Essential Utilities, Inc. quarterly report, Q3 FY2017

Business context and reporting period

This is Aqua America, Inc.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. The filing identifies Aqua America as the registrant; it does not use the name Essential Utilities. Aqua America operated regulated water and wastewater utilities in eight states, serving almost three million people, alongside smaller market-based activities.

Key financial metrics

Amounts below are in millions of dollars, except per-share data and percentages.

At September 30, 2017, total assets were $6.545 billion, stockholders’ equity $1.938 billion, and total long-term debt including current maturities $2.059 billion. Cash was $4.1 million. Current assets of $138.3 million were below current liabilities of $253.0 million. The $250 million revolving credit facility had $183.5 million available, and short-term credit lines had $114.5 million available. Nine-month dividends paid were $104.3 million; declared dividends were $0.2047 per share in Q3 and $0.5873 year to date.

Material changes versus prior comparable periods

• Revenue declined 5.1% in Q3 and 2.7% year to date. Management attributed the decreases mainly to lower customer water consumption and the disposition of market-based businesses.
• Q3 operating and maintenance expense fell $11.8 million, and nine-month expense fell $19.4 million, primarily reflecting disposed businesses, lower water production costs, lower employee medical costs, and lower postretirement expense. Operating income nevertheless edged down in both comparisons.
• Net income increased 4.2% in Q3 and 0.9% year to date, despite slightly lower operating income. Lower effective income tax rates—4.3% in Q3 versus 10.3%, and 6.0% year to date versus 8.4%—were a key contributor.
• Interest expense rose 11.1% in Q3 and 8.3% year to date, primarily due to higher average borrowings. Year-to-date operating cash flow fell to $282.1 million while capital expenditures increased to $337.7 million.
• Total debt increased from $1.911 billion at year-end 2016 to $2.059 billion at September 30, 2017; capital expenditures and debt issuance funded utility investment and other cash requirements.

Outlook, management commentary, risks and unusual items

• Management said internally generated funds, credit facilities, and long-term debt proceeds should support working capital and financing needs for at least the next 12 months. The company routinely operates with negative working capital. Short-term credit lines require annual renewal, and renewal and future terms are not assured.
• During the first nine months, approved base-rate increases and infrastructure surcharges were designed to add $7.4 million and $3.7 million, respectively, to annual revenue. The filing gives no earnings or revenue guidance.
• Four 2017 acquisitions added 1,003 customers. Agreements to acquire five municipal systems for approximately $145.7 million, adding about 14,900 customers, were subject to regulatory approval; closings were expected by mid-2018, subject to approval timing.
• Capital investment was $337.7 million year to date, focused on water mains, treatment plants, tanks, hydrants, service lines, wells, and other system improvements. The company issued $230 million of first mortgage bonds during the period and reported a further $75 million issuance in October, after quarter-end.
• Management cited regulation, abnormal weather, capital requirements and funding, acquisitions, capital-market conditions, and integration of acquired operations as risks to forward-looking expectations. It reported no material changes to previously disclosed risk factors or market-risk exposure.
• Accrued loss contingencies totaled $16.9 million; about $5.4 million was estimated recoverable through insurance. Management did not expect the matters to have a material adverse effect, while noting outcomes cannot be predicted with certainty.
• Tax deductions for qualifying infrastructure improvements in Pennsylvania reduced the effective tax rate and increased regulatory assets. The company reported $81.2 million in federal and $600.4 million in gross state NOL carryforwards; a portion of state NOLs is subject to a valuation allowance.
• Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Confirm the issuer identity: this source is Aqua America’s 2017 filing, not a filing under the Essential Utilities name.
• Assess whether lower consumption and discontinued market-based activities continue to pressure revenue, and whether approved rate changes and customer growth offset that pressure.
• Review the drivers and sustainability of earnings growth, particularly the lower tax rate and reductions in operating costs.
• Evaluate funding needs against rising capital expenditures, increased debt, low cash, the working-capital deficit, and renewal risk for short-term credit lines.
• Track regulatory approvals and closing terms for the five pending municipal acquisitions, along with the cost and timing of integration.
• Monitor legal contingencies, insurance recoveries, state NOL realizability, and regulatory treatment of infrastructure-related tax items.