Good morning, and welcome to American Water's Third Quarter 2022 Earnings Conference Call. As a reminder, this call is being recorded and is also being webcast with an accompanying slide presentation through the company's Investor Relations website. The audio webcast archive will be available for 1 year on American Water's Investor Relations website. I would now like to introduce your host for today's call, Aaron Musgrave, Vice President of Investor Relations. Mr. Musgrave, you may begin.

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, will 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. And 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…

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 $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…

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,…

[Operator Instructions] Our first question comes from Angie Storozynski with Seaport.

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?

Well, Angie, a lot in your question there, and let me maybe just comment at a high level, and then I'll have John jump in and talk a little bit more around -- our thinking around equity and the plan there. But recall from our, I guess, really the last few years, as we've talked about our equity needs and our expectation around that, we've been signaling sort of mid-plan and we released that guidance probably 2-plus years ago. So I think this '23 timing now that we're giving a little bit more insight into is consistent with our prior messaging, the increase in the size of the equity that we now have in this plan, I think, as we've highlighted, really has to do with the increased capital over the course of the 5 years. And Cheryl indicated that we're kind of stepping up to roughly a $2.9 billion investment per year over that 5-year period. So there is more capital coming in throughout the entire 5-year focus of the plan. And then we've also added a little bit of additional equity expectation here just to create some additional balance sheet capacity as we think about that going forward. The other important thing I would comment on around -- your opening comment around hitting expectations for '23. I just want to underscore again what we said in our prepared remarks around our regulatory approach to these inflationary costs. We have been very proactive in trying to get our hands around what we thought those impacts might be and we have worked very closely with regulators to try to build in, in these existing cases we're working on, the coverage for those costs. And I think we've said something well over 75% of those expected costs in the near term, we have built in these cases that we're ramping up now. So I think I'd say, again, to summary, the equity plan is pretty much on track with what we've said historically and the increase in capital is driving the bulk of that need of additional equity in the plan. And then our proactive approach on regulatory is absolutely part of our ability to be confident about our expectations for '23. So John, anything to add on the equity piece?

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, I think it's a good question, Angie. But I think Cheryl hit on it and you did even in your remark there, we just don't view it as our core competency. There are folks that are sort of in that business, and we believe we have the opportunity to work closely with them to develop solutions and take advantage of those renewable sources that are out there without owning them. We've got enough to do. And you even acknowledge, it's not really a growth driver. We've got plenty to do on just our investment side to continue the growth. So we don't need it from that standpoint. Your observation around tax, I think, is also a good one. But I would tell you, we think we have the right strategy here to finance this plan and manage all the elements of the requirements in that plan with what we've laid out here. So while we're always interested in and spend quite a bit of time on tax planning and tax strategy, it just does not -- it just doesn't fit 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. And 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.

Our next question comes from Shar Pourreza with Guggenheim Partners.

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'd say the smaller proportionality is really just a function of the increase in the regulated -- our organic CapEx, I'd say the -- which has more visibility attached to it, as you know, than regulated acquisitions. So in no way are we kind of decreasing our thoughts around putting dollars to work on regulated acquisitions and we continue to feel very good 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 a last one for me is just the shape of that 7% to 9%, I mean, obviously, you guys, you're executing on the regulatory front. You've got a good footprint there, some dilution. But I guess what else should we assume -- or I guess as we're thinking about modeling and the extension, where are you sort of within that range as we're thinking about like the near term versus the longer term as we're just thinking about 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.

Our next question comes from Insoo Kim with Goldman Sachs.

First, just going back to the -- 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.

Got it. I thought I'd try. Then just 1 more apologies. Maybe for Cheryl, I think the EPA maybe still -- late this year may be on track to put out some mandates related to PFOS and other water contaminant kind of at the maximum levels. Just based on your operations and your jurisdictions, how would that -- given what could come out, how could that impact your CapEx or O&M strategy a bit?

Yes. So great question. We do anticipate that EPA is going to release those regulations later this year. And 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, put treatment in place right away. We have gotten -- we 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.

Our next question comes from Julien Dumoulin Smith with Bank of America.

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.

Okay. All right. Sorry. I just -- I wanted to just press a little bit. All right. And then if I -- a little bit then -- I was checking here. If I can speak a little bit about the trajectory though. As you think about the commentary and I heard the early response on equity dilution for '23. What does that say for '24 vis-a-vis within that range? Obviously, '23 being at the lower end of 7% to 9%. As you think about rolling forward that dilution it seems like more so into '24. Do you think that, again, the 7 to 9 "backhalf weighted" regardless of whatever time period 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. All right. .

Our next question comes from Richard Sunderland with JPMorgan.

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. And 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 it's -- that's probably the right way to think about it. We're continuing in the jurisdictions of our states that don't have those agreements in place. We're continuing to evaluate those opportunities and working very closely with now the HOS ownership or leadership to see if opportunities exist. So it's a very active part of our business plan.

Our next question comes from Durgesh Chopra with Evercore ISI.

Just -- congrats by the way, on the regulatory execution here year-to-date. You guys have done a phenomenal job and great outcomes. Just on the acquisition side of things, can you update us on where you stand year-to-date versus your targets? I think this year, you're planning on hitting $500 million in acquisitions. So could you just update us there? And then I 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 another kind of 5,000 or so customers to come. I would say that on a dollars basis, as we disclosed in our slides, our expected closings for the year will be in the neighborhood of $350 million, which -- and as you know, we target about $300 million to $400 million a year. We've said over 5 years, we're $1.5 billion to $2 billion on a run rate basis.

Got it. $250 million for this year. Okay. And then maybe I was just -- and I don't want to front on your equity process, but just anything, John, you can share in terms of what are you looking for in terms of valuation or price ranges for this equity? I understand significant portion is expected to land next year. Any additional color that you can share with us there?

No, Durgesh, I wouldn't say we think of in terms of specific price ranges. Obviously, we'll be very cognizant of market conditions. But I'd say we just -- we think of it more in terms of what we've messaged in the past, which is the equity from a mid-plan perspective. And as we approach 2023 here, that is mid plan relative to our historical messaging.

Our next question comes from Steve Fleishman with Wolfe Research.

So just on the -- a couple of questions related to the equity and balance sheet. So the -- in the 2023 guidance, are you kind of assuming that it's kind of averaged roughly over the year or beginning of the year or just kind of how are you incorporating that into the '23 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 only add that -- let me just add quickly, Steve. I think that -- and John said this, market conditions, of course, will drive this. But we are still looking at how best to do it. You've heard us talk in the past about it's likely going to be in sort of a single issue or a block, but we do need to evaluate all the options available to us. So that's still in the works.

Okay. Makes sense. And then could you -- maybe just on the balance sheet, could you give more color on the comment about getting -- adding some of this for balance sheet, cushion or flexibility? And what's the thinking there today versus in the past? Is it just the volatility of markets? Is it what you see in terms of kind of acquisition pipeline or regulated investment pipeline? Or is it tax related? Just why now for the additional balance sheet capacity not a year ago or 2 years ago?

John, do you want to take that?

Sure. Yes, I'd say, Steve, just as we've thought about our metrics over time, we're in a very strong credit position, but we do look at our ramping up of capital spend, both on the organic side as well as on the acquisition side. And so we just think it's healthy for us to have some cushion there. I would say just also, as we're thinking about the cadence of our equity issuance, where we'll do much of it in 2023, but then waiting until the back end of our plan for another issuance as we thought about it. That's just a natural consequence of creating some cushion for ourselves.

Yes. Steve, I'd simply add to that. I think that we talked a lot about payout ratio on the dividend. And obviously, we narrowed the dividend range a little bit here. We just feel the need to continue to really push ourselves on the ability to advance this capital spending. As Cheryl talked about the replacement cycle, we just don't want to find ourselves in a situation where we have to put some constraints on that on the investment side. So I think if we can create a little capacity here, it just helps us have that level of certainty around our ability to continue to accelerate. And these market conditions obviously are quite volatile, and it just doesn't hurt in this environment to have a little bit of extra cushion there. So I think that's really honestly the driver.

Next question comes from Gregg Orrill with UBS.

I was wondering if your guidance on the operating cash flows for '23 to '27, that ramp-up versus the prior plan, if there's anything sort of non-operating in there or adjustments or if that's really the growth of the business?

It really is the growth of the business, Gregg. Again, we just -- we feel very good about how we're -- how the investment is being rolled out, cash flows from operations and the ability to get good, solid, timely regulatory solutions.

And Gregg, I'd just add to that, a significant portion is just the roll forward. So if you think about what's rolling off in 2022 versus what's being added in 2027, there's a pretty -- because of the ramp-up in CapEx through those years, that differential is reasonably significant. And then in the interim years because of our ramp, we're recovering additional depreciation -- deferred tax contribution to cash flows. But a lot of it is the roll forward by itself.

This concludes our question-and-answer session as well as our conference for today. Thank you for attending. You may now disconnect.