American Water Works Company, Inc. quarterly report, Q2 FY2017

American Water Works Company, Inc. — Q2 2017 Form 10-Q

Reporting period: Three and six months ended June 30, 2017; filed August 2, 2017. Amounts are in millions except per-share data. The company primarily operates regulated water and wastewater utilities, alongside Market-Based Businesses.

Financial results and position

Metric	Q2 2017	Q2 2016	Six months 2017	Six months 2016
Operating revenue	$844	$827	$1,600	$1,570
Operating income	$308	$299	$535	$513
Net income attributable to common stockholders	$131	$137	$224	$219
Diluted EPS	$0.73	$0.77	$1.26	$1.23
Operating margin, calculated	36.5%	36.2%	33.4%	32.7%
Net margin, calculated	15.5%	16.6%	14.0%	13.9%

Revenue rose 2.1% in Q2 and 1.9% year to date. Operating income increased 3.0% and 4.3%, respectively. Q2 net income fell 4.4%, while six-month net income increased 2.3%.
Q2 regulated-business net income increased 3.7%; six-month regulated-business net income increased 5.4%. Market-Based Businesses net income declined by $4 in both comparative periods, largely reflecting less Military Services Group capital-upgrade work.
Cash flow: Six-month operating cash flow was $524, versus $536 in 2016. Investing used $640, including $602 of capital expenditures; financing provided $105. Cash and equivalents were $64 at June 30, down from $75 at year-end. Cash flows are seasonal and are generally higher in the third quarter.
Debt and liquidity: At June 30, long-term debt was $5,650, current maturities $686, and short-term debt $1,117. Combined reported debt was about $7,453, up from about $7,172 at year-end. The $1.75 billion AWCC revolving facility supported $1.1 billion of commercial paper; about $1.66 billion was reported available for liquidity and letters of credit. The debt-to-capitalization covenant ratio was 0.58 versus a maximum of 0.70; the company reported compliance.
Common equity was $5,384, versus $5,218 at year-end. The declared dividend was $0.415 per share, up from $0.375 in the 2016 comparison.

Material changes and drivers

Regulated revenue growth reflected authorized rate increases and infrastructure surcharges, acquisitions, and organic growth; lower demand partly offset growth. Rate increases and surcharges contributed $47 to six-month revenue growth, while acquisitions and organic growth contributed $19.
Regulated operating costs increased, including depreciation and amortization, as additional utility plant entered service. Consolidated O&M expense decreased 1.9% year to date, chiefly because of lower Military Services Group activity and related costs.
Interest expense rose $9 year to date, reflecting higher debt and short-term borrowing costs. Short-term borrowing rates averaged 1.14% for the first six months, versus 0.75% in 2016.
The Q2 effective tax rate increased to 41.8% from 39.1%, mainly due to a $4 noncash cumulative charge following New York tax-law changes. A $5 share-based-payment tax benefit partly offset the change for the first half.
The company completed ten regulated-system acquisitions for total stated consideration of $42, adding approximately 15,000 customers. Shorelands, serving about 11,000 customers, was acquired for approximately 438,211 shares.

Outlook, commentary, risks and contingencies

Investment outlook: Management expected 2017 capital investment, including regulated acquisitions, of $1.5–$1.6 billion. A proposed McKeesport wastewater-system acquisition for approximately $162 million was expected to close by Q1 2018, subject to conditions and regulatory approval. The company also estimated up to $165 million for a new Camden headquarters, with $70 million expected in 2017.
Efficiency: The adjusted regulated O&M efficiency ratio was 34.5% for the 12 months ended June 30, compared with 35.2% a year earlier. This is a non-GAAP measure; the company attributed the improvement primarily to regulated revenue growth and excluded specified items, including the Freedom Industries settlement impact.
Rate activity: New rate authorizations effective in the first half were expected to generate $43 of annualized general-rate-case revenue and $23 of annualized infrastructure-surcharge revenue. Pending or filed requests included Pennsylvania general rates of $108, Missouri general rates of $84, and infrastructure surcharges of $5 in Missouri and $3 in West Virginia. Requests are not guaranteed to be approved.
Freedom Industries spill: A proposed $126 global settlement remained subject to court approval. The company recorded a $65 charge net of insurance receivables in Q3 2016; the settlement liability and offsetting insurance receivable were reflected at June 30, 2017. On July 6, the court denied preliminary approval without prejudice, identifying concerns with settlement procedures. The company intended to propose revisions. Two insurers with $50 of aggregate coverage had not agreed to participate; related coverage disputes were being pursued. WVAWC’s proposed contribution was $65, subject to final approval and settlement terms.
The company reported approximately $139 of accrued probable loss contingencies and up to $28 of reasonably possible losses that could be reasonably estimated; some matters could not be estimated. A new class action over the 2015 Dunbar water-main failure sought unspecified damages, and the company said it could not reasonably estimate potential losses.
Other notable matters: California regulators were considering a proposed settlement over residential tariff administration; the administrative law judge discussed a possible penalty range of $3–$179, while the company said the probable or reasonably possible portions were immaterial at June 30. In East Palo Alto, a state citation addressed potential operator-certification, lead-and-copper sampling, and reporting violations; it imposed no monetary penalty but reserved further enforcement rights. Illinois tax changes were expected to produce an estimated $3 noncash earnings charge in Q3, partly offset by a regulatory asset.
Forward-looking risks include regulatory rate decisions and timing, weather and demand, infrastructure condition, cybersecurity, operating costs, capital-market access and interest rates, environmental and water-quality matters, litigation, and acquisition execution. Management reported disclosure controls effective at a reasonable level of assurance and no material change in internal control over financial reporting during Q2. The filing provides no full-year EPS guidance.

Important facts for investors to verify

Progress toward court approval and final terms of the Freedom Industries settlement, including insurance recoveries from nonparticipating carriers.
Rate-case and surcharge outcomes, particularly the large Pennsylvania and Missouri requests, and the timing of authorized revenue recovery.
Funding and execution of the $1.5–$1.6 billion 2017 investment plan, the proposed McKeesport acquisition, and headquarters construction.
Whether regulated revenue growth and efficiency gains continue to offset lower demand, rising depreciation, and higher financing costs.
Developments in the Dunbar class action, California tariff proceeding, and East Palo Alto compliance matter, including any penalties or additional costs.
The expected Q3 tax impact from Illinois legislation and the company’s ability to maintain liquidity, debt-covenant compliance, and credit ratings.