AWK

American Water Works Company, Inc. - 10-Q Summary (Q3 2008)

Business Context and Reporting Period

This report covers the quarterly period ended September 30, 2008. American Water Works Company, Inc. is the largest investor-owned water and wastewater utility in the United States. The company operates through two primary segments: Regulated Businesses (water and wastewater utilities subject to state regulation) and Non-Regulated Businesses (contract operations, homeowner services, and applied water management). The company completed its Initial Public Offering (IPO) in April 2008, with RWE Aqua Holdings GmbH retaining approximately 60% ownership.

Key Financial Metrics

Note: Nine-month net loss is heavily impacted by a non-cash goodwill impairment charge of $750.0 million recorded in Q1 2008.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased by $39.1 million (6.2%) for the quarter and $108.0 million (6.5%) for the nine months compared to 2007. This growth was driven by rate increases in regulated businesses and higher contract operations revenue in non-regulated businesses, partially offset by lower water sales volumes due to wetter weather conditions.
• Profitability: The company reported a net income of $88.2 million for the quarter, a significant improvement from a net loss of $160.1 million in Q3 2007. The prior year loss included a $243.3 million goodwill impairment charge. Conversely, the nine-month period showed a net loss of $598.8 million, primarily due to the $750.0 million goodwill impairment recorded in Q1 2008.
• Operating Expenses: Excluding impairment charges, operating expenses increased due to higher employee-related costs (wages, stock-based compensation, and pension expenses) and maintenance costs. However, Sarbanes-Oxley remediation costs decreased significantly compared to 2007.
• Capital Structure: Following the Q1 impairment, RWE contributed $245.0 million in cash to the company, which was used to reduce short-term debt. Total long-term debt remained relatively stable at approximately $4.67 billion.

Outlook, Risks, and Management Commentary

• Goodwill Impairment Risk: Management noted that while no interim triggering event occurred in Q3, the company's market capitalization remains below its carrying value. Future impairments are possible if stock prices decline further, valuation multiples of peers drop, or forecasted results deteriorate. The annual impairment test is scheduled for November 30, 2008.
• Liquidity and Credit Markets: Due to severe disruptions in credit markets in September 2008, the company was unable to issue commercial paper. It relied on its $800 million revolving credit facility to meet liquidity needs. A majority of lenders agreed to extend $685 million of this facility to September 2013.
• Regulatory Developments: The company received rate authorizations totaling $73.9 million in annualized revenue in the first nine months of 2008. Additional rate cases totaling $272.9 million in potential annualized revenue were filed in ten states during the period.
• Internal Controls: The company disclosed that its disclosure controls and procedures were not effective as of September 30, 2008, due to material weaknesses in internal control over financial reporting (e.g., staffing, month-end closing, contract maintenance). Remediation efforts are ongoing, with an estimated additional cost of $0.4 million to complete in 2008.
• Dividends: The company paid a quarterly dividend of $0.20 per share in September 2008 and declared another $0.20 per share payable in December 2008.

Investor Verification Checklist

• Goodwill Valuation: Verify the assumptions used in the upcoming November 2008 annual goodwill impairment test, given the volatility in the company's stock price and the credit market environment.
• Liquidity Position: Monitor the company's ability to access capital markets and the status of its revolving credit facility extensions in light of ongoing credit market disruptions.
• Internal Control Remediation: Track the progress of remediation for material weaknesses in internal controls to ensure compliance with Sarbanes-Oxley Act Section 404 requirements.
• Rate Case Outcomes: Review the final orders for pending rate cases in Ohio, Hawaii, and the eight states where cases were filed in 2008, as these impact future revenue recovery.
• Environmental Liabilities: Assess the status of the MTBE contamination litigation settlements and the NOAA conservation agreement regarding steelhead trout, which involve significant potential costs.