AWK

Business Context and Reporting Period

Company: American Water Works Company, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Overview: American Water is the largest investor-owned water and wastewater utility in the United States, serving approximately 15 million people across 32 states and Ontario, Canada. The company operates through two segments: Regulated Businesses (89.1% of revenue) and Non-Regulated Businesses (11.6% of revenue). The reporting period covers the company's first full year as a publicly traded entity following its Initial Public Offering (IPO) in April 2008.

Key Financial Metrics

Note: The 2008 operating loss and net loss were significantly impacted by non-cash goodwill impairment charges of $750.0 million.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenue increased 5.5% to $2,336.9 million, driven by rate increases ($132.8 million) and customer growth, partially offset by lower water consumption due to wet weather in the Midwest and economic downturns affecting industrial usage.
• Profitability Decline: The company shifted from a modest operating income of $15.1 million in 2007 to an operating loss of $186.9 million in 2008. This reversal was primarily due to a $750.0 million goodwill impairment charge, compared to $509.3 million in 2007.
• Capital Expenditures: Construction expenditures increased 34.4% to $1.0 billion, reflecting a strategic acceleration in infrastructure replacement and treatment facility upgrades.
• Expense Increases: Operation and maintenance expenses rose 4.6% to $1.3 billion, driven by a 9.1% increase in employee-related costs (including pension expense) and a 3.8% increase in production costs (fuel, power, and chemicals).

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Capital Plan: The company estimates Company-funded capital investment will total between $4.0 billion and $4.5 billion from 2009 to 2013. For 2009, construction expenditures are expected to be approximately $800 million.
• Dividend Policy: The Board declared a quarterly dividend of $0.20 per share, payable March 2, 2009. The policy targets distributing 50% to 70% of net income annually.
• Pension Funding: Due to lower asset returns in 2008, the company estimates a $32 million pre-tax increase in pension and postretirement expense for 2009. Expected contributions to plan trusts range from $125.9 million in 2009 to $161.9 million in 2012.

Risks and Contingencies

• Market Disruptions: The company faced significant liquidity challenges in late 2008 due to the global financial crisis. It was unable to issue commercial paper in September 2008 and had to rely on its $840 million revolving credit facility. In early 2009, the company purchased its own variable rate demand bonds ($120.3 million) as no buyers were available at market rates.
• Goodwill Impairment Risk: The company holds $1.7 billion in goodwill. Management noted that fair value approximates carrying value, leaving little margin for error. Future declines in stock price or market multiples could trigger additional impairment charges.
• Regulatory Lag: Recovery of increased operating costs and capital investments is subject to regulatory approval, creating a lag between cost incurrence and rate recovery.
• Internal Controls: A material weakness regarding the maintenance of contracts and agreements remained as of December 31, 2008, though other weaknesses identified in 2006 were remediated.

Key Facts for Investor Verification

• Impairment Sensitivity: Verify the assumptions used in the goodwill impairment test, specifically the control premium and stock overhang adjustments, as the fair value of reporting units was close to their carrying value.
• Liquidity Position: Confirm the status of the $120.3 million in variable rate demand bonds held in treasury and the company's ability to access capital markets given the credit rating downgrades (S&P BBB+, Moody's Baa2).
• Pension Obligations: Monitor the funded status of pension plans and the actual cash contributions required in 2009 versus the estimated $125.9 million, given the volatility in asset returns.
• Regulatory Approvals: Track the status of the proposed $75 million acquisition of the City of Trenton water system, which is subject to a referendum and final PUC approval.
• Internal Control Remediation: Review progress on remediation of the remaining material weakness related to contract maintenance to ensure compliance with Sarbanes-Oxley Section 404.