American Water Works Company, Inc. quarterly report, Q2 FY2018

American Water Works Company, Inc. — Q2 2018 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2018. The company provides regulated water and wastewater utility services and complementary market-based services. Figures are in millions of dollars except per-share amounts, percentages, and where noted.

Financial performance and position

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Operating revenue	$853	$844	$1,614	$1,600
Operating income	$302	$310	$519	$540
Operating margin, approximately	35.4%	36.7%	32.2%	33.8%
Net income attributable to common stockholders	$162	$131	$268	$224
Diluted EPS	$0.91	$0.73	$1.50	$1.26
Operating cash flow	—	$525	$524

• Revenue rose 1.1% in Q2 and 0.9% for the first half. Operating income fell 2.6% and 3.9%, respectively, as operating expenses grew faster than revenue. Approximate operating margins are calculated from reported revenue and operating income.
• Reported diluted EPS includes a favorable after-tax $15 million insurance settlement benefit, or $0.08 per share, related to the Freedom Industries spill. Excluding that benefit, the company reported adjusted diluted EPS, a non-GAAP measure, of $0.83 for Q2 and $1.42 for the first half, up 13.7% and 12.7% year over year.
• First-half investing cash outflow was $1,149, including $739 of capital expenditures and $377 for acquisitions. Financing cash inflow was $638. Cash and cash equivalents were $68 at June 30; cash, equivalents and restricted funds totaled $97.
• At June 30, long-term debt was $6,345, current maturities of long-term debt $364, and short-term debt $1,649. Short-term debt was primarily commercial paper; its weighted-average rate was 2.15% for the first half versus 1.14% a year earlier. The company reported $2,172 of available credit-facility capacity and $451 of available commercial-paper capacity.
• Total assets were $20,471 and stockholders’ equity was $5,736 at June 30. The declared quarterly dividend was $0.455 per share, versus $0.415 a year earlier.

Material changes and notable items

• The effective tax rate declined to 27.0% in Q2 and 26.0% for the first half, from 41.8% and 39.5%, respectively, largely reflecting the federal corporate tax rate reduction under the Tax Cuts and Jobs Act (TCJA). Management recorded $54 of first-half revenue reserves for estimated tax savings expected to benefit regulated customers.
• Regulated revenue growth from rate increases, acquisitions, organic growth, and demand was substantially offset by TCJA-related customer benefits. For the first half, regulated revenue increased $5 year over year; market-based revenue increased $8.
• Q2 O&M expense included a $20 insurance-settlement benefit. First-half O&M rose $14 overall, reflecting higher purchased-water and chemical costs, employee costs, and maintenance expense, partly offset by that benefit.
• The company completed the $363 Pivotal Home Solutions acquisition on June 4, adding approximately 1.2 million customer contracts across 18 states. It financed the purchase with approximately equal proportions of debt and equity; a stock issuance generated $183 in net proceeds.
• First-half capital expenditures were $739, up from $602. Management expects 2018 capital investment of $2.0–$2.1 billion, including the Pivotal acquisition. The new Camden headquarters was estimated to cost up to $164, with $77 expected in 2018.

Outlook, risks, and contingencies

• Management reported an adjusted regulated-business O&M efficiency ratio of 35.3% for the 12 months ended June 30, versus 36.3% for the comparable prior-year period. This is a company-defined non-GAAP measure.
• Management expects federal cash income taxes to begin around the start of 2020 as federal net operating loss carryforwards are used, with full cash-taxpayer status expected by 2021; timing may vary with results and regulatory outcomes.
• Rate proceedings remain important: New Jersey filed for $117 in additional annualized revenue and put approximately $75 of provisional rates into effect, subject to refund. Other pending requests include West Virginia, California, and Maryland; requested increases are not assured.
• The Freedom Industries global class settlement received final approval, effective July 16, 2018. The $126 settlement was expected to cost the West Virginia subsidiary $23 net of insurance recoveries. The company accrued approximately $136 for probable loss contingencies and estimated $25 of reasonably possible losses that could be reasonably estimated; certain matters could not be estimated.
• Other exposures include a class action concerning a 2015 West Virginia water-main break, California water-supply and desalination project proceedings, and potential condemnation of service assets. The filing says losses in the water-main case cannot currently be reasonably estimated.
• Moody’s outlook was negative; S&P’s outlook was stable. Management said it believed operating cash flow, capital-market access, and revolving credit would meet short-term needs, while noting access and lender availability were not assured. The company reported compliance with its debt-to-capitalization covenant.
• Additional risks include regulatory decisions and rate recovery, water quality and supply, severe weather, infrastructure reliability, cyber and physical security, operating costs, financing conditions, litigation, and reputational issues. The filing added disclosure of a New York regulatory investigation relating to incorrect property-tax data and customer overpayments.

Important facts for investors to verify

• Whether regulated rate cases and TCJA customer-credit proceedings allow timely recovery of infrastructure investment and how much tax benefit will be passed to customers.
• Whether the $2.0–$2.1 billion 2018 investment plan, acquisitions, and headquarters project affect financing needs, debt levels, and cash generation as expected.
• How much of reported earnings growth is recurring, given the Freedom Industries insurance benefit and lower tax rate; compare GAAP EPS with the company’s adjusted non-GAAP EPS.
• Developments in the Freedom Industries settlement and other litigation, including the Dunbar water-main action and California water-supply matters.
• Commercial-paper costs and availability, credit ratings, and dividend sustainability amid substantial capital spending and increased short-term borrowings.