American Water Works Company, Inc. — Q3 2016 Form 10-Q
Business and period: The company provides regulated water and wastewater utility services, alongside non-regulated water-related businesses. This filing covers the quarter and nine months ended September 30, 2016; interim results are seasonal and not necessarily indicative of full-year results.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenue | $930 million | $896 million | $2.500 billion | $2.376 billion |
| Operating income | $319 million | $361 million | $832 million | $843 million |
| Net income attributable to common stockholders | $148 million | $174 million | $367 million | $377 million |
| Diluted EPS | $0.83 | $0.96 | $2.05 | $2.09 |
| Operating margin, approximate | 34.3% | 40.3% | 33.3% | 35.5% |
- Q3 revenue increased 3.8%; nine-month revenue increased 5.2%. Regulated revenue growth reflected rate increases, infrastructure surcharges, acquisitions and organic growth.
- Operating and maintenance expense rose 18.7% in Q3 and 10.4% year to date. The Q3 increase included a $65 million charge for the Freedom Industries settlement, as well as a $5 million write-off of timekeeping-system costs.
- The company reported adjusted regulated-business O&M efficiency of 34.9% for the twelve months ended September 30, versus 35.8% a year earlier. This is a non-GAAP measure; management cited revenue growth and expense timing, and expected higher O&M expense in Q4.
- Regulated net income was $152 million in Q3 and $374 million year to date, versus $174 million and $377 million, respectively, in 2015. Market-Based Businesses earned $7 million in Q3 and $26 million year to date, down from $12 million and $31 million. Q3 military-services revenue fell with completion of projects and lower military-base infrastructure budgets.
Cash flow, balance sheet and liquidity
- Nine-month operating cash flow was $925 million, up from $856 million. Capital expenditures were $928 million, compared with $791 million; operating cash flow therefore fell $3 million short of capital expenditures before acquisitions and other investing items. Net investing cash outflow was $1.014 billion.
- Cash and cash equivalents were $46 million at September 30. Short-term debt was $951 million, current long-term debt $53 million, and long-term debt $5.842 billion. Total reported debt across these categories was approximately $6.85 billion.
- The company reported $5.238 billion of common stockholders’ equity. Its debt-to-capital covenant ratio was 0.57 to 1.00, within the 0.70 maximum. Short-term debt and current long-term debt rose to 8.3% of capital structure from 5.9% at year-end 2015.
- The revolving credit facility had $1.75 billion of capacity; $89 million was used for letters of credit, and $1.661 billion was reported available for short-term liquidity and letters of credit. The facility supported $951 million of outstanding commercial paper. Management said operating cash flow, capital-market access and the facility should fund near-term needs, while noting access is not assured.
- Dividends paid were $194 million for the nine months, versus $178 million. The quarterly dividend declared was $0.375 per share. The company repurchased $65 million of shares during the nine months.
Material changes, outlook and key matters
- Freedom Industries settlement: On October 31, 2016, after quarter-end, the parties reached a binding agreement in principle for a proposed $126 million global settlement. The company recorded a $65 million pretax Q3 charge, net of $61 million in insurance receivables, or $39 million after tax. WVAWC’s proposed contribution is $65 million; final settlement terms and court approval remained pending. Two insurers providing $50 million of coverage had not agreed to participate, and recovery from them is uncertain. WVAWC agreed not to seek West Virginia rate recovery for settlement payments or about $4 million of prior response costs.
- The company accrued approximately $136 million for probable loss contingencies and estimated up to $48 million of reasonably possible losses for certain matters; it could not estimate losses for some matters. Separately, the Missouri infrastructure-surcharge litigation had a reasonably possible loss range of zero to $26 million.
- Capital spending and growth: Full-year 2016 capital investment, including acquisitions, was expected to be $1.4–$1.5 billion, primarily for regulated infrastructure. The company closed ten regulated-system acquisitions in the first nine months, adding approximately 7,600 customers. Proposed acquisitions included Scranton wastewater assets for a stated $195 million purchase price, McKeesport wastewater assets for approximately $156 million, and Shorelands Water Company; each remained subject to applicable conditions and approvals.
- Management cited ongoing growth from regulated investment and rate increases. It also noted that market-based earnings faced pressure from lower military project activity. The filing did not provide a clear full-year earnings or EPS guidance figure.
- Rate cases and surcharges are subject to regulatory approval. At November 2, the company was awaiting general rate-case orders in five states seeking $97 million of annualized revenue and surcharge approvals in two states seeking $13 million; there is no assurance these requests will be granted. A California rate case sought $51 million over three years.
- Risks include regulatory decisions and recovery timing, water contamination and related litigation, weather and demand, infrastructure and technology disruptions, operating costs, interest rates, capital-market access, and acquisition execution. A non-cybersecurity firmware failure in April affected an IT storage device; water and wastewater operations were not impacted, and disaster-recovery procedures were used. Management reported disclosure controls were effective at a reasonable level of assurance.
Most important facts for investors to verify
- Whether the Freedom Industries settlement received final court approval, the final payment allocation, and whether the two non-participating insurers reimburse WVAWC.
- Whether the Q3 profit decline is viewed as primarily settlement-related or reflects continuing cost pressure; compare results excluding the disclosed settlement charge.
- Progress on rate-case and surcharge approvals, including the outcome of Missouri litigation and the timing and recoverability of large infrastructure investments.
- Funding needs and liquidity as capital spending, commercial paper borrowings and proposed wastewater acquisitions proceed.
- Whether military-services revenue weakness persists and whether management’s expected higher Q4 O&M costs materialize.