Essential Utilities, Inc. (WTRG) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. And welcome to the Essential Utilities Virtual Annual Shareholder Meeting. At this time, the meeting will begin and it is my pleasure to turn the floor over to your host, Chris Franklin. Sir, the floor is yours.

Thank you, Paul, and good morning. Welcome to the Annual Shareholder Meeting of Essential Utilities, formerly Aqua America. Thank you for joining us today. Last year, you may recall that we held this meeting in Richmond, Virginia. And this year, we were planning to hold the meeting in Pittsburgh, Pennsylvania at the headquarters of Peoples Natural Gas, which we acquired in March of this year. But due to the COVID-19 pandemic, we've shifted this meeting to be completely virtual so that shareholders can safely attend the annual meeting. I hope you find the virtual experience to be useful, and I appreciate your participation. You may recall that we announced the acquisition of Peoples back in October of 2018. We spent much of 2019 working on regulatory approvals and integration. And in January of 2020, we received our final regulatory approval. And then in February, we changed the company's publicly traded name from Aqua America to Essential Utilities to better reflect the structure of the company, which now includes both regulated water and natural gas, of course. I'll discuss this a little bit more in my company update remarks in a few moments. Now a couple of administrative issues before we begin. I will remind you that today's meeting is being recorded and will be available on our website. Copies of the meeting minutes from our 2019 Annual Shareholder Meeting are available in the virtual meeting program. I will conduct the formal business portion of the meeting. And after the formal business is adjourned, I'll review the results from 2019 and discuss our corporate strategy. [Operator Instructions] All right. Now in accordance with the company's bylaws, the notice of today's meeting and Internet availability of the proxy and materials were mailed on March 27, 2020, by Broadridge Corporation to all shareholders of record as of March 9, 2020. This date was fixed by the Board of Directors as the record date for shareholders entitled to vote at this meeting. This will be included in the records of today's meeting. A copy of the shareholders entitled to vote at today's meeting is available for review. Mr. Peter Descovich, who has been appointed judge of elections, has taken his oath of office. Mr. Descovich has confirmed that 82.69% of the 223,307,879 shares of common stock outstanding on the record date are entitled to be voted at the meeting are present, either in person or by proxy. Therefore, a quorum is present, and the meeting will now come to order. I will act as Chairman of the meeting. And Christopher Luning, Essential's General Counsel and Corporate Secretary, will act as secretary of the meeting. Outlined in the proxy are 5 proposals to be voted on by shareholders this morning. The first proposal is the election of 9 directors to serve until the 2021 annual meeting of shareholders and until their successors have been duly elected and qualified. As set forth in the proxy statement, the following nominees have been proposed for election: Elizabeth Amato, Nicholas DeBenedictis, Wendy Franks, Daniel Hilferty, Francis Idehen, Ellen Ruff, Lee Stewart, Christopher Womack and me, Christopher Franklin. The directors' backgrounds and qualifications are explained in the proxy. I will introduce each of the candidates later in the meeting. The second proposal is the ratification of the appointment by the Audit Committee of Board of Directors of PricewaterhouseCoopers, LLP as the independent registered public accounting firm for the company for the fiscal year 2020. The Board recommends approval of this proposal. And the third proposal is the approval on an advisory basis of the company's executive compensation for 2019 as disclosed in the proxy statement. The compensation program you are voting on was updated for 2020 based on feedback from many of our shareholders. The Board recommends approval of this proposal. The fourth proposal is the approval of the amendment to the articles of incorporation to adopt a majority voting standard in uncontested director elections. The Board recommends approval of this proposal. And the fifth and final proposal is the approval of an amendment to the articles of incorporation to increase the number of authorized shares of common stock. The Board also recommends approval of this proposal. These 5 proposals are the only matters to be voted on by the shareholders at this meeting. Before declaring the polls open for balloting on these matters, we'll take a moment to respond to any submitted questions or comments specifically concerning these 5 proposals. Mr. Luning, the Corporate Secretary, indicates that there are no relevant questions to answer at this time. I now declare the polls open for voting on these proposals. If you have already voted by proxy and do not wish to change your vote, your vote will be cast as previously instructed and no further action is required. To submit your vote or change your vote previously filed, please click the Vote Here button toward the bottom, right-hand side of the screen. Please follow the instructions for the proxy ballot that will pop up and appear in the upper, right-hand side of the screen. [Voting]

Now while we wait for the votes to be tabulated, let me introduce you to the candidates for the Board of Directors. Elizabeth Amato recently retired from United Technologies, UTC, where she most recently held the position of Executive Vice President and Chief Human Resources Officer. She joined UTC at Pratt & Whitney in 1985 and has held a variety of the most senior human resources leadership positions across the corporation. She's a member of the Corporate Governance and Executive Compensation committees. Nicholas DeBenedictis is Chairman Emeritus of the Board, having retired as CEO of the company in 2015 and as nonexecutive Chairman of the Board in 2017. Mr. DeBenedictis was CEO from 1992 until 2015 and Chairman of the Board from 1993 to 2017. He currently chairs our Risk Mitigation and Investment Policy committee. Wendy Franks has served as a senior principal of the Canada Pension Plan Investment Board, CPPIB, since 2012. She joined the Board -- the Essential Board as a nominee by the CPPIB, who invested $750 million in the company in a private placement transaction associated with our purchase of Peoples. She's a member of the Audit and Risk Mitigation committees. Daniel Hilferty has served as President and Chief Executive Officer of Independence Health Group, one of the nation's leading health insurers since 2010. He became a director in 2017 and is our lead independent director. He is also a member of the Executive Committee and Executive Compensation committee and presently chairs the Corporate Governance committee. Francis Idehen is Chief Operating Officer of GCM Grosvenor, an independent alternative asset management firm. He's been in the position since May of 2017. Prior to this, he held senior roles with Exelon Corporation. He's a member of the Audit and Risk Mitigation committees. Ellen Ruff is former President of Duke Energy, Ms. Ruff has served as a Board member since 2006. She's a member of the Executive Committee and the Corporate Governance committee and presently chairs the Executive Compensation committee. Mr. Lee Stewart is a private financial consultant with over 25 years of experience as an investment banker. He was CFO of Foamex International and Vice President at Union Carbide Corporation. Mr. Stewart has served as a Director of numerous public companies, including ITC, AEP Industries and Momentive Performance Materials. He presently chairs the Audit committee and is a member of the Risk and Investment Policy committee. Christopher Womack has served as President, External Affairs at Southern Company since 2008. He worked in various executive leadership positions at Southern Company since 1988. From 1979 to 1987, he served as a legislative aide in the U.S. House of representatives. Mr. Womack is a member of the Corporate Governance and Executive Compensation committees. And finally, for reelection to the Board, I am Christopher Franklin, Chairman of the Board, Chief Executive Officer and a member of the Risk Mitigation and Investment Policy committee and chair of the Executive Committee. Now if you want additional information on any of the Board members, please refer to the Board of Directors web page on the Corporate Governance section of the Investors page on our website. And that concludes the presentation of the items of business that you've been asked to vote on at today's meeting. At this point, the polls are now closed. I ask for a report of voting results as received from the judge of elections. I now ask Mr. Christopher Luning, as Corporate Secretary, to report those results.

Thank you, Mr. Chairman. I received the preliminary voting results from the judge of election based on the proxies received as of the opening of the polls of today's meeting. Preliminary votes are as follows. For proposal number one, each of the 9 nominees listed in the proxy statement has received at least 94% of the votes cast in their favor of the election with an average vote of 98.35%, and therefore, have been elected to a 1-year term expiring at the annual meeting in 2021. For proposal #2, the Board proposed to ratify the appointment of PricewaterhouseCoopers, LLP and as the independent registered public accountants for the 2020 fiscal year, and that has been adopted with at least 97% of the votes cast in favor. For proposal #3, the Board proposal for an advisory vote approving the company's named executive officers' compensation, that has been approved with at least 95% of the votes cast in its favor. For Proposal #4, the Board proposal for an amendment to the articles of incorporation to establish a majority voting standard in uncontested director elections has been adopted with at least 98% of the votes cast in its favor. And finally, for proposal #5, the Board proposal for an amendment to the articles of incorporation to increase the number of authorized shares of common stock from 300 million to 600 million has been adopted with at least 94% of the votes cast in its favor. All votes are subject to final count certification by the judge of election. We will report the final vote results in the Form 8-K filed with the SEC within 4 business days from today's meeting. Thank you, Mr. Chairman.

Thank you, Mr. Luning. Is there any other business to properly come before the Board today? If not, I'll adjourn the formal part of today's meeting. Now that the formal part of the meeting is adjourned, I'll provide an update on the corporation. If you refer to the slides, the first slide is our forward-looking statement. I direct you to the SEC filings for factors that can cause actual results to differ from expectations. I also want to highlight that some of the information that we present today is non-GAAP financial information. This presentation and the reconciliations to GAAP are on our website, essential.co. All right. Let's start with the primary topic on everybody's mind right now, our response to the COVID-19 pandemic. And let me start by thanking the employees of Essential for their loyalty and the dedication they've shown to the company's critical mission of providing safe water, wastewater and natural gas service to our 1.7 million customers across the 10 states. The employees have just done an unbelievable job keeping service through this difficult time. In mid-March, we activated our business continuity plan, which included nearly 1/3 of our employees would work from their homes. We also implemented social distancing and alterations to cleaning policies, work processes and construction activities. We did all of this with the goal of keeping our employees and our customers safe and in service. You might imagine how difficult this decision could be to send people home, but considering the fact that we closed a $4.3 billion transaction with Peoples Natural Gas on March 16, it was even more difficult to ask our new colleagues to work from home beginning the same day we closed the transaction. Now I'll say in hindsight, it was the right decision. Only 4 of our employees have tested positive for the virus, and 3 are back safely at work already. I have to tell you that there is a silver lining to the closing of a transaction in the middle of a pandemic. The Aqua and Peoples management teams were immediately forced to work closely together in crisis mode. I am incredibly proud and energized by what I've witnessed. The management teams have come together and performed with excellence. I couldn't be more pleased. This COVID crisis has accelerated the development of relationships between the 2 organizations and we are truly stronger for it. Now like most companies, we're weighing our options and potential approaches to bringing our employees back to the office. We'll continue to follow guidance from the government and have developed a detailed plan at this point and it's almost ready to be rolled out. We continue to enhance communications with employees, customers and regulators to ensure all of our shareholders and stakeholders have the most current information. Now like most American companies, out of abundance of caution and because of the uncertainty of the credit markets in March, we took a term loan out for $500 million and put the cash on the company's balance sheet. Since that time though, the credit markets have relaxed, and we went into the public debt market and sold 1.1 billion in long-term notes at favorable rates and paid down our lines of credit. At this point, we feel very comfortable with our current financial position. Now with a secure balance sheet, we anticipate staying on track to complete our nearly $1 billion annual capital budget. This is important for both our customers and our shareholders. Finally, recognizing that we're part of the fabric of the communities where we serve, we recently made a $300,000 donation to food banks across our footprint in the 10 states. We'll continue to provide funding like this from our foundation as part of an important safety net for individuals and charitable organizations that are having a difficult time through the COVID-19 crisis. Now with that, I'd like to provide a quick summary of 2019. We had an especially strong year last year. First, we installed a record amount of infrastructure, over $500 million to improve and enhance the service for our customers. We don't always take the time to recognize that. But this is a massive effort in order to invest this level of capital in that period of time. Second, we met financial expectations that we laid out for the year, coming in right in the center of our guidance range at $1.47 non-GAAP. Third, we completed 5 municipal transactions, signed 3 more, including DELCORA, which is the largest municipal transaction in our history at $276 million. In addition, we secured fair market value legislation in Ohio and Texas and, even just recently, in Virginia. Fourth, and most obvious, we continued our path to closing the Peoples transaction. While it took longer than we had hoped, we are proud to have completed this important transaction. Related to this, we developed comprehensive integration plans, came up with a new name to rebrand the publicly traded company and worked through regulatory approvals in all 3 states. Now we achieved all of these accomplishments while continuing our operational excellence in providing service to our customers every day. I continue to be amazed at what our people accomplish, and I'm proud to lead this company and believe our company has a very bright future. On the growth in income-per-share slide, you'll see the steady increase in our income per share since 2014. In February this year, we rolled out our guidance for 2020 of non-GAAP adjusted earnings per share of $1.53 to $1.58, a range of 5% to 7% growth in earnings per share, which is strong growth for a regulated utility. Now assuming we achieve the center of the guidance range at 6% earnings growth, plus the current dividend yield of just over 2%, our total shareholder return profile is 8%, which I think you'll agree is pretty strong for a regulated utility. The adjusted earnings per share for 2020 is meant to provide an illustration of the earnings power of the new combined company for a full year. Now let's discuss the dividend trend over this same period of time. In 2019, we increased the dividend by 7%. We've increased the dividend 29 times in 28 years. And as of March 1, we have a 75-year history of paying quarterly cash dividends, and we know how important this has been to our long-term shareholders. On this next slide, you can see the acquisitions that we closed in 2019 and already in 2020. If you look back over the last couple of years, you'd notice that we've been approaching a run rate of about $100 million in annual rate base growth through these acquisitions. Sometimes the regulatory process takes longer than expected, and this happened with 2 of our deals this year valued over $50 million in rate base that we originally expected to close in 2019, but now slipped into 2020. We'll discuss this more on the next slide here. I would note that we have completed nearly 400 acquisitions of water and wastewater systems, both private and municipals in the last 25 years. Starting in 2016, we really refocused our efforts on municipal acquisitions as opposed to smaller private systems. This shift in focus has provided more sizable opportunities for us. So since 2015, we've closed 57 transactions, many of them municipal, adding nearly 48,000 connections and approximately $237 million in new rate base. While municipal acquisitions, such as the ones shown on this slide, are great long-term investments, it's important to point out that when we initially closed the acquisition, we assume the operating expenses of the utility but often have to file with regulators to achieve the associated revenue to achieve full earnings, and this process can sometimes take a couple of years. And finally, with this level of municipal acquisitions and organic growth, we continue to think that 2% to 3% customer growth is a realistic annual target for our Water and Wastewater business going forward. On this next slide, you can see the acquisitions where we have currently signed agreements in place but not yet closed. New Garden and East Norriton are expected to close in 2020. We continue working diligently to move these through the regulatory process. DELCORA, which may close late this year or maybe early in 2021, is the largest municipal deal we've ever signed. As I said, we paid $276 million for DELCORA, which is a wastewater authority serving the equivalent of 198,000 customers in Southeastern Pennsylvania. Once these deals are closed, we will add over 205,000 customer equivalents and nearly $330 million in a rate base. I want to take a moment to -- on the company's newest platform: Peoples Natural Gas. For those who maybe haven't followed it as closely, I think it's important to outline our rationale for the Peoples transaction. To be clear, we were not looking to buy just any natural gas utility. The Board was very clear on what we were looking for. We were looking for a natural gas distribution company, LDC, right, that was not complicated with other lines of business, that was in a constructive regulatory state and that did not participate in exploration or fracking and that had a strong set of growth opportunities. When we found Peoples, we found a company that is 99% regulated, operates primarily in the constructive state of Pennsylvania, sits on top of the Marcellus shale region, had 3,000 miles of pipe that needed to be replaced and that does not have an exploration business. Furthermore, the LDC business has a lot of similarities to the Water business, not the least of which, we're both underground pipe companies. For these reasons, along with the fact that Peoples came with a strong management team, we believe that Peoples was and, frankly, still is, a great opportunity. And by the way, the significant pipe replacement program that will bring long-term reliability and safety of customers, improved environmental benefits by reducing methane emissions from leaks and will give us highly visible rate base growth for the next 15-plus years. This is truly a win for all of our stakeholders. On this next slide, we're looking at the combined utility profile after the acquisition. You can see that we have combined the second largest stand-alone regulated water utility in the United States with the fifth largest stand-alone regulated gas LDC in the United States. This unique water-gas combination now has operations in 10 states with over $7.3 billion in rate base. More than 75% of the rate base is based in Pennsylvania, and the overall mix is approximately 70% water, 30% gas. And as we continue to see more significant opportunities in Water, like DELCORA, that 70-30 mix would lean more -- even more heavily toward Water. We will continue to look at opportunities to expand our regulated operations in all 10 states where we operate. With that, let's take a quick look back at the growth strategy we unveiled back in January of 2016. The format on this slide may look a little different than what we showed before in 2016, but it's the same strategy we introduced when I became CEO. Our growth strategy is rooted in those core competencies that we have consistently demonstrated. These same core competencies will remain critical to our operational execution in the coming years. Let's talk about what our focused strategy has yielded already. On the first prong of the growth strategy, which is municipal acquisitions, we've seen more progress on municipal deals than I think anyone expected. In fact, we have added over $520 million in new rate base, if you add the transactions we have announced or closed since January of 2016. That progress includes the agreement that we signed last fall with DELCORA that I mentioned. On the second prong, which is strategic M&A, I think I've said it already, we've identified a unique strategic opportunity in Peoples, which presents us with the ability to have a second platform for growth in a state we know well with significant organic growth, replacing a large amount of miles of the gas main, and its customer base sits right on top of the Marcellus shale formation. And lastly, while the strategy slide may not illustrate it well, we really deemphasized our nonregulated, or what we call market-based business activities. You'll recall that we exited many of these market-based activities when I became CEO. We really shifted our focus almost entirely on the regulated business opportunities and only keeping the Royalty Insurance line business and some existing contracts to operate local systems. Looking forward, I really don't see a change or a shift in this strategy. As you listen to our presentation today, I hope you'll walk away with the same level of confidence that we have in our team's ability to continue to execute our already successful growth strategy. Take a look at our 2020 objectives. I think they're pretty straightforward: integration, growth, operational excellence, all accomplished with a strong ESG approach. Our top priority has always been operational excellence. This is sometimes taken for granted by those outside the company, but this is listed as one of our core values at the company. It's an exciting time to be in the Water business, and we will continue to be industry leaders. And while doing all of this, we will invest nearly $1 billion a year in necessary infrastructure improvements. Second, 2020's going to be the year of integration. We are integrating 2 nearly equally sized organizations in Aqua and Peoples and while we're preparing to onboard DELCORA right on the heels, along with its large customer base. And third, since I became CEO, we have focused on growth. This will not change. Our municipal pipeline is robust, and while we'll likely not do something the size of Peoples every year, we will continue to pursue strategic acquisitions when they make sense. Now all 3 of these key objectives will be accomplished while we deploy a very strong ESG. Let me define ESG: environmental, social and governance. We'll deploy very strong ESG fundamentals while we accomplish all of these things. We've been building our ESG program for several years now. In 2019, we completed the CDP survey. And that was the second time we did that survey and increased our grade from a C to a B-, which I have to say is a significant accomplishment for a newcomer like us. We spent portions of 3 of our corporate Essential Board meetings on how we think about each of the E, the S and the G. The results of this you can see on the tearsheets we published this week on our website. Now as we enter the world of fossil fuel with the purchase of Peoples Natural Gas, we remain focused on a reduction of the company's carbon footprint. In this regard, we announced in February that we entered into a contract to significantly reduce our carbon footprint. In fact, our New Jersey, Pennsylvania, Ohio and Illinois subsidiaries will all be purchasing 100% renewable power by 2022. This put our water utility in alignment with the Paris Accord and will allow us to make a significant contribution toward the environment. At Essential, we will do our part to limit long-term global temperature rise to less than 1.5-degree Celsius, which is an aggressive goal for our company. We're going to achieve this while simultaneously lowering our overall cost of energy in those states. We're very proud of that. These commitments to renewable energy reduce Aqua's overall absolute greenhouse gas emissions by nearly 60% from our 2018 baseline. We really want to set the standard for the industry to follow by making this important move. Additionally, now that we closed Peoples, we now have begun to ramp up the capital program at the gas utility, which will be significant in reducing methane emissions by tightening up the natural gas grid. In February, we made one additional ESG announcement. You're likely all familiar with the family of PFAS chemicals at this point. In fact, the recent movie, Dark Waters, is centered around this contaminant that they call the "forever chemical" because it's very difficult to break down. Today, the federal government has not regulated this contaminant other than to set a health advisory level at 70 parts per trillion for PFOA and PFAS. As a result of the federal government in action, many states are adopting their own standards, and they vary significantly. Most people hadn't heard of PFAS before just a few years ago, but now it's a pretty regular topic in the news. Earlier this year, we announced that we will provide water in all of our states that meets 1 standard level, which is far more protective than the federal health advisory level and even CDC recommendations and builds on the scientific health-based standards developed in New Jersey. Beginning this year, Aqua will begin the process to install mitigation at all sites that exceed 13 parts per trillion of PFAS, PFOA or PFNA, individually. We anticipate spending approximately $25 million across our platform to accomplish this. This is a major step in addressing PFAS. But we will be continuously evaluating if further action is needed as additional science becomes available on these chemicals. We plan to work closely with our environmental and our economic regulators to address this important issue. Now to the best of our knowledge, Aqua is the only water supplier in the country that intends to install treatment for these chemicals in our systems without having an exceedance of the EPA health advisory to prompt actions. I hope that you'll agree that this is a bold but prudent step to protect the public health by investing in appropriate utility assets to address these contaminants. Now with that, I'd like to close my formal comments with a review of our 2020 guidance. On earnings per share, the 5% to 7% compound annual growth rate shows the power of the strong platform that we have built. This does not include municipal M&A, which in the short term can sometimes hurt the earnings growth before we get new acquisitions into a rate case. We expect to continue providing an EPS range each year and would like to continue to provide a 3-year look, but we will always be respectful of our regulators and ongoing rate activity. On our capital program, the operations team has a lot of work ahead of them. We will be investing nearly $1 billion annually across the Essential platform, primarily on pipe replacement, both gas and water and plant upgrades. This core organic growth provides a strong baseline for future performance. Our rate-base growth of 6% to 7% for Water and 8% to 10% for Gas means a total company rate base growth in the range of 8%. This doesn't include future municipal opportunities. It does not include future municipal opportunities. Over the long run, we would expect to see rate base and earnings growth to be more closely aligned. From year-to-year, there's sometimes a bit of a disconnect due to timing of acquisitions, equity issuances, periods of over- or under-earning and maybe some onetime items. But long term, there's nothing structural that would keep earnings per share and rate base growth from having nice alignment. And lastly, we expect annual customer growth in Water to be between 2% and 3% on average. And with that, I will open up the floor for questions.

[Operator Instructions] We'll review the questions and answers as many of those that time permits.

Chris, we do have a couple of questions. The first one is about municipal opportunities. DELCORA sounds like a great opportunity for the company, but I wonder how many other possibilities are there like that out there.

Yes, DELCORA is a large one, or largest one that I've mentioned, and we believe that there are others. What we don't know is the outcome -- the outcome of the COVID-19 crisis will force other municipals, maybe even of larger size, to consider a sale or transfer of assets to a utility like ours. But the short answer is yes, there are larger opportunities out there. We've seen the opportunities continue to climb in size over the last couple of years. And as a matter of fact, there are discussions happening even today on some fairly sizable municipal acquisitions in the platform.

Chris, additional question. You now have fair market value legislation in all states that you operate in. What do you think is next from a regulatory or legislative perspective?

Yes, that's a good question, too. As we think about legislation in the market, Water Quality Accountability Act, which was passed in New Jersey, is probably the next logical piece of legislation to begin to pass. We hired a really top team at the National Association of Water Companies, NAWC, the industry group, and they're largely leading this work. But the Water Quality Accountability Act forces municipals to provide service and metrics on operations at a similar level as utilities that are regulated by the public utility commissions. So that bottom line is a very positive for the customers of all utilities to be able to receive service at the same level across the country. I think that's probably the next level of -- and we probably will start in states like Pennsylvania, where we have some of the largest concentrations of our customers.

And Chris, maybe time for one last question that came in here. You spoke a bit about strategy, but how do you think of where you'll see the company in the next 5 years?

Good question. A lot of people ask us what does the Water and Gas mix look like in the coming years. And I think as municipal opportunities continue to mount, I believe there's a tremendous opportunity in the Water and Wastewater business to grow and be a solution really for municipals. So I don't see a large shift in the mix. We like a 70-30 mix. As I mentioned in the formal remarks, that 70-30 mix is even shifting more toward Water with larger municipal transactions. And so we will look at Gas transactions across the country and evaluate them as they become available. But it appears at this point that over the next, call it, 3 to 5 years, the larger opportunity is probably in Water for acquisitions. And then in the Peoples Natural Gas, we'll focus largely on their capital program, as we said, growing their rate base significantly from 8% to 10% annually.

I think that's all the time we have for questions today.

Great. Great. Well, thank you for joining us this morning. And as always, we stand ready to answer your questions. More information, of course, exists on our website, if you need. Thank you very much.

Thank you, ladies and gentlemen. This does conclude today's shareholder meeting. Thank you for your participation. And have a wonderful day.