Business context and reporting period
This unaudited Form 10-Q is for the quarter and nine months ended September 30, 2019. The issuer named in the filing is Aqua America, Inc. (the company identified in the request as Essential Utilities). Its regulated water and wastewater utilities served nearly three million people in eight states; a major strategic focus was the pending acquisition of Peoples, a natural gas utility serving about 740,000 customers.
Financial performance and liquidity
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $243.6 | $226.1 | $663.7 | $632.3 |
| Operating income | $106.5 | $104.3 | $254.9 | $260.4 |
| Net income | $88.5 | $78.2 | $160.3 | $195.6 |
| Diluted EPS | $0.38 | $0.44 | $0.76 | $1.10 |
| Operating margin | 43.7% | 46.1% | 38.4% | 41.2% |
Third-quarter revenue rose 7.7% and net income rose 13.1% year over year, while diluted EPS fell as the share count increased substantially. For the first nine months, revenue grew 5.0%, but net income declined 18.1%, reflecting acquisition-related costs, swap valuation losses and debt-refinancing charges, among other factors.
Operating cash flow was $228.0 million for the first nine months, down from $290.7 million. Capital expenditures were $401.6 million, implying operating cash flow less capital expenditures of negative $173.5 million. Cash and cash equivalents were $2,030.6 million at September 30, including $1,968.1 million of financing proceeds held for the Peoples acquisition. Long-term debt, including current maturities, was $3,112.0 million, compared with $2,563.7 million at year-end 2018. Stockholders’ equity increased to $3,862.6 million from $2,009.4 million, primarily due to equity financing.
The company reported positive working capital at quarter-end, largely because acquisition financing remained in cash. Its $550 million revolving facility had $532.4 million available, and short-term lines totaling $135.5 million had $125.5 million available. Management said cash generation, credit facilities and debt and equity financing should cover working capital and financing needs for at least 12 months.
Material changes and notable items
- Revenue growth reflected higher water and wastewater rates, customer growth and acquisitions; lower customer consumption and an Illinois customer advisory partly offset the increase.
- Q3 operations and maintenance expense rose 19.5%, including $2.5 million of Peoples transaction costs and $2.3 million to address the Illinois advisory. The company expected advisory-related revenue reductions and remediation expenses to continue in Q4 2019.
- Nine-month results included a $23.7 million expense from changes in the fair value of interest-rate swaps and an $18.9 million debt-extinguishment loss. The swaps were settled in April for $83.5 million; $6.3 million of the debt make-whole payment was deferred as a regulatory asset for expected future rate recovery.
- The company issued common stock, tangible equity units and senior notes in 2019 to finance the planned Peoples acquisition and refinance debt. A further approximately $750 million private placement was expected to close with the acquisition.
- Quarter-end cash and current assets were unusually elevated by acquisition financing; they should not be interpreted as ordinary operating liquidity.
Outlook, risks and contingencies
The Peoples acquisition, with a stated cash purchase price of $4.275 billion subject to adjustments, remained subject to Pennsylvania regulatory approval and closing conditions. The company expected closing in late 2019 or early 2020 and anticipated assuming approximately $1.432 billion of Peoples debt. An administrative law judge recommended approval in October 2019; the filing does not report final approval. Certain breaches by the company could trigger a $120 million reverse termination fee. The company had $750 million remaining under its bridge commitment and noted that the senior notes could be subject to mandatory redemption if the acquisition did not proceed under specified conditions.
No specific earnings guidance was provided. Management cited risks including regulatory decisions and rate recovery, abnormal weather, capital-market access and financing costs, acquisition completion and integration, water contamination and emerging contaminants, and the possibility that earnings growth may lag rate-base growth. Management reported no material change in market-risk exposure, effective disclosure controls, and no pending legal proceeding expected to have a material adverse effect. Accrued loss contingencies were $19.7 million, with an estimated $7.8 million potentially recoverable through insurance.
Key facts for investors to verify
- Whether and when the Peoples acquisition received final Pennsylvania approval and closed, and the final purchase-price and debt-assumption amounts.
- How the acquisition financing, including the pending private placement and tangible equity units, affects leverage, interest expense and future share dilution.
- Whether the Illinois advisory’s expected Q4 revenue and remediation-cost effects, and customer-consumption trends, continued.
- Whether the expected regulatory recovery of the deferred $6.3 million debt-refinancing cost was approved and collected through rates.
- Whether operating cash generation and capital spending support the company’s funding needs after acquisition cash is deployed.