AWK

Business Context and Reporting Period

Company: American Water Works Company, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2008
Business Overview: The Company is the largest investor-owned U.S. water and wastewater utility, operating in two segments: Regulated Businesses and Non-regulated Businesses. The reporting period covers the second quarter and first six months of 2008, immediately following the Company's Initial Public Offering (IPO) in April 2008.

Key Financial Metrics

Material Changes vs. Prior Period

• Goodwill Impairment: The most significant change is a non-cash goodwill impairment charge of $750.0 million recorded in the first quarter of 2008. This charge, driven by the IPO price and subsequent trading levels being lower than anticipated, resulted in a net loss for the six-month period despite positive operating cash flows.
• Revenue Growth: Operating revenues increased 5.5% ($30.6 million) for the quarter and 6.7% ($68.9 million) for the six months compared to 2007. Growth was driven by rate increases in regulated businesses and expansion in non-regulated contract operations.
• Operating Expenses: Excluding the impairment charge, operating expenses increased due to higher employee-related costs (wages, stock-based compensation from the IPO, and pension expenses) and increased maintenance costs (removal costs, tank painting).
• Capital Structure: Following the IPO, RWE Aqua Holdings GmbH retained approximately 60% ownership. RWE made a capital contribution of $245.0 million in May 2008 to offset the impairment charge, which was used to reduce short-term debt.

Outlook, Risks, and Management Commentary

• Regulatory Developments: The Company received authorizations for $47.2 million in additional annualized revenues from rate cases in the first half of 2008. It has filed cases in ten additional states seeking $271.0 million in annualized revenue increases, though approval is not guaranteed.
• Capital Investment: The Company anticipates spending approximately $950 million on capital investment in 2008, including a major $162–$168 million water treatment plant project in Kentucky.
• Dividend Policy: The Board declared a quarterly cash dividend of $0.20 per share, payable September 2, 2008. The policy targets distributing 50% to 70% of annual net income.
• Internal Control Weaknesses: Management concluded that disclosure controls and procedures were not effective as of June 30, 2008, due to material weaknesses identified during the transition from a private subsidiary to a public company. These include inadequate staffing, controls over financial reporting, and tax accounting. Remediation is expected to be completed in 2008 at an estimated additional cost of $2.8 million.
• Market Risk: The Company faces risks related to interest rate fluctuations and credit market conditions. A hypothetical 10% increase in interest rates would decrease pre-tax earnings by $1.2 million. Standard & Poor's downgraded the senior unsecured issuer rating to "BBB+" in June 2008.

Investor Verification Checklist

• Impairment Sustainability: Verify if the $750 million goodwill impairment is a one-time event or if further impairments are likely given the stock price performance relative to the IPO price.
• Rate Case Approvals: Monitor the status of the $271.0 million in pending rate case filings, as regulatory approval is critical for future revenue growth.
• Internal Control Remediation: Track the progress of remediation efforts for the identified material weaknesses in internal controls over financial reporting to ensure compliance with Sarbanes-Oxley Act Section 404.
• Debt Covenants: Confirm continued compliance with debt covenants, specifically the consolidated debt to capitalization ratio (currently 0.55, limit 0.70), especially following the S&P downgrade.
• Capital Expenditure Funding: Assess the Company's ability to fund the projected $950 million capital program given the liquidity crisis in credit markets and the recent reduction in cash reserves.