American Water Works Company, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Financial amounts below are in U.S. dollars; millions are shown unless noted. American Water operates regulated water and wastewater utilities and market-based service businesses. Interim results are seasonal and are not necessarily indicative of full-year results.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Operating revenue | $782.1m | $754.8m | $1,480.2m | $1,433.8m |
| Operating income | $277.6m | $254.8m | $481.9m | $442.2m |
| Income from continuing operations | $123.1m | $110.2m | $203.1m | $179.3m |
| Net income | $123.1m | $109.3m | $203.1m | $177.4m |
| Diluted EPS | $0.68 | $0.61 | $1.13 | $0.99 |
| Operating margin | 35.5% | 33.8% | 32.6% | 30.8% |
Revenue increased 3.6% in Q2 and 3.2% in the first half. Management attributed growth to regulated rate increases, infrastructure charges and demand, and to higher military-contract and Homeowner Services revenue. First-half diluted EPS growth was 13 cents; excluding 2014 Freedom Industries spill costs, management cited growth of 9 cents, driven by revenue growth, lower regulated O&M and California rate-case outcomes.
- Expenses and margins: Consolidated O&M decreased 0.4% in both Q2 and the first half, while depreciation and general taxes rose, principally with new plant and higher property taxes. Regulated O&M fell $25.3m in the first half; Market-Based O&M rose $27.1m alongside business growth. The company’s non-GAAP regulated O&M efficiency ratio improved to 35.9% for the twelve months ended June 30, from 37.7% a year earlier.
- Cash flow: First-half operating cash flow was $418.0m, down from $450.6m. Capital expenditures were $478.8m, versus $401.8m; investing cash use was $567.2m. Financing provided $270.9m, and cash ended the period at $144.8m. Working-capital changes and higher benefit contributions reduced operating cash flow.
- Debt and liquidity: At June 30, long-term debt was $5.433bn, current long-term debt $62.0m and short-term commercial paper $821.0m. Combined reported debt was approximately $6.315bn, up from approximately $5.944bn at December 31, 2014. The $1.25bn revolving facility was extended to June 2020; $1.210bn was available, with $40.4m of letters of credit outstanding and no revolver borrowings. The debt-to-capitalization covenant ratio was 0.56, within the 0.70 maximum. Current assets were $890.1m and current liabilities $1.512bn.
- Capital and shareholder returns: First-half capital investment was approximately $514.9m, including regulated infrastructure work and acquisitions. Dividends paid were $116.6m; the declared quarterly dividend was $0.34 per share. The company repurchased 250,000 shares for approximately $13.2m under its anti-dilution program.
Material changes and notable items
- Regulated revenue grew $8.7m in Q2 and $16.5m in the first half; Market-Based revenue grew $19.0m and $30.6m, respectively. Market-Based growth was mainly from military construction activity, two added military bases and Homeowner Services contract growth.
- Three regulated-system acquisitions closed in the first half for an aggregate purchase price of approximately $41.2m. On July 9, 2015, the company acquired a 95% interest in Keystone Clearwater Solutions for approximately $130m, subject to purchase-price adjustments.
- On July 9, 2015, the company reported expected 2015 capital investment of $1.2bn–$1.3bn, with most directed to regulated infrastructure and an additional $200m allocated for acquisitions and strategic investments. This is the filing’s stated investment outlook; it does not provide an earnings or EPS forecast.
- California’s general rate-case settlement was approved in April, with rates retroactive to January 1, 2015; it also allowed recovery of certain prior costs and a sharing mechanism for contamination proceeds. A first-quarter cumulative adjustment of $8.4m, net of tax, was recorded upon adoption of service-concession accounting, reducing opening accumulated deficit.
Outlook, risks and contingencies
- Rate proceedings remain important: West Virginia requested approximately $35.6m of annualized additional revenue; Missouri filed a request for approximately $25.2m in July. As of July 31, the company was awaiting final orders on requests totaling $127.0m. Management cautioned there is no assurance requested increases will be granted.
- California’s severe drought prompted mandatory conservation measures. Management said the Water Revenue Adjustment Mechanism should limit the earnings effect, but related surcharges or surcredits may affect cash flow because recovery or refunds generally occur over 12–36 months. The reported first-half WRAM cash-flow impact was approximately $10m.
- The Freedom Industries spill litigation remains active. A class-certification motion was pending, and mediation was scheduled for September 30, 2015. The company said it believed claims against it were without merit and would defend them. Across legal matters, approximately $3.8m was accrued for probable losses; estimated maximum reasonably possible losses were $29.6m, with some matters not estimable.
- Other notable matters include litigation related to California’s proposed regional desalination project and a Virginia diesel-fuel spill. EPA removal work was completed; a state notice of violation remained under discussion, with no specific penalty stated. The company also estimated a possible new headquarters could cost up to $165m, subject to location and incentives.
- Management reported no material changes to previously disclosed risk factors and no significant change in market-risk exposure. It stated disclosure controls were effective at a reasonable level of assurance.
Important facts for investors to verify
- Whether pending rate-case requests and infrastructure charges are approved, and when approved rates translate into revenue and cash collection.
- Capital-spending execution, acquisition costs and integration—including the subsequent Keystone purchase—and the funding required for the stated investment plan.
- Commercial-paper balances, refinancing needs, available revolving capacity and compliance with debt covenants as investment continues.
- Developments in Freedom Industries spill claims and California water-supply-project litigation, including any change in estimated exposure or insurance recovery.
- Whether drought-related conservation, WRAM balances and delayed collections affect operating cash flow despite the expected regulatory protection to earnings.