American Water Works Company, Inc. quarterly report, Q3 FY2018

American Water Works Company, Inc. — Q3 2018 Form 10-Q

Business context and period. The company provides regulated water and wastewater services across the U.S. and operates complementary market-based businesses. This unaudited filing covers the quarter and nine months ended September 30, 2018; amounts are in millions of dollars except per-share data. Interim results are seasonal and are not necessarily indicative of full-year results.

Financial performance

Metric	Q3 2018	Q3 2017	Nine months 2018	Nine months 2017
Operating revenue	$976	$936	$2,590	$2,536
Operating income	$335	$432	$854	$972
Net income attributable to common stockholders	$187	$203	$455	$427
Diluted EPS	$1.04	$1.13	$2.53	$2.39
Operating margin, calculated	34.3%	46.2%	33.0%	38.3%

Revenue rose 4.3% in Q3 and 2.1% for the nine-month period. Regulated revenue grew modestly, while market-based revenue benefited notably from the Pivotal acquisition. Rate increases and customer growth were partly offset by lower revenue reflecting Tax Cuts and Jobs Act (TCJA) customer benefits.
Operating income declined 22.5% in Q3 and 12.1% year to date, principally reflecting higher operating costs and a $57 million Keystone impairment. The lower income-tax provision—reflecting the federal rate reduction from 35% to 21%—helped support nine-month net income growth despite lower operating income.
Management’s non-GAAP adjusted diluted EPS was $1.20 for Q3, up 11.1%, and $2.61 for nine months, up 11.5%. These figures exclude specified items, including the Keystone impairment and the Contract Services Group sale gain; they are not GAAP measures.
Nine-month operating cash flow was $992 million, versus $1,020 million. Investing cash outflow was $1,545 million, including $1,136 million of capital expenditures and $381 million for acquisitions. Financing provided $586 million; cash and restricted funds ended at $116 million.
At September 30, cash was $86 million, current assets $800 million, and current liabilities $1,748 million. Long-term debt was $7,570 million, short-term debt $564 million, and current long-term debt $263 million. The company reported a 0.59 debt-to-capitalization covenant ratio and $2.16 billion available under its principal revolving facility, including capacity supporting commercial paper.
Dividends declared were $0.455 per share for Q3, compared with $0.415 a year earlier. The adjusted regulated-business O&M efficiency ratio was 35.7% for the twelve months ended September 30, versus 35.9% on the comparable adjusted basis.

Material changes and notable items

Q3 included a $57 million noncash, pretax impairment—$53 million goodwill and $4 million intangible asset—after Keystone exited construction and water-trucking activities to focus on water transfer services. The after-tax charge attributable to the company was reported as $40 million, or $0.22 per diluted share.
The sale of 20 Contract Services Group contracts generated a $14 million pretax gain, or $10 million after tax ($0.06 per share). Two additional contract sales remained subject to customer consent.
The company acquired Pivotal Home Solutions for $365 million, adding approximately 1.2 million customer contracts. It funded the acquisition with approximately equal debt and equity, including $183 million net proceeds from a common-stock issuance.
In August, the company issued $1.325 billion of senior notes: $625 million at 3.75% due 2028 and $700 million at 4.20% due 2048. Proceeds refinanced debt and commercial paper and supported general corporate purposes. Debt increased from year-end 2017.
The company recorded a $55 million regulatory reserve for estimated TCJA customer savings during the first nine months. Regulatory proceedings on tax savings remained pending in five jurisdictions. A postretirement-plan amendment reduced the accumulated benefit obligation by $227 million, with a corresponding regulatory liability.
The Freedom Industries settlement was finalized; the company’s aggregate pretax contribution, net of insurance recoveries, was stated as $23 million. The filing reported $40 million of settlement payments reflected in accrued liabilities at quarter-end, with offsetting insurance receivables in other current assets.

Outlook, risks and contingencies

Management expected 2018 investment of $2.0–$2.1 billion for capital expenditures and acquisitions. It did not provide a clear full-year EPS forecast in the supplied filing text.
After quarter-end, New Jersey regulators approved $40 million of annualized additional revenue, effective June 15, 2018, with a 9.6% authorized return on equity. A West Virginia rate-case stipulation proposing $23 million of annualized revenue was pending regulatory approval.
The company reported a new 50-year Fort Leonard Wood military-services contract, effective October 1, with estimated revenue of approximately $591 million, subject to annual economic price adjustments. Two wastewater acquisitions, in Alton and Exeter Township, were pending approval.
California regulators approved a certificate for a 6.4-million-gallon-per-day Monterey desalination project. Completion was estimated no earlier than sometime in 2021; litigation, permitting, cost caps, environmental requirements, and the 2021 water-diversion compliance deadline create execution and cost risks.
Other risks include regulatory rate outcomes and recovery of costs, weather and water supply, infrastructure reliability, cybersecurity, acquisition integration, interest rates and access to capital, condemnation proceedings, and potential goodwill impairment. The company accrued approximately $55 million for probable loss contingencies and estimated up to $25 million for reasonably possible losses that could be reasonably estimated; certain matters could not be estimated.
New York subsidiary NYAW agreed to provide up to $4.5 million in customer benefits not recoverable in rates, accelerate approximately $6.4 million of customer credits, and fund independent monitors under a settlement. The filing warned of possible further proceedings and reputational or regulatory consequences.
Moody’s outlook was negative; S&P’s outlook was stable. Management stated that short-term funding depended on operating cash flow, capital-market access, commercial paper, and the revolving facility, and cautioned that future market access was not assured.

Key investor verification points

Reconcile GAAP EPS with adjusted EPS and assess the recurrence and cash impact of the impairment, sale gain, tax-related customer reserves, and settlement items.
Track operating-cost growth, particularly purchased water and chemical costs, employee expenses, main-break maintenance, and property taxes, against rate increases and efficiency gains.
Review debt maturities, commercial-paper balances, interest costs, credit outlooks, and liquidity available after planned capital spending and acquisitions.
Monitor regulatory decisions on TCJA savings, rate cases, infrastructure surcharges, and recovery of investment; verify the effects of the New Jersey order and any West Virginia approval.
Assess Keystone’s post-exit performance and valuation assumptions, Pivotal integration, pending acquisitions, and the remaining Contract Services Group divestitures.
Follow Monterey project approvals, costs, schedule, litigation, and compliance obligations, as well as the unresolved Freedom Industries and Dunbar water-main litigation.