Essential Utilities, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Unless otherwise noted, amounts are in U.S. dollars; financial statement amounts below are in millions. The company provides regulated water and wastewater services and, following its March 16 acquisition of Peoples Natural Gas, regulated natural gas service. Peoples’ results are included only from the acquisition date.
Key financial results
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Operating revenue | $255.6 | $201.1 |
| Operating income | $73.5 | $67.4 |
| Operating margin | 28.8% | 33.5% |
| Net income | $51.8 | $16.9 |
| Diluted earnings per share | $0.20 | $0.09 |
| Operating cash flow | $95.5 | $79.3 |
| Capital expenditures | $118.7 | $133.8 |
Revenue increased 27.1%, principally reflecting $38.5 million of Peoples natural gas revenue and higher water and wastewater rates. Operating income rose 9.0%, while operating margin declined, in part reflecting acquisition-related and other costs. Net income was higher than the prior-year quarter, which included a $34.8 million noncash loss from interest-rate swap fair-value changes. The 2020 tax provision was a $7.1 million benefit, including a $5.9 million reduction from tax treatment of qualifying infrastructure investment.
Peoples contributed $38.5 million of revenue and $13.4 million of earnings from March 16 through March 31. The acquisition’s short contribution period limits direct comparison with the prior-year quarter. The filing also presents supplemental pro forma results assuming the acquisition occurred January 1: revenue of $536.7 million and net income of $137.3 million for Q1 2020, versus $598.7 million and $68.1 million, respectively, for Q1 2019. The company cautions these figures are not necessarily representative of actual or future results.
Acquisition, debt and liquidity
- The company paid $3.465 billion cash consideration for Peoples and assumed $1.101 billion of indebtedness. The preliminary purchase-price allocation included $2.288 billion of goodwill and remains subject to adjustment.
- Total long-term debt, before issuance costs, was $4.872 billion at March 31, up from $3.077 billion at December 31, 2019. Loans payable were $381.0 million, versus $25.7 million. The company issued $730.1 million of common stock in a private placement and recorded $800.2 million of long-term debt proceeds during the quarter.
- Cash and cash equivalents were $31.8 million, down from $1.869 billion at year-end, largely because cash raised in 2019 was used to fund the acquisition. Current assets were $368.0 million versus current liabilities of $827.4 million.
- At quarter-end, $178.5 million was available under the $1.0 billion revolving facility and $85.5 million under short-term credit lines. Management said internal cash generation, credit facilities, and future debt and equity issuances should fund operations and requirements for at least 12 months.
- After quarter-end, the company drew a $500 million unsecured term loan due April 2021; issued $1.1 billion of long-term notes in April, at 2.704% and 3.351%, due 2030 and 2050; and Aqua Pennsylvania issued $175 million of bonds in May, at 3.49%–3.55%, due 2051–2056. Proceeds were used in part to repay borrowings and for general corporate purposes.
Cash flow, margins and shareholder items
Operating cash flow was $95.5 million, compared with $79.3 million a year earlier. Investing cash outflow was $3.565 billion, mainly reflecting the Peoples acquisition; financing cash inflow was $1.632 billion. The company declared dividends of $0.2343 per share, totaling $52.2 million. Revenue growth and operating-income growth were below the reported revenue increase; the operating margin fell to 28.8% from 33.5%.
Outlook, risks and unusual items
- COVID-19: Management reported no material first-quarter effect on estimates or forecasts but said the longer-term effect could not be determined. It is monitoring customer usage and collections, potential bad debts, added workforce and facility costs, supply availability, and possible delays or higher costs for capital work. Regulators temporarily curtailed certain collection practices, including service disconnections. The company continued its capital program and said it was too early to assess the pandemic’s revenue impact.
- Acquisition commitments: As a condition of regulatory approval, the company committed to an estimated $120 million gathering-pipe replacement program over seven years, recoverable through customer rates, and $23 million of customer rate credits by year-end 2020.
- Operating and regulatory risks: Newly disclosed natural-gas risks include supply and interstate-pipeline availability, pipeline integrity and related spending, seasonal gas-purchase financing needs, and possible regulatory disallowance of purchased-gas costs. COVID-19 may also affect demand, collections, regulatory approvals, capital markets, and operations.
- Other contingencies: The company accrued $21.8 million for loss contingencies, with an estimated $7.7 million recoverable through insurance. An Illinois water-quality class action related to a 2019 do-not-consume advisory was in discovery; class certification had not been granted. Management said the ultimate outcome could not be predicted and had not accrued a liability for possible future fines or penalties related to the advisory.
- Other pipeline of growth: Pending water and wastewater utility acquisitions include DELCORA, expected to close in late 2020 or early 2021 subject to regulatory approval, and East Norriton Township and New Garden Township, also subject to approvals and closing adjustments.
- The company reported effective disclosure controls. Integration of Peoples’ internal controls was in progress. No formal earnings guidance is provided in the supplied filing text.
Important facts for investors to verify
- Final Peoples purchase-price adjustments and purchase accounting, including the substantial preliminary goodwill balance.
- Post-acquisition earnings, debt levels, interest expense, and the company’s ability to service and refinance borrowings.
- COVID-19 effects on customer demand, collections, operating costs, regulatory actions, and capital-project execution.
- Progress, costs, and regulatory rate recovery for the $120 million pipeline commitment and delivery of the $23 million customer credits.
- Developments in the Illinois water-quality matter and any potential fines or penalties not accrued.