American Water Works Co. Inc (AWK) — Q3 2022 Earnings Call Transcript

Thank you, Sarah. Good morning, everyone, and thank you for joining us for today's call. At the end of our prepared remarks, we will open the call for your questions. Let me first go over some safe harbor language. Today, we will be making forward-looking statements that represent our expectations regarding our future performance or other future events. These statements are predictions based on our current expectations, estimates, and assumptions. However, since these statements deal with future events, they are subject to numerous known and unknown risks, uncertainties, and other factors that may cause actual results to be materially different from the results indicated or implied by such statements. Additional information regarding these risks, uncertainties, and factors, as well as a more detailed analysis of our financials and other important information, is provided in the earnings release and in our September 30 Form 10-Q, each filed yesterday with the SEC. And finally, all statements during this presentation related to earnings and earnings per share refer to diluted earnings and earnings per share. Susan Hardwick, our President and CEO, will discuss third quarter and year-to-date highlights and touch on 2023 guidance and our long-term targets. John Griffith, our Executive Vice President and CFO, will cover our financial results in detail, provide an update on active general rate cases and acquisition activity, and will close with further details on our 2023 and longer-term outlook, including the overall financing plan. Cheryl Norton, our Executive Vice President and COO, will then discuss our capital investment plan, rate base growth expectations, and our focus on affordability. Cheryl will then conclude with a review of some important new operating goals and disclosures that align with our focus on ESG. We'll then close by answering your questions. With that, I'll turn the call over to American Water's President and CEO, Susan Hardwick.

Thanks, Aaron, and good morning, everyone. As Aaron said, we have a lot to discuss this morning in addition to third quarter results. Specifically, we also want to cover today our outlook for 2023 and our longer-term targets. As you know, last year, at this time, we shared some significant news when we sold our homeowner services business to transition to a pure-play regulated water and wastewater utility. In that update, we announced a new 5-year plan and acceleration of capital investments and some adjustments to our financial targets. The updates that we'll share today are largely an affirmation of last year's plan and targets with adjustments primarily reflecting the shift out to 2027 in our 5-year outlook. We will also share additional thoughts and plans around our continuing ESG journey. So let's dive in and turn to Slide #5, where I'll start by covering some highlights of 2022 to date. In the first 9 months of 2022, earnings were $3.70 per share compared to $3.40 per share in the same period of 2021. Strong organic growth and increased earnings from infrastructure investments continue to be our year-over-year drivers for the quarter and year-to-date periods. Favorable weather also added to results in the third quarter. Though we generally, like others, are experiencing a higher cost environment, our team continues to deliver on our financial and operating plans. This includes staying on track to achieve our total capital investment goal of $2.5 billion in 2022 and executing on significant regulatory activities, including constructive settlements in 2 of our outstanding general rate cases. Further, we continue to effectively manage and mitigate cost increases and have been successful in recent regulatory efforts to further lessen the impact of inflationary pressures into the future. These regulatory solutions are very important to our ability to manage inflationary headwinds as we move into 2023. So I'm pleased that we've successfully executed our plan so far this year in a challenging and very active period. John and Cheryl will provide additional details on financial, operating, and regulatory results later in today's call. But before I move on, let me comment about how excited we were to sign an agreement a few weeks ago to serve the nearly 15,000 customers of the Butler Area Sewer Authority in Western Pennsylvania. This is another great example of how partnerships with municipalities can lead to positive outcomes for customers, employees, and the community at large. Our team worked very hard to understand the community's objectives and created an opportunity that we believe benefits all stakeholders. Turning to Slide 6. As announced yesterday, we affirmed our 2022 earnings guidance. We continue on track to meet our expectations for the year as we've indicated throughout the year. In addition, we have had the incremental contribution from weather this quarter. Also yesterday, we initiated our 2023 earnings guidance of $4.72 to $4.82 per share. This near-term plan as well as our longer-term plan remains very strong, and with our record of execution, we are confident in our ability to achieve our earnings expectations for 2023. Later, John will talk more about the drivers of our growth in 2023, but our expected growth builds on the accelerated CapEx plan we put forth last year. As we've said many times, the full effect on earnings growth from the increasing capital spending will ramp up over time. John will talk further about our updated financing plan, but this plan reflects our prior discussion that the growing investment plan will result in regular access to equity capital. As we've illustrated on this slide, we expect our investments in infrastructure and regulated acquisitions to drive significant earnings growth through 2027 and beyond. Finally, on Slide 7, I want to make a few comments about our purpose here at American Water and how that drives our growth strategy, our operating plans, and our company's targets and goals. Our mission is to provide safe, clean, affordable, and reliable water and wastewater services to the communities across the country. Our services are vital to sustaining life. So while much has been said in the news about the clean energy transition that's happening, what drives us every day is an equally important need in our country. We believe that everyone should have access to safe, clean, affordable, and reliable drinking water and wastewater services, and that communities are stronger because American Water has the privilege to serve them. It's true that we have many similarities to the utilities, and we embrace the knowledge sharing and best practices that can come with those similarities. In fact, we joined EEI as a strategic partner a few years ago because of common values around customer service, safety, and cybersecurity, to name just a few. And as many of you know, I've spent most of my career in the gas and the electric industry. So I have a deep appreciation for the utility industry as a whole. However, the water industry and American Water also have some important differences from other utilities. Our capital projects, for example, are much smaller on average than those in the electric and natural gas industries, even though they add up to a similar and very significant investment need. Another difference is our greenhouse gas emissions footprint, which is very small compared to most other publicly traded electric and gas utilities. That said, we are seeing the impacts that climate variability can have through more extreme droughts or severe floods. We strongly believe we must do our part to reduce overall greenhouse gas emissions. We have now set ambitious greenhouse gas reduction goals, including achieving net-zero by 2050. Along with our goals for system resiliency, and water use and efficiency, we see our greenhouse gas reduction goals as part of our commitment to providing superior and affordable service to our customers. We believe American Water is the leader in a clean water and wastewater transition in the United States. For the communities we already serve and the communities we hope to serve in the future, the capital investment needs that are required to deliver more sustainable water and wastewater services are immense. It's up to us to find ways to balance those CapEx needs with the affordability of services for our customers. That's why we've added a customer affordability target to our list of key drivers you see here. As a company, we also continue to raise the bar on our efforts to create a fair and equitable place to work in addition to making sure our operations align with the spirit of environmental justice. Two recent examples of our broad focus were the recognition through the 2022 WaterSense Excellence Award from the Environmental Protection Agency and the 2022 Leading Disability Employer by the National Organization on Disability. Cheryl will provide some examples later of the good things we are doing internally in these areas. Finally, on this slide, you can see we are affirming our long-term earnings growth targets, and most of our other long-term financial targets remain unchanged. During our planning process this fall, we decided to narrow our long-term dividend growth target to 7% to 9%, which maintains our position in the top tier of dividend growth and payout ratio in the industry. Our long-term dividend growth target now fully aligns with our compelling EPS growth target of 7% to 9% and the significance of our capital investment plan and related financing. This minor adjustment rounds out our strong long-term plan and will help us achieve our other important financial targets over time. In summary, we believe the combination of our EPS and dividend growth, supported by a significant and yet low-risk capital investment plan, as well as our ESG leadership premium, and constructive position on affordability will continue to be rewarded by investors. Based on the long-term plan and our history of executing on our strategies, we expect to continue to deliver a very competitive and sustainable shareholder return for many years to come. And with that, I'll turn it over to John to cover more detail on our 2022 financial results, our 2023 and longer-term outlook, and our financing plans.

Thanks, Susan, and good morning, everyone. Turning to Slide 9. Let me provide a few more details on third quarter results. Regulated results in total increased $0.16 per share compared to the prior year. We saw a $0.32 per share increase related to higher revenues from new rates, acquisitions, and organic growth. Also, weather was favorable by an estimated $0.07 per share year-over-year due primarily to warmer and drier conditions in 2022. O&M and other expense increased by $0.10 per share, which reflects an estimated $0.07 of inflation on chemical, power, and fuel costs and higher interest rates. Depreciation expense also increased by $0.04 per share in support of growth in the regulated business. And as you know, 2021 third quarter results included $0.09 per share of operating earnings from our former New York subsidiary. Finally, the market-based business and other results decreased in the third quarter of 2022 as the $0.09 per share of operating earnings from HOS in the third quarter of 2021 was offset by the $0.06 per share of earnings in 2022 from interest income and revenue share agreements. Moving to Slide 10. Consolidated results increased $0.30 per share for the year-to-date period compared to the same period last year, driven by many of the same factors as in the third quarter. While I won't go through all of the details of the year-to-date results, in short, we are pleased with our financial performance over the first 9 months of the year. Our leaders across the business have adjusted to the changing economic environment in 2022. Their ability to do so has put us in a good position to achieve the full-year operating results we laid out in our initial 2022 guidance a year ago. Let's turn to Slide 11 and cover the regulatory activity in our states. Shown here is our summary of completed rate cases in 2022 and key facts for each of the rate case filings so far this year. In the appendix, we also share some details of changes in our infrastructure charges year-to-date. These efforts reflect Susan's comment on our team's ability to execute our regulatory strategies, which is the critical success factor for continuing to grow our business. As we've said before, the common thread in all of these cases is the focus on recovery of infrastructure investments made since the last round of rate cases totaling over $4 billion, and in some states, the roll-in of acquisitions. As we continue to ramp up capital investments in 2023, it will take time to see recovery of those investments in rates. We continue to expect to file general rate cases generally every 2 years in our bigger states. As we have already communicated in August 2022, the New Jersey BPU approved the settlement of our rate request authorizing a total annualized revenue increase of approximately $61 million. The new rates became effective on September 1, 2022. Two key outcomes in this case were the incorporation of our request to update estimates of production costs, including chemicals, fuel, and power costs, and the approval of deferral accounting for pension expense beginning January 1, 2023. The success of our proactive regulatory approach to these pressures will lessen the risk to shareholders into the future. Turning back to active cases. You can see we have general rate cases in progress in 5 jurisdictions. In 2 of these states, Pennsylvania and Virginia, we have reached settlement agreements with the parties and have on-file petitions for approval of the settlements. In Pennsylvania, we filed a general rate case in late April, seeking recovery of $1.1 billion of investments since the prior case. The settlement provides for a total annualized revenue increase of $150 million and incorporates updated estimates of pension and OPEB expense. Similar to New Jersey, this settlement also includes increases in production costs, including chemicals, fuel, and power costs. In the coming weeks, an administrative law judge will review the settlement filing and render a recommendation to the Pennsylvania Commission regarding approval of the settlement. After its review, the commission will issue a final order. We expect the order by January 2023, with new rates to be effective as of January 28, 2023. Moving on to Virginia. In late September, a settlement agreement supported by all parties, except one, was filed with the Virginia State Corporation Commission and provides for a $12 million annual revenue increase compared to our original request of $15 million. A final decision in this case is expected in the first quarter of 2023. In Illinois, where it's been about 6 years since our last general rate case, progress has been steady since our February filing, and last Friday, a proposed order was issued by the case's administrative law judges. We view the key terms of the proposed order as very constructive, including recommended approval of our updated revenue request to capture higher production costs and expected higher pension costs. We expect a final order in the case by January at the latest. Our cases in California and Missouri were filed in July and are progressing as expected so far. In January of 2023, we will file an update in Missouri for costs and other elements of the case as needed with hearings then to be held in February. We expect the case to reach conclusion by the end of the second quarter of 2023. On the legislative front, there was 1 additional notable piece of legislation signed since our second quarter call, California Senate Bill 1469, which allows the commission to consider and authorize the implementation of a decoupling-like mechanism. The legislation was signed by the governor on September 30, 2022, and will become effective on January 1, 2023. Our California subsidiary is grandfathered into the previous water revenue adjustment mechanism through the end of our current rate case for 2024, and the team is working to renew decoupling under the new mechanism and the general rate case that was filed July 1 for our next rate period beginning in 2024. Turning to Slide 12 and the acquisition piece of our growth triangle, as Susan mentioned, we were excited to announce in October our agreement to purchase the Butler Area Sewer Authority's Wastewater System for $232 million. This agreement was executed under Pennsylvania's fair market value legislation, which is a framework that exists across 11 of the states in which we operate. Through September, we have closed on $308 million of acquisitions in 2022, which represents about 65,000 customer connections, and we are excited to have nearly $350 million of signed purchase agreements through October, which sets us up for 2022 and 2023 to be strong years for growth through acquisitions. With the pipeline of over 1.3 million customer connections, we expect to continue this track record of success. On Slide 13, we provide some considerations regarding our outlook for 2023 results in our EPS guidance range of $4.72 to $4.82 per share. First, as you would expect, our growth will be driven by capital investment to serve our customers and earn a return on that investment. As we've talked about previously, 2022 is year one of our accelerated CapEx plan, so it will take some time to ultimately see the ramp-up reflected in earnings. Recent regulated acquisitions that are being incorporated into active or just completed rate cases will also drive growth next year. I'd like to add that our Military Services Group does add incrementally to our earnings growth expectation as we have continued to show on our growth triangle. 2023 results will benefit from MSG's successful addition of its first Navy contract that we announced earlier this summer. Just as critical to our strategy is our ability to recover in rates the operating costs it takes to run the business, which goes to my final point on the slide. The regulatory solutions we are pursuing such as cost deferrals and expense recovery mechanisms are closely aligned with the interest of regulators and customers in managing affordability and limiting variability of customer bills, which ultimately aligns with our investors' interests as well. As we conclude this current round of rate cases, we expect to have in place regulatory solutions for over 75% of the inflationary costs we anticipate in the near term, including pension, interest, and production costs. And as always, our team remains vigilant and disciplined on cost management. Finally, related to pension, I'd simply remind you that our pension obligation remeasurement will be done at year-end 2022 and that will drive the determination of our 2023 pension expense. Wrapping up the 2023 outlook on Slide 14. Here, we are providing some more specifics regarding the key drivers for 2023 that I just discussed. This slide demonstrates the importance of our regulatory execution and the results it drives. It also reflects the financing plans we expect to execute in 2023 that support our capital investment plan, which is an additional $1 billion over the next 5 years as compared to last year's plan. You will notice that we have included a bar for incremental debt and equity financing, which reflects the cost of incremental debt issuance in 2023 to support our growth, as well as equity to be issued in 2023, which I will address on the next slide. Our cost of increased interest rates on 2022 debt balances is captured in the cost inflation and interest rates bar, the majority of which is being recovered through the current round of rate cases as just described. We are confident in our ability to deliver on this plan for 2023. Turning to Slide 15, I'll provide a financing plan update before closing with a look at our balance sheet and liquidity profile. Our financing plan now includes an estimated $2 billion of equity issuances from 2023 through 2027, which is an update to the $1.1 billion of equity financing need through 2026 we have previously discussed. Consistent with our prior messaging on mid-plan timing, subject to market conditions, we are likely to raise a significant portion of the total planned equity in 2023. The increase in the anticipated total equity need is driven largely by the $1 billion of increased CapEx that extends through 2027 in this new plan, along with adding some incremental balance sheet capacity. The remaining portion of the $2 billion of planned equity not completed in 2023 is expected to be issued near the end of the 5-year plan. As we've said for several quarters now, we expect equity will be a regular financing tool going forward to help fund our growth and maintain a strong balance sheet. Let me conclude by turning to Slide 16 with a reminder that we have a strong balance sheet and credit profile. I'm confident our new 5-year plan is supportive of our current credit ratings as well as our long-term financial target of less than 60% debt to total capital. Another thing I'll point out is our debt maturity profile at the bottom left of the slide. We believe these levels, along with our planned debt issuances are very manageable. In a rising interest rate environment, it's important that the company has taken a laddered approach to long-term debt financings over the years in order to minimize interest rate risk. And as the utility that predominantly invests in long-term assets, I expect us to continue to exclusively issue fixed-rate long-term debt to protect against the risk of interest rate volatility. On liquidity, we continue to remain confident that we have sufficient access to capital for the foreseeable future. In fact, we just announced that we increased our commercial paper program and our revolving credit facility by $500 million each to $2.6 billion and $2.75 billion, respectively, and we extended the maturity of our revolving credit facility to October 2027. We believe these actions were appropriate to support our growing business and increased capital investment plan. With that, I'll turn it over to Cheryl to cover our CapEx and rate base growth plan, affordability, and some new sustainability goals in more detail.

Thanks, John, and good morning, everyone. On Slide 18, I'll start by talking about our updated capital plan. I want to first acknowledge that our teams have done a great job executing on our accelerated capital investment plan in 2022. We're on pace to meet our overall capital plan of $2.5 billion this year, which includes acquisition investments. Looking ahead to 2023, we plan to again step up our investment level this time to roughly $2.9 billion, which will generally be our new annual threshold for the next several years. As John just mentioned, over the next 5 years, we expect to invest approximately $14 billion to $15 billion, an increase of about $1 billion over our previous plan. This increase is mostly driven by including the increased investment for 2027 in the 5-year window as well as about $250 million of inflationary impacts expected in the near term. We expect this pace of spend to drive our current pipe replacement cycle plan lower and much better than the industry average. On the longer horizon, you can see that we plan to spend approximately $30 billion to $34 billion in our regulated business over the next 10 years. We see this capital plan to be largely in line with last year's plan, reflecting the higher annual run rate as well as modestly higher costs for pipe and other capital goods. Turning to Slide 19. This graph illustrates that our continued execution on capital investments, both infrastructure projects and acquisitions are succeeding and growing the regulated business at a long-term rate of 8% to 9%. Rate base growth, of course, will drive earnings growth as long as we continue to prudently invest in our systems and successfully execute the regulatory process. Moving on to our regulatory recovery strategy on Slide 20, our theme here is around timely, consistent recovery of investments and operating costs. When we achieve timely and consistent recovery, it levels out bill increases to our customers, which helps promote affordability. It's beneficial to our customers that we operate in states that have constructive regulatory mechanisms. We've engaged with policymakers and regulators for well over a decade to find the best ways to invest in water and wastewater infrastructure while putting the customer first. In the states where we operate, 27 new mechanisms have been added over the past 12 years. As water and wastewater industry challenges grow, we'll continue to focus on constructive regulatory and legislative outcomes. I'd also like to discuss timely recovery of our investments across our footprint with the pie chart on the right side of the page. Through capital recovery mechanisms and forward test years, we are able to reduce regulatory lag and lessen the reliance on general rate cases. This enables us not only to earn our return but also to mitigate the size of the general rate increases for our customers. We expect about 45% of capital investments over the next 5 years to be recoverable through infrastructure mechanisms, which is the key to unlocking a more consistent annual earnings growth pattern for the long term. Turning to Slide 21. Our focus on operating efficiency has been a part of our company's DNA for many years. As you know, we've historically used O&M efficiency as one of our benchmark metrics to measure our success at managing costs as we grow the business. This focus positioned us well to manage through much of the pressure over the last couple of years on the supply chain and even cost increases brought about by the effects of the pandemic. As we look ahead, we've been asked if we can go below the 30% efficiency threshold. While we're continuing to evaluate that question, we've continued to emphasize that revenue growth has been just as important to our success with O&M efficiency as managing costs. So with that realization in mind, there may very well be additional opportunity to go below the 30% threshold. However, we're analyzing whether this is the best metric by which to judge our effectiveness at managing costs and running an efficient business. Moving to Slide 22. One of the most difficult challenges we face in the water and wastewater industry is balancing customer affordability with the magnitude of the system investments that are needed. Thankfully, as we sit here today, our industry and our company are in very good relative positions in terms of affordability or wallet share. In fact, as investors and analysts study the sustainability of American Water's long-term earnings growth potential, we believe our affordability proposition is an important consideration. We realize, though, that we must continue to evolve our strategies around rate design and programs to assist our customers who are challenged with affordability. We must also consider our focus on technology, efficiencies of scale and a sharp focus on cost management in order to deliver on values around customer affordability. Moving on to Slide 23, and as Susan mentioned earlier, we are excited to announce our new science-based greenhouse gas emission reduction goals and our first disclosure of estimated Scope 3 emissions. Before we dive in, I'll walk you through our greenhouse gas emissions profile in a bit more detail. As an essential service provider, American Water is often compared to the broader utility sector emissions, which can be misleading. As Susan noted earlier, it's an important distinction that our emissions footprint as a water utility is much smaller than most publicly traded gas and electric companies on both an absolute and per customer basis. To help put it into context, American Water represents just 0.1% of the total Scope 1 and Scope 2 emissions produced by the top 20 largest U.S. utilities measured by market cap. As we show on the slide, our total emissions footprint is made up of 7% direct Scope 1 emissions, such as heating, cooling, and fleet; 44% indirect Scope 2 emissions or our purchase power; and 49% estimated Scope 3 emissions, which for us largely includes purchased goods and services, capital goods, and fuel and energy-related activities. Framing it in a different way, more than 90% of our overall emissions footprint is generated from external sources, which is another key differentiator from most other utilities. Turning to Slide 24, there's a lot to unpack here. Let me say first, at a high level, we believe it is prudent for our company to focus our efforts on environmental initiatives that are in the purview of a water utility and aligned with our core mission. Our view is that greenhouse gas emission reductions fit as part of our sustainability strategy that, over time, will help protect customers against service disruptions from more severe weather patterns such as droughts and floods. We believe we've set forth new compelling goals to support this strategy. First, we expect to reduce our absolute Scope 1 and Scope 2 emissions 50% by 2035 from a 2020 baseline. Second, we expect to achieve net-zero Scope 1 and Scope 2 emissions by 2050. We believe these new medium- and long-term emissions goals are rooted in science and aligned with the Paris Agreement. We also believe our approach is a responsible path that considers all of our stakeholders' interests, including doing our part by setting ambitious reduction goals. Our approach here will allow us to stay on course with our customer affordability metrics as we continue to deliver clean, safe, affordable, and reliable water to our customers. This was a foundational component of our analysis and recent discussion with our Board level SETO Committee, which oversees our safety, environmental, technology, and operations efforts. It's also important to note that as we deliver water and wastewater solutions to more customers over time through acquisitions and organic growth, our energy usage is going to increase. We will rebaseline each year to account for our growth through acquisitions of systems, which is an acceptable practice under the standards of the science-based targets initiative, or SBTi. We did consider making a commitment to SBTi as part of our analysis this year. However, we concluded that some of SBTi's expectations around Scope 3 emission commitments, mostly around timing, were not in the best interest of our stakeholders. We do expect, though, to continue to work with our suppliers and vendors to consider what can be done to reduce Scope 3 emissions over time. And as I stated, we are confident that our new medium- and long-term Scope 1 and Scope 2 goals are science-based and aligned with the Paris Agreement. As you can see at the bottom of the slide, these are more than just goals. We have plans in place and capital ready to deploy to achieve these goals, obviously with greater visibility to the path to 2035. Since our footprint is heavily weighted by Scope 2 emissions, the continued greening of the electric grid is a significant component of our reduction plan. We hope to see that transition continue by our fellow utilities and other providers. For us though, we know that it is cost prohibitive and outside of our core competencies to self-generate all or even a significant portion of our power needs. We will, though, continue to look to enter into clean purchase power agreements or partner on renewable investments where appropriate, similar to our engagement with New Jersey Resources on the floating solar array at one of our treatment plants in New Jersey. Lastly, we will continue to focus on emissions reduction activities that we can control within our operations. This includes water efficiency and operational efficiency gains in order to reduce the energy and emissions associated with the pumping of water, which we disclosed previously is by far the largest driver of our purchase power needs. Capital projects will include the deployment of additional leak detection technologies and more efficient water pumps across our systems, as well as converting some of our fleet vehicles and other assets to more efficient options. These are small but important pieces of our plan. And in large part, these capital investments will align perfectly with some of our existing reliability and resiliency goals. Next, let's turn to Slide 25 and discuss some new disclosures related to our continued ESG journey. First, soon, we will release summary results of our most recent pay equity study on our ID&E website, diversity@aw.com. This is our third such pay equity study. Each time we have engaged a third-party consultant to conduct an objective pay equity analysis. I'm pleased to share that you will see that we're very close to achieving pay parity across employee groups, including gender. Our performance is a testament to American Water's commitment to fair and equal pay and how our teams have leveraged findings from these regular assessments to correct any inequalities and update processes around compensation. We will also share some initial summary findings of our internal labor market analysis that began in 2021. This analysis was also led by a third-party firm and was commissioned because we believe the factual and statistical analysis of our workforce was needed to support a holistic evidence-based inclusion, diversity, and equity strategy. Lastly, I'd like to touch on 2 of our new goals that were established earlier this year in our annual performance plan. The first is to increase representation of female employees at American Water, and the second is to increase ethnic and racial diversity among American Water employees. Both of these goals complement existing safety and environmental sustainability goals that are tied to annual performance plan compensation for all employees. As mentioned earlier, these goals reflect our company's focus on social benefits that we believe will help us operate as a stronger company, ultimately for the benefit of our employees and to help us better reflect the customers and communities we serve. Whether it's our ESG leadership or our consistent execution on our earnings growth goals or our leading safety culture, our team at American Water has consistently raised the bar for success in the water and wastewater industry. We have full confidence in our ability to achieve the goals we talked about today for 2023 and beyond. So with that, I'll stop and turn it back over to our operator to begin Q&A and take any questions you may have.

So first on '23 guidance, I mean, I guess it's a relief for all of us to see that you're messaging to get to consensus expectations even with the increased basically equity needs that you're addressing in 2023. So I mean, is it basically that you are front-end loading equity to finance CapEx that will materialize in the latter part of that 5-year plan? And as such, it's not only that CapEx is back-end loaded, but it's also that there is some incremental dilution that sort of weighs on those '23 results?

Angie, your question covers a lot of ground. At a high level, I want to emphasize that our recent guidance aligns with the expectations we've communicated over the past few years regarding our equity needs. We initially provided this guidance more than two years ago. The timing for 2023 that we're now clarifying is consistent with our previous messages. The increase in the equity size within the plan is largely due to the additional capital anticipated over the next five years. As Cheryl mentioned, we're planning for approximately $2.9 billion in investment per year throughout that period, indicating a rise in capital inflows during our five-year focus. We've also adjusted our equity expectations slightly to enhance balance sheet capacity as we move forward. It's essential to highlight our proactive strategy concerning the inflationary costs mentioned in your opening remarks. We've been working diligently to understand these impacts and have collaborated closely with regulators to ensure that we've integrated coverage for these costs into the cases we're currently developing. We're confident that over 75% of these anticipated costs in the short term have been accounted for. In summary, the equity plan is progressing as we have historically outlined, with the increase in capital being the primary driver for the additional equity needs. Our proactive regulatory strategy also supports our confidence in meeting our 2023 expectations. John, do you have anything to add regarding the equity aspect?

I would just add that as we think about how we're delineating the equity, as we said in our prepared remarks, we'll issue or we expect to issue a significant portion of the equity in 2023. As we think about the consequences of that, based on how we trade, I would characterize that the dilution associated with that is relatively modest. And then as also we pointed out in our remarks, whatever we don't issue in 2023, we would expect to issue in the back end of our plan.

Good. Okay. And then changing topics a little bit, and I know it's not your core competence. But you are a cash taxpayer, so you do have cash appetite, I mean tax appetite, I'm sorry. So why not develop or at least own some of those renewable power plants that you currently contract under the PPAs. Again, as a tax strategy as opposed to like a true growth driver?

Yes, that's a good question, Angie. Cheryl touched on it, and you mentioned it as well. We don't see it as our primary strength. There are others in that field, and we believe we can collaborate with them to create solutions and utilize those renewable sources without having to own them. We have plenty on our plate. You recognized that it's not really a driver for growth. We have enough to focus on within our investment side to support our growth. Therefore, we don't need it from that perspective. Your point about taxes is also valid. However, I would say we have the right strategy in place to finance our plan and manage all its components with what we have outlined. While we are always interested in tax planning and strategy, it simply doesn't align with our profile.

Okay. And last one really quickly. So you have had some big muni deals announced since the second quarter earnings call. I think we've all been concerned about some of those high-profile privatizations of wastewater systems sort of falling through. So are you seeing that there is any sort of systemic change to how municipalities look at sales of their water and wastewater systems? Or is it just very much kind of system-specific?

Yes, Angie, let me just turn it to John and have him sort of weigh in on that question.

Yes, Angie, I would say, I'm glad you asked the question because our answer is No. We haven't really seen a fundamental change in the landscape for making acquisitions. So there's certainly been some noise out there around particular deals. But really nothing has changed. There's a huge number of systems out there, many of which are underinvested and are ripe for potential acquisition. When we think about the footprint that we have and the focus that we have, we continue to very much like our relative position there, and regulated acquisitions will continue to be a key focus area for us.

Yes. And I just would add to that simply that we work very hard in cultivating these opportunities to make sure we're developing the right solution for these communities, and I think that's a big advantage for us.

A couple of quick ones here. If I recall correctly, the HOS sale ate up a lot of your, I think, NOL carry-forwards and you've been a cash taxpayer this year. Is it your expectation that you’ll be subject to the minimum tax going forward? Does this latest financing plan kind of embed an ongoing assumption for that?

Well, the first part of your statement is correct. Yes. The gain on the HOS transaction sort of advanced us to being a cash taxpayer. Still evaluating what the IRA means and the alternative minimum tax and financial income greater than $1 billion. There's still lots to be sorted out in terms of what that final rules are and the final interpretation of those. So we're monitoring it closely. We've obviously modeled a variety of scenarios around it. And I would just say, in all those scenarios, this plan adequately covers any exposure we think we might have there.

Got it. Okay. Perfect. And then I think John may have touched on this a little bit, but it looks like the amount of CapEx dollars allocated to regulated acquisitions is the same as the prior plans. So a slightly smaller overall proportion. Anything to sort of read into here? Is the opportunity set fairly fixed? Are you getting more selective? Just maybe a little bit of an elaboration on John's comments, please?

John, do you want to take that?

Sure, Shar. I would say the smaller proportion is really just due to the increase in our organic CapEx, which has greater visibility compared to regulated acquisitions. Therefore, we are not reducing our focus on investing in regulated acquisitions, and we continue to feel optimistic about that.

Yes. And I don't think we highlighted it really much on this call. But our pipeline remains in excess of 1.3 million connection opportunity. So still very, very strong. There are lots of good work in that area.

Got it. And then just one last question from me regarding the shape of that 7% to 9%. Clearly, you are executing well on the regulatory side and have a solid footprint there, despite some dilution. But what else should we consider as we think about modeling and the extension? Where do you see yourselves within that range when comparing the near term to the longer term in relation to the profile of that shape?

Yes. I think it's a good question, and I'll just repeat what I've said several times now. And I do think you can tie it back to the HOS sale. Recall our discussion about a year ago that when we sold that business and this transition to sort of full utility, the opportunity created by that sale would result in a ramp-up of the spend. So it takes us a while to get that spend fully deployed and get it fully in rates. So I'd say in the near term, like you see a little bit in '22 and our guidance for '23, which we think is quite strong, there is obviously a ramp-up still reflected there. And we've got the proceeds that will come in from the note on the HOS sale at the end of '26. So again, you think about that sort of working its way into the plan. I'd just say what we've laid out in '22 and '23 is reflective of that ramp-up. Our view continues to be this long-term growth rate of 7 to 9, we see that extending well into the future. And we just got to get through this sort of ramp-up period, and you'll see that growth rate continue.

Terrific. We'll see you in a couple of weeks. Appreciate it.

All right. Thanks, Shar.

First, just going back to your comments on the financing, especially the equity, I appreciate your commentary on the bulk of it potentially being in '23. I guess, is it possible that when you assess the various equity options that you could potentially look to price that equity in 2022, but look to draw that down in 2023, just given market volatility.

Yes. I think market conditions certainly play into our decisions here around timing and ultimate size and the tool that we use. So that's obviously still in all of our discussions internally. John, anything you want to add to that?

No, that's right. And I'd say that we're not expecting to issue in 2022 into. But obviously, as Susan said, everything is subject to market conditions.

Got it. And then that 7% to 9% EPS growth rate, should we assume that it's now kind of basing off of the '23 guidance? Or should we still use '21 or '22.

Yes. It's a good question. Obviously, we get this question a lot. And I'm confident my answer will frustrate you. Our view is that it's a long-term growth rate. We would expect that 7% to 9% to be the guidance regardless of the period that you're looking at. Internally, we actually don't really use a base year to do the math off of. Our view is it's a long-term growth rate. I know in the past, we have used sort of prior year actual or your latest actual information to base off of. But again, our view would be it doesn't really matter. The long-term growth rate is really the driver.

I understand. I thought I would give it a shot. I also want to apologize once more. Perhaps for Cheryl, I believe the EPA might still be on track to release some mandates regarding PFOS and other water contaminants at maximum levels later this year. Considering your operations and jurisdictions, how could the potential regulations impact your capital expenditures or operational maintenance strategy?

Yes. So great question. We do anticipate that the EPA is going to release those regulations later this year. Because we don't know exactly where they're going to fall, it's a little hard to kind of put a specific dollar amount on it, but we have a really good handle on what we have across our system and what the needs will be depending on what those EPA regulations come out at. And we're prepared to invest the capital needed, putting treatment in place right away. We have found it to be a very quick process to design and get treatment online wherever we may need to. So we know what we've got out there, and we kind of know what to expect depending on what EPA comes out with. So we just have to wait and see. We don't want to spend more capital than we have to, but we also want to make sure that we're meeting the regulations as quickly as possible and protecting our customers.

Congratulations. Just wanted to follow up. I know there's a lot of questions about the growth rate. Just what's the base here point here? Are we talking about pre-'23 at this point? Or are we rolling forward to '23 to the 7% to 9% outlook, if we could just start there.

Well, Julien, as I said to into, we don't really look at it that way. Our view is a long-term growth rate of 7% to 9% is the answer. So our view is you can start within a year you want, and you're going to get the same result.

I wanted to follow up and press a bit. If I could speak about the trajectory, considering the commentary and the early response regarding equity dilution for 2023, what does that imply for 2024 within that range? Since 2023 is at the lower end of 7% to 9%, as you think about rolling forward that dilution, it seems more likely leaning into 2024. Do you believe that the 7% to 9% is still back half weighted, regardless of the timeframe you want to use?

Yes. I think John's comment about the impact of dilution is really the right one. Our view is that the dilution is pretty minimal from the issue that we're anticipating in '23. I think the real driver is the ramp-up of the CapEx. I mean we're just putting these dollars all to work. We've got the proceeds coming in again from HOS in '26. I think as we continue to see that ramp up work its way through the plan, you'll start to see towards the back end of the plan more consistent growth rates.

All right. Excellent. No, fair enough. And then just lastly, just to clarify some of the earlier conversation about the cash tax rate. So what are the planning assumptions reflected in the guidance here as you think about '22, '23, et cetera, just trying to baseline ourselves here, if you can.

Well, I mean, obviously, we're a full cash taxpayer now. So this 5-year plan reflects that. The comment earlier around what does IRA mean to us in terms of the alternative minimum tax, I mean, again, there's still many rules and definition still to be done around that, that I don't think any of us know exactly how it will work. But I would just reiterate what I said a minute ago, we've modeled a variety of scenarios, all of which fit in this plan that we've laid out here.

Well, the time all the best. We'll speak to you soon.

Just starting on 2023 guidance. The $0.25 to $0.29 cost inflation and interest rates with 75% of that covered in rates. I'm curious on the pension side, does that kind of bake in your estimate of the current marks and is it still fair to think about you say market moves from here in the interest rate backdrop as potential upside or downside versus this outlook? Just curious what you baked in on the assumptions there.

Yes, it's a good question. And as John said in the prepared remarks, obviously, we'll measure at the end of the year and determine what our actual '23 expense is once we get to the end of the year. But how we've handled this from a regulatory perspective is for the most part, what we have gotten accomplished here is whatever the '23 expense ends up being, that's what will get reflected in rates. So we've left it a little bit open-ended in that regulatory arena, where we'll actually set it at the number once we know what the number is. And in other situations, we've estimated what we think the impact will be based on year-to-date performance and expected performance for the balance of the year.

Okay. Understood. And I guess to tackle the other side on chemicals, fuel power, is that effectively a reasonable assumption in terms of rolling forward to '24 as well if the current environment persists? Or is there sufficient kind of incremental regulatory activity coming down the road here to mitigate even more of that in the $24 million?

Yes. I think what we have accomplished so far in the regulatory arena, obviously, will be in rates until we adjust rates again. I think we'll have continued opportunity in the regulatory arena to address these cost impacts in other jurisdictions. And again, in some cases, the ability to adjust for what the actual costs are in existing cases or in existing jurisdictions. It just depends on how we address it in each specific state. I think, again, the overall conclusion here is we've got the vast majority of these costs covered and should not really be a drag on our expectations going forward.

Got it. That's very clear. Understood. And if I could just sneak in 1 more on '23. Is there any step-up that you expect on the revenue share related to the Homeowner Services transaction? I guess just curious in terms of walking year-over-year on the hot side, it looks like effectively steady contributions less the post-close adjustments in '22. Is that the right way to be thinking about it?

Yes, I think that's probably the right way to think about it. We're continuing in the states that don't have those agreements in place. We're evaluating those opportunities and working closely with the leadership of HOS to see if opportunities exist. So it's a very active part of our business plan.

Congratulations on the regulatory execution this year. You have done a phenomenal job with great outcomes. Regarding acquisitions, could you provide an update on your progress year-to-date compared to your targets? I believe your goal this year is to reach $500 million in acquisitions. Could you give us an update on that? I also have a follow-up.

Sure. John, you want to handle that?

Durgesh, we're on track. I think we've closed about 65,000 customers to date with around 5,000 more expected. On a dollar basis, as mentioned in our slides, we anticipate closing the year with approximately $350 million, aiming for a target of $300 million to $400 million annually. Over five years, we've projected a run rate of $1.5 billion to $2 billion.

Got it. $250 million for this year. Okay. And then maybe I was just wondering if you could share what you're looking for in terms of valuation or price ranges for this equity. I understand a significant portion is expected to land next year. Any additional insight you can provide on that?

No, Durgesh, I wouldn't say we think in terms of specific price ranges. Obviously, we'll be very aware of market conditions. But I would say we think more in terms of what we've communicated in the past, which relates to the equity from a mid-plan perspective. As we move towards 2023, that aligns with our historical messaging.

So just regarding a couple of questions related to equity and the balance sheet, in the 2023 guidance, are you assuming that it will average roughly over the year, at the beginning of the year, or how are you incorporating that into the 2023 guidance?

John, do you want to take that?

Sure. Yes, I think, Steve, that's a fair way to characterize '23 for modeling purposes. I'd say, I think the words we used, a significant portion of our equity, I think you can think of that as is north of $1 billion of issuance in '23. And as you know, we'll have to kind of find the right windows. But I think midyear is a reasonable way to think about it.

I would like to mention that market conditions will certainly influence this. However, we are still exploring the best approach. In the past, we indicated that it's likely to be in a single issue or a block, but we need to assess all the available options. So, this is still being considered.