of
quick questions, if I may, first of all, in terms of the revenue in
the quarter, how much of that was acquired and then, as well as
O&M, how much of that was--
NICHOLAS DEBENEDICTIS: In the some of the acquisition of the increase
I think was 13% year-over-year. 55% was acquired. Seacliff. New York
Water. Mantino and the other small acquisitions.
SELMAN AKYOL: But that's looking at '07 over '06. I'm just looking at
the quarter.
NICHOLAS DEBENEDICTIS: Oh, for the quarter. I can't -- I'll have it
get back to you on that. Do you have for the quarter?
DAVID SMELTZER: 9%. most of the quarter, and this is what I said
earlier, the rates did in the really help us in the first half of the
year, for the quarter, revenues were 9% or $12.2 million.
NICHOLAS DEBENEDICTIS: 7.6 of that was acquisitions.
SELMAN AKYOL: Okay.
DAVID SMELTZER: The bulk of it was acquisitions.
NICHOLAS DEBENEDICTIS: New York Water and Sea Quest. And then the
other (inaudible) for rates.
SELMAN AKYOL: And when I looked at the O&M line, how much of that
was due to the up positions?
NICHOLAS DEBENEDICTIS: O&M, O&M, O&M.
DAVID SMELTZER: It was $8.7 million. Acquisitions were well over $3
million of that. Insurance was $1.8 million. It (inaudible) that was
the big hit in the fourth quarter. And post retirement benefits were
a million, which was the one I mentioned, we'll get it back in rates
in year end throughout.
SELMAN AKYOL: Got it. And then just one other question, you had North
Carolina and Florida still to file, I guess, and that's part of the
$67 million total. Can you break those two out?
NICHOLAS DEBENEDICTIS: North Carolina and Florida are not part of the
$67million.
SELMAN AKYOL: Okay.
NICHOLAS DEBENEDICTIS: They are in addition. And I'm going to say
that Florida just from our last filing you can judge that it is a
year later and we've put more capital in, expenses went up. We felt
we justified seven million last time so that would be the floor. And
on the North Carolina, I just don't have a number but I think it's
high single digits, because it is a bigger state and we haven't been
in for a number of years. And we put a lot of capital into North
Carolina so you figure seven, eight, nine million dollars.
SELMAN AKYOL: I got you. Do have you a number for Ohio?
NICHOLAS DEBENEDICTIS: Yes, Ohio will be -- we're negotiating -- we
already got one rate increase in the first quarter, that was 400,000.
We have the Lake county rate increase which is part of the $67
million, Dave, what's that? $2.5million?
DAVID SMELTZER: Three.
NICHOLAS DEBENEDICTIS: Three million and that's in final stages of
negotiation now that hearing is-- matter of fact, the hearing was
last night. And the other one is -- is stark division, which we
locally negotiate. And that's probably about half a million to three
quarters of a million.
SELMAN AKYOL: So in total approximately approximately $4 million for
Ohio?
NICHOLAS DEBENEDICTIS: Yes.
SELMAN AKYOL: Okay. Thanks so much.
OPERATOR: And our final question will come from [Vishal Catrowall]
with Stanford Group.
VISHAL CATROWALL, ANALYST, STANFORD GROUP: Nick and Dave, how are you
doing?
NICHOLAS DEBENEDICTIS: Hi, how are you Vishal?
VISHAL CATROWALL: Doing good. Just a quick question about the Fort
Wayne system, the litigation, they are offering $16.9 million, Nick,
what is the fair value according to you?
NICHOLAS DEBENEDICTIS: What is a fair value of Fort Wayne? I think
because of the litigation I -- the lawyers told me I'm only allowed
to say -- I apologize, but I'm only allowed to say that it is more
than our book value. You see, we're going to be negotiating in court.
VISHAL CATROWALL: Okay. And again the difference between book value
and what you get, you know, after the litigation, will that hit the
O&M line just like the -- systems or will that be a separate line
item?
DAVID SMELTZER: You would expect -- Vishal that any gains in the end
of the Fort Wayne negotiations might be more significant than those
gains which were realized in the past and, if so, we'd likely have a
separate line in the operating section to break that out. The gains
historically have been somewhat immaterial and that's why they've
been included in the O&M line.
VISHAL CATROWALL: Okay. That helps a lot. Thanks.
OPERATOR: With that the -- I would like to turn the call back over to
management for closing comments.
NICHOLAS DEBENEDICTIS: Okay. I think that the turning program and all
of the questions we've gotten we'll clarify more individually about
you but it will be part of our ongoing story, generating cash and
equity for the Company which means less knead for new stock sales,
which should be less diluted in the sense of what's happened in the
past and I think we'll try and clarify it on the accounting as Dave
just mentioned so it's very clear as to what we bring in but I
consider it absolutely as part of our ongoing business model now as
to how we're going to achieve our goal of 4-7-10-5. So I appreciate
all your time it was kind of granular but I thought it was an
important one since it was a year end call. Thank you.
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