American Water Works Company, Inc. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; balance-sheet figures are as of March 31, 2011. Unless noted otherwise, amounts below are in millions of dollars. Interim results are unaudited and subject to seasonal variation.
Business context and reporting period
American Water is a U.S. water and wastewater utility with regulated businesses and market-based operations. Results for the regulated systems in Arizona, New Mexico, and Texas are reported as discontinued operations because the company has agreements to sell them. Comparisons below are to Q1 2010.
Key financial metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Continuing-operations revenue | $610.9 | $566.8 | +$44.2, or 7.8% |
| Operating income | $144.9 | $124.6 | +$20.2 |
| Operating margin | 23.7% | 22.0% | +1.7 percentage points |
| Income from continuing operations | $41.5 | $29.7 | +$11.8 |
| Net income, including discontinued operations | $47.3 | $30.8 | +$16.5 |
| Diluted EPS, continuing operations | $0.24 | $0.17 | +$0.07 |
| Diluted EPS, total | $0.27 | $0.18 | +$0.09 |
| Cash from operating activities | $161.5 | $176.0 | −$14.5 |
| Capital expenditures | $176.4 | $142.7 | +$33.7 |
- Revenue growth was led by a $39.2 million increase in regulated businesses, principally from rate increases, and a $6.0 million increase in market-based operations.
- Operating expenses increased 5.4% to $466.1 million. Operation and maintenance expense rose 4.9% to $320.6 million, while depreciation and amortization rose 7.3% to $88.0 million.
- Continuing-operations net margin was approximately 6.8%, compared with 5.2% in Q1 2010. The reported effective tax rate on continuing operations was 40.9%, versus 38.6%.
- Cash and cash equivalents were $13.5 million. Current assets were $1.306 billion and current liabilities $1.135 billion; current assets include $801.2 million of discontinued-operation assets.
- Long-term debt was $5.362 billion; short-term debt was $323.5 million, and the current portion of long-term debt was $12.2 million. Short-term debt included $313.1 million of commercial paper. Stockholders’ equity was $4.151 billion.
- The company reported $850 million of revolving credit commitments and $813.6 million of available facility capacity at quarter-end. It was in compliance with debt covenants; the debt-to-capitalization covenant ratio was 0.58 against a maximum of 0.70.
- Quarterly dividends were $0.22 per share, up from $0.21 a year earlier. The board declared another $0.22 dividend for payment June 1, 2011.
Material changes versus the prior comparable period
- Continuing-operations income increased primarily because of rate increases and higher market-based revenue. Regulated revenue rose 7.9%; management cited approximately $44.1 million of year-to-date impact from rate increases, partly offset by about $7.6 million from lower demand.
- Management’s non-GAAP regulated operating efficiency ratio improved to 48.2% from 49.4%.
- Regulated billed water volume was lower overall: residential volume fell 0.6% and commercial volume fell 1.6%; industrial volume increased 2.2%. Management cited economic conditions, weather, and conservation as possible contributors to lower demand.
- Operating cash flow declined mainly because pension and postretirement contributions increased to $48.8 million from $37.8 million and a tax refund received in Q1 2010 did not recur. Pension and postretirement benefit costs decreased, but contributions remained a material cash use.
- Capital expenditures increased to $176.4 million from $142.7 million. Investing cash outflow was $166.2 million, while financing cash flow was positive $5.1 million, including $135.2 million of net short-term borrowings.
- Net income included $5.9 million from discontinued operations, versus $1.1 million in Q1 2010. Approximately $4.7 million of the year-over-year net income increase resulted from ceasing depreciation on assets classified as discontinued operations.
Outlook, management commentary, risks, contingencies, and unusual items
- Management said it expected the Missouri acquisition of 11 water and 59 wastewater systems to close in Q2 2011. It expected the Texas asset sale to close in Q2 or Q3 2011 and the Arizona and New Mexico divestiture in late 2011 or early 2012, subject to approvals and closing adjustments. The stated sale prices were approximately $6.1 million for Texas and $470 million for Arizona and New Mexico. Proceeds from the latter were intended to reduce equity and debt financing.
- For Q1, the company received authorization for $10.9 million in annualized infrastructure-charge revenues. In April, Tennessee and West Virginia rate cases were approved for annualized increases of $5.6 million and $5.1 million, respectively. By May 4, the company was awaiting final orders in eight states on requests totaling $173.9 million in annualized revenue, with additional surcharge requests of approximately $1.9 million. Management cautioned that requested increases may not be granted in full.
- The filing gives no consolidated earnings or revenue guidance. Management’s stated 2011 priorities included executing portfolio optimization, resolving rate cases, addressing declining water usage, improving efficiency, increasing earned returns toward authorized returns, and selectively expanding market-based businesses.
- Management said operating cash flows are seasonal and are typically greatest in the third quarter. It believed operating cash flow, capital-market access, and revolving facilities would fund short-term capital needs, but warned that access to commercial-paper and loan markets, and lender commitments, cannot be assured.
- Discontinued-operation estimates include a $561,000 pretax Texas goodwill impairment and an estimated $52,000 after-tax loss on sale. Sale-related estimates may be adjusted. Continuing-operation goodwill was $1.204 billion; management warned that future impairment could result from adverse market, valuation, rate-case, investment, or forecast developments.
- Legal matters had approximately $2.4 million accrued as probable costs; additional losses were reasonably possible up to $10.7 million. The company said certain matters could not be estimated and did not expect claims to have a material adverse effect.
- Environmental remediation accruals were $6.6 million. The company also disclosed long-term military and other operations-and-maintenance contract commitments, including estimated remaining military contract revenue of $2.065 billion; military agreements have customary federal termination provisions.
- The company made $42.0 million of pension contributions and $6.8 million of other postretirement-plan contributions in Q1; it expected further 2011 contributions of $97.6 million and $20.4 million, respectively.
- Credit ratings were Moody’s Baa2 for senior unsecured debt and P2 for commercial paper, and S&P BBB+ and A2, respectively; outlooks were stable. The filing notes that downgrades could raise financing costs or lead counterparties to seek collateral. Management reported no material change in market risk and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the Texas, Arizona, and New Mexico sales close on expected schedules, receive regulatory approvals, and deliver proceeds consistent with stated terms.
- Whether pending rate cases and surcharge requests are approved, and whether awarded rates offset lower water usage and rising operating costs.
- Whether operating cash flow can support the elevated capital-spending program, pension contributions, and dividends without materially increasing short-term borrowing.
- How much of reported earnings growth is sustainable: Q1 net income benefited from discontinued-operation accounting, including $4.7 million from depreciation cessation.
- Whether demand trends, operating efficiency, and market-based contract revenues develop as management expects, and whether goodwill, legal, or environmental estimates change.