Essential Utilities, Inc. Q2 FY2025 Earnings Call

Ladies and gentlemen, thank you for standing by. My name is Desiree, and I will be your conference operator today. At this time, I would like to welcome everyone to the Essential Q2 2025 Earnings Conference Call. I would now like to turn the conference over to Brian Dingerdissen. You may begin.

Thank you. Good morning, everyone, and thank you for joining us for the second quarter 2025 earnings call. If you did not receive a copy of the press release, you can find it by visiting our website. The slides are also found on the website. 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 10-Q, 10-K and other SEC filings for a description of such risks and uncertainties. During the course of this call, references may be made to certain non-GAAP financial measures. Reconciliation of any non-GAAP to GAAP financial measures is posted on our website. We will begin the call with Chris Franklin, our Chairman and CEO, who will provide an update on the company. Then Colleen Arnold, the President of our Aqua business will provide an update on the Water business; Dan Schuller, our Chief Financial Officer, will then provide an overview of the financial results before Chris closes the call and opens it up for questions. With that, I will turn the call over to Chris Franklin.

Thanks, Brian, and good morning, everyone. Let's just jump right in on Slide 5 there with some highlights from the quarter. We delivered another strong quarter, reporting GAAP earnings per share of $0.38. That's a 35% increase over the same quarter last year. Both our Water and Gas businesses performed very well and in line with our expectations. And simply put, both divisions are firing on all cylinders. Our gas business continued its impressive trajectory with net income for the quarter of $17.5 million. I'm not going to steal any thunder from Colleen. She is going to share a little bit more about the Water business in a few minutes. But as you come to expect, we are executing nearly flawlessly in both our Water and our Natural Gas segments. Based on our strong year-to-date performance, we expect to achieve GAAP earnings per share above our guidance range of $2.07 to $2.11, largely due to several nonrecurring benefits. We're also reaffirming our capital investment plans with a target of approximately $1.4 billion in infrastructure investment for 2025. As of June 30, we've already deployed $613 million in critical infrastructure improvements across our footprint. Now let me take a moment to highlight some exciting developments happening in our home state of Pennsylvania. Earlier this month, we participated in the Pennsylvania Energy and Innovation Summit, which was hosted by our new United States Senator, Dave McCormick. Energy leaders from around the country gathered to share thoughts and breakthroughs in energy and technology. Our Gas division President, Mike Huwar, showcased our ongoing hydrogen pilot project. This is a cutting-edge technology developed in partnership with H Quest and the University of Pittsburgh. The comparatively low price of energy in Pennsylvania makes it a logical choice for hyperscalers looking to locate data centers, and we continue to have active discussions with some of those hyperscalers as we speak. Now moving from Pennsylvania to Texas, we serve customers in the Kerrville area of Texas. You'll recall the terrible flood that took place just several weeks ago. Fortunately, all of our employees and their families made it through the storm. One of our employees and his family had 9 feet of water in their home and had some absolutely harrowing moments. But thankfully, they are healing from their injuries and working to reestablish their home. During the height of the event, we had some customer outages, but restored service to most customers within 24 hours and all customers within 48 hours, which was a really exemplary job done by our Texas team. Speaking of employees, last month we wrapped up our most recent employee engagement survey under the theme 'Better Together.' I know employee engagement is becoming a common topic for investors. Our results reflected the impact of our focused efforts to enhance our work environment. In fact, participation in the survey increased 23%, which was fantastic. Satisfaction scores rose by 6%, and on average, survey scores improved by 7 points. These results reflect our continued focus on creating an engaging, inclusive, and supportive workplace. Each year, we take great pride in reminding shareholders that for more than 30 years in a row, we've increased our dividend. As an expression of continued confidence, yesterday the Board of Directors approved a 5.25% increase in the dividend. We remain committed to delivering long-term shareholder value through dividends and share price appreciation. So let's take a look at Slide 6. I want to touch on a couple of community engagement issues. In April, we successfully concluded our fourth annual Essential Earth Day. This is a 30-day campaign dedicated to environmental stewardship and community engagement. The slide showcases our efforts in recent years, which include volunteer events, environmental programs, and a significant investment from our Essential Foundation. In recognition of our community engagement and leadership, we were recently honored as one of Greater Philadelphia's most community-minded businesses. This recognition is something we really appreciate and take to heart. Modeled after the Points of Light national program, the award recognizes companies that set the standard for civic engagement through the use of their time, talent, and resources. This commitment to community engagement is something we do in all of our states where we have businesses. Finally, on a personal note, I am thrilled and honored to be named the Chairman-elect of the Philadelphia Chamber of Commerce. I look forward to partnering with leaders from around the region to promote economic growth and regional priorities, which hopefully end up with more utility customers. Moving to Slide 7, let's talk about shareholder value. We continue to deliver steady, reliable growth in earnings and in dividends. 2025 is shaping up to be another strong year, with core earnings per share expected to grow between 5% and 7%. Most of this growth is driven by investments in Water and Natural Gas infrastructure. Notably, since we started providing annual guidance back in 2016, we have consistently met or exceeded market expectations. This consistency has enabled strong dividend growth, underpinned by the outstanding execution of our operations team and their commitment to the communities we serve. I continue to be impressed by what our team has achieved, and I'm honored to continue being a steward of this great company with its 140-year history. Today, I want to continue the tradition of spotlighting our business segment leaders. Last quarter, you heard from Mike Huwar, President of our Natural Gas division. Today, we welcome Colleen Arnold, President of our Water Division, who will share some thoughts on our Water business. Colleen?

Thanks, Chris. I'm happy to be here today and especially appreciate the opportunity to highlight the important work that the team at Aqua is doing. As a reminder for our investors, Aqua, as Chris just mentioned, has a strong 140-year history and has grown from a small water company in suburban Philadelphia to serving more than 1 million customers with over $7 billion of rate base in eight states. Notably, as shown on Slide 9, we are expecting annual rate base growth of 6% through 2029, not including acquisitions. The need for infrastructure investment has never been greater, with the EPA estimating a $1 trillion need in water and wastewater infrastructure, that growth rate could easily grow with acquisitions. I've worked in the water industry for over 30 years, including as a consultant for municipalities and for a large city itself. Given the increasing complexity of PFAS, cybersecurity, wastewater, and declining funding, the conditions have never been more opportune. Highlighting our operational excellence on Slide 10, our O&M efficiency performs in the top quartile and has done so for over a decade. We take pride in ensuring that we are spending our customers' dollars efficiently. Importantly, this is not at the expense of safe, reliable service. The top right-hand side chart shows that we outperform water systems nationally with 5 to 9 times fewer health-based and aesthetic violations. The bottom chart also shows our strong safety record, with top quartile performance with respect to severe safety incidents. As we move to Slide 11, we are tremendously proud of our industry-leading PFAS commitment. We have been working on this for our customers since 2016, well before the EPA and state NCLs, because it was the right thing to do for our customers. Our laboratory in Pennsylvania was one of the first certified, and we proactively sampled all of our sources, enabling us to be where we are today. At this point, we have over 50 of our 300-plus sites mitigated and approximately another 50 under construction. This level of execution was made possible by the ingenuity of our engineering team, who designed a proprietary modular system with applicability for groundwater systems. We've recently signed a distribution agreement with ChartWater to sell this patent-pending solution called PFAS Guard to community water systems, generating a lot of interest. While we expect increased regulation to enhance acquisition opportunities, municipal systems, speaking from my experience, are slow to meet regulatory requirements, and many are just beginning to do the initial monitoring for PFAS now. The extension of regulatory deadlines may enable them to delay longer. However, we remain optimistic that as the monitoring results come in, with our strong leadership, proven track record, and partnerships, this will be a strong avenue for acquisition growth. Additionally, I wanted to highlight Aqua Texas, where we have grown by nearly 25,000 connections to over 100,000 connections over the last 10 years and currently have another 90,000 under contract or negotiation. This aligns with the impressive growth the state has seen, with a 16% population increase and corresponding 30% GDP growth. Our three core operational areas outside of Spring, Austin, and Fort Worth, Texas grew from 20% to 40%, most notably, Austin Metro, our area of highest developer growth, grew 40%. Based on customer growth and infrastructure needs, we expect to nearly double rebate to $1.1 billion in Texas by year-end 2029. It's a good time to mention that we recently led with the Texas Association of Water Companies the passage of future test year legislation. This will enable us to recover that capital investment and minimize regulatory lag. I would like to thank our amazing employees who made that possible. We are excited for our future in Texas. With that, I will turn it to Dan for a review of the financials.

Thanks, Colleen. Let's begin on Slide 15 with a high-level view of the first quarter results, and then we'll get into the details on the waterfall. Our quarterly performance was strong, with revenues up 18.5%, due primarily to favorable rate case outcomes in Pennsylvania, both for our gas and water subsidiaries, higher purchased gas costs, and increased gas volumes. Corresponding earnings per share are up 35.7% on a year-over-year basis due to those drivers, partially offset by higher O&M, depreciation, interest, and taxes. On Slide 16, we have the revenue waterfall for the first quarter. Revenues increased $80.5 million from $434.4 million a year ago to $514.9 million this year. Approximately $44 million of that increase is a result of rates and surcharges, with $31 million attributed to water and $13 million from natural gas. Purchased gas, representing the cost of gas sold by the company, increased $23 million year-over-year due to an increase in gas commodity prices and higher natural gas usage. The other category of $9.8 million includes $4.6 million in weather normalization and $4.1 million in reduced tax credits to customers as a result of last year's Peoples' rate order. Increased gas volumes provided $4.3 million in increased revenue, while growth in the water business contributed $2.1 million. These were offset by $2.6 million from lower water volumes due to wet weather, which saw decreased consumption in several of our states. Next, on Slide 17, our O&M slide. O&M expenses were up about $6 million or 4.2% year-over-year. The main drivers include an increase in employee-related costs of $6.1 million compared to the prior period, an increase in bad debt expense of $2.2 million, and increases in legal expenses, partially offset by favorability in other expenses, primarily as a result of capitalization. The increase in employee-related costs includes about $650,000 of increased insurance reserves as we moved the Peoples employees from a fully insured health plan to a self-insured health plan. If we normalize out the growth, the universal services rider increase, and the higher-than-normal employee expenses, such as the insurance reserve, we get to a year-over-year increase of less than 3%, which aligns with our historic norms. On Slide 18, our earnings slide, we can see the previously mentioned effects: an $0.11 positive impact from rates and surcharges, a $0.01 increase due to higher natural gas volume, and a $0.02 negative impact from lower water volume and increased expenses. Turning to Slide 19, this is a slide we introduced last quarter that provides more insight into how our annual EPS breaks out by quarter. We have now added the two quarters as reported, both at the high end of the shaded ranges. For the third quarter of 2025, we expect our EPS to be between 10% and 20% of our annual guidance, and we expect our fourth quarter to be between 20% and 30% of our yearly guidance. We have some nonrecurring items this year that benefit earnings. On a normalized basis, we continue to target $2.07 to $2.11, and as Chris mentioned, we currently expect GAAP EPS to exceed $2.11. Lastly, let’s move to Slide 20 to provide an update on regulatory activity. On July 1, 2025, our natural gas operating subsidiary in Kentucky received an order from the Kentucky Public Service Commission, which approved a settlement agreement allowing base rate increases designed to increase total annual operating revenues by $7.7 million or 11.2%. New rates in Kentucky went into effect on July 1. We currently have three pending rate cases or surcharges in North Carolina, which is a 3-year forward-looking rate case, Ohio, Texas, and Virginia, with requested annual revenue increases of $96.6 million. It's a busy year on the regulatory front. We continue to manage our regulatory activity to maintain safe and reliable service, earn an appropriate return on the capital we invest, and minimize regulatory lag while considering affordability for our customers. Before I conclude, we wanted to take a moment to recognize Bob Rubin. Bob has been with the company for 36 years and has been our Chief Accounting Officer for 20 years. During this time, Bob has had ultimate responsibility for our financials and SEC filings and played a critical role in our earnings call preparation. Thanks for your contributions to the company, Bob, and for your friendship. You will be missed. Fortunately, over the past few quarters, Bob has worked to transition his role to Brad Palmer, our new Chief Accounting Officer, so we won’t miss a beat. Welcome to that new role, Brad. With that, I’ll turn it back over to Chris.

Alright. Thanks, Dan. Now let's move to Slide 23, where we touch on our long-term growth through acquisition strategy that has been focused on growing our water and wastewater business for many years. Last week, we finalized our $37.75 million purchase of the City of Beaver Falls wastewater system in Beaver County, Pennsylvania, serving about 7,000 customers. That's near Pittsburgh. We plan to invest $10 million in the system, focusing primarily on improving both operational efficiency and environmental compliance. We’re excited to welcome our new customers and bring their system up to our standards. For 2025, in total, the company has acquired systems serving approximately 10,300 customers for approximately $58 million. We also have another four signed purchase agreements for relatively small systems in Pennsylvania and Texas. I'll remind you that progress on DELCORA continues to be stalled by a stay put in place by a federal bankruptcy court judge related to the bankruptcy of the City of Chester. There is nothing new to report on DELCORA, but I'll remind you that DELCORA is not included in our current guidance numbers. Turning to Slide 24, I'll close by reiterating some of our goals and aspirations, both short term and long term. We continue to see strong growth potential in our water and gas platforms, with our combined utility rate base expected to grow at a compounded annual growth rate of about 8%. Breaking this down further, the Regulated Water segment is expected to grow about 6%, and our Regulated Natural Gas segment rate base will grow about 11%. We are reaffirming our 5% to 7% multiyear earnings per share guidance through 2027. This includes acquisitions expected to close in 2025 and 2026 but excludes DELCORA. This projection includes the crucial work we’re doing to remediate PFAS across our water platform, as well as our work to replace aging water and natural gas pipes. We remain committed to maintaining a strong balance sheet, improving our cash flow and debt metrics, and delivering consistent dividend growth while keeping our payout ratio between 60% and 65%. All in all, we see a bright future for our company as we continue to invest in our nation's infrastructure and continue to deliver long-term value to our shareholders. With that, I’m going to conclude the formal remarks for today, and we’ll open it up for questions. Let me send it back to you, operator.

Operator Instructions. Our first question comes from the line of Julien Dumoulin-Smith with Jefferies.

Maybe actually just to break it down, a bit of a nuanced question, but it has implications here. You guys provide this timing through the year in terms of quarterly earnings. If you take the midpoints from those and look at what's implied, it kind of implies maybe the high end is better if you look at implied third quarter and fourth quarter here. Again, I don't mean to nitpick too much, but if you have any comment there, I'd love to kind of read between the lines there, if there's anything you'd say.

Yes. So what we said on the call here, both Chris made the point and I did as well, that we're going to come out on a GAAP basis above our guidance range, so above that $2. We had strong revenue in gas this winter, with more gas usage than weather alone would have predicted. This year as well, we benefited from some tax items, the reversal of a regulatory reserve due to the Aqua Pennsylvania rate order, and we had some insurance proceeds also in our favor. Those are the positive side. We’ve also had some headwinds this year with the wet summer in several of our states, which impacted us in Q2 and continues to impact us in the early part of the third quarter. Interest rates remain higher than expected. Inflation is still impacting areas like chemicals, and we’re still in the investing stage on our lean initiative. It’s still early in the year relative to the gas business. We’ve had half of last year’s heating season, and we still have November and December to go this year. So things can still move around. We’re not being overly specific on where we’ll land, but we’re saying on a GAAP basis, it will be above the guidance range.

Yes, got it. Just wanted to elaborate a little bit there. And then just on the cash flow front, I mean, just where are you trending on FFO through the year here? And then specifically within that, how are you thinking about PFAS here and some of the tailwinds from the settlements here and the timing for the collection of those, if you will?

Yes. Let me touch on those in pieces. Our focus for this year is to be above that 12% downgrade threshold, ideally putting some distance in there, call it like a 12.2% target. We’ve been in close conversations with Moody’s, and we’d like to see that negative outlook removed in early 2026 once they see full year 2025 results. In terms of PFAS settlement dollars coming in and being helpful from a cash perspective, you'll see when we file the Q on Monday next week that we received about $7.1 million in PFAS proceeds from those lawsuits already, and we expect a number this year in the $45 million to $46 million range in total.

Our next question comes from the line of Ryan Connors with Northcoast Research.

So a couple of big picture questions on Pennsylvania and then a housekeeping for you, Dan. I know you're out of rates in Pennsylvania at the moment, but obviously, we have the new consumer advocate there. I assume your team watches other matters going on very closely. So I'm curious whether you've gotten any feel for the approach he's going to take and how that will differ from the prior consumer advocate.

Yes. Listen, I think our engagement with Darryl Lawrence and the OCA has been very positive. I expect that Darryl and his team will continue to do their job as advocates for the customers, and we'll do our job. I think there is maybe an enhanced desire in that group to figure things out, put this puzzle together in a way that's constructive and that all parties feel comfortable with. I expect a more constructive relationship there at the OCA, and that's been our observation so far. The small business advocate has a role as well, and these are statutory parties with their priorities. The advocate has been open to conversations and has visited us here at the company in Brynmawr, which is encouraging. I'm hopeful that we can have constructive relationships with all the advocates, and that's been our experience.

Great. That's very helpful color. And then secondly, on the fair market value front, I've been hearing that there are some municipal sellers out there holding out for a price above the reasonable review ratio that was set in the reform to FMV in Pennsylvania. I guess the reasoning is that the PUC has the ability to approve something above that level on a case-by-case basis. Is that something you’ve seen? And would you be willing to take that risk over the cap, or would you just stay at or below the RRR?

Yes. I can't say that we've seen that yet. But I will say that on occasion, we might pay more than the RRR if we believed there was significant rate base growth potential that we could grow into. The RRR is a target for both seller and buyer, given the impact on rates. The Chairman and the commission's primary goal was to minimize the impact on rates from transactions. We believe that’s important. I’m not saying it would never happen, but we prefer that buyer and seller negotiate around the RRR rather than above it.

Got it. Okay. Very helpful. And then Dan, just on the tax rate, it’s kind of jumping around and has been difficult to model. Any perspective you can give us on how to think about the landing zone there for the balance of '25 and even into next year?

Yes. The way I think about that is for the full year 2025, think of a low single-digit benefit. For the whole of 2026, we haven’t finished our budget or plan, but I’d think of that as a low single-digit expense. So think of a crossover from a small benefit this year to a small expense next year.

Operator Instructions. Our next question comes from the line of Davis Sunderland with Baird.

Two questions for me. Maybe first, just jumping back, Chris, to your comments about the hyperscalers and obviously, a lot of activity going on in Pennsylvania right now. Could you talk a bit more about the potential opportunity here and the timeline for folding some of these into the rate base?

Yes. Most of the hyperscalers that are talking want a really short turnaround. Pennsylvania is a prime location, particularly Western Pennsylvania, where there is low-cost energy. I have to be careful in what I say, as there are some NDAs in place, so I can’t talk much about the opportunities we are currently engaged with. I will say quick turnaround is essential. I would position it to think about not all rate base or all regulated, but some unregulated opportunities as well.

That is super helpful. And then maybe second one, Colleen, I appreciate the comments on PFAS. Could you speak about this potential EPA pushout and whether it changes how you’re thinking about upgrades?

Thanks for the question. There’s no change to our program at all. We’re full steam ahead. Regarding the acquisition and growth opportunities, there’s no change there either. Most municipalities are going to wait to the last possible minute. They’re just starting monitoring. This gives them a little more time to delay. However, the opportunities will still be there. Given our position and experience with systems operating well, we’re well-positioned to assist.

Colleen, if we think about it, yes, municipalities might have a couple more years to comply. Given we have a resource solution, we might be able to accelerate some of those solutions with our filtration system. This could lead to conversations, wouldn’t you agree?

Yes. At the American Water Works annual conference this year, it generated a lot of interest. Many engineers came to me asking about it. As they get their heads out of the sand and realize they must comply, I know our solution will be a great fit.

That concludes the question-and-answer session. I would like to turn the call back to Chris Franklin for closing remarks.

Thanks, folks. Appreciate you joining us today. As always, the team is ready to answer questions or follow-ups if you have them. Thanks so much. Have a great weekend.

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.