American Water Works Company, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012; filed November 7, 2012. Dollar amounts below are in millions unless noted. Interim results are unaudited and subject to seasonal variation.
Business context
American Water operates regulated water and wastewater utilities and market-based service businesses. During 2012 it completed sales of its Arizona, New Mexico and Ohio regulated subsidiaries, acquired six regulated systems—including Aqua New York, adding approximately 50,000 customers—and continued a business transformation project. Disposed businesses are reported as discontinued operations.
Financial results and liquidity
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Operating revenue | $831.8 | $760.9 | $2,196.0 | $2,026.5 |
| Operating income | $327.6 | $281.4 | $758.0 | $626.1 |
| Operating margin | 39.4% | 37.0% | 34.5% | 30.9% |
| Income from continuing operations | $154.1 | $128.5 | $320.0 | $244.0 |
| Net income | $153.8 | $137.4 | $302.6 | $244.8 |
| Diluted EPS, continuing operations | $0.87 | $0.73 | $1.80 | $1.38 |
| Diluted EPS, net income | $0.86 | $0.78 | $1.70 | $1.39 |
Quarterly revenue rose 9.3%; operating income increased 16.4%. For the first nine months, revenue increased 8.4% and operating income 21.1%. Management attributed the improvement chiefly to regulated rate increases and higher water demand, partly offset by increased operating and depreciation costs. The regulated O&M efficiency ratio, a non-GAAP measure, improved to 37.0% from 39.6% in Q3 and to 39.6% from 43.3% year to date.
- Cash flow: Nine-month operating cash flow was $735.0, versus $576.0. Capital expenditures were $680.4, leaving approximately $54.7 of operating cash flow after capital expenditures, before acquisitions and other investing items. Investing cash use was $185.4, including $560.1 of proceeds from asset and securities sales and $44.3 for acquisitions.
- Debt and capital: At September 30, long-term debt was $5,184.5, short-term debt $297.9 and the current portion of long-term debt $35.0. Common stockholders’ equity was $4,447.6. The company reported a 0.55 debt-to-capitalization covenant ratio and compliance with its covenants.
- Liquidity: Cash and cash equivalents were $18.5; current assets were $642.5 against current liabilities of $1,005.9. Commercial paper outstanding was $297.9. The then-current revolving facility had $649.5 of available capacity at quarter-end. On October 29, after quarter-end, the company replaced it with a $1.0 billion facility expiring in October 2017.
- Dividends: The company declared a quarterly dividend of $0.25 per share, payable December 3, 2012. Quarterly dividends were $0.23 in the first two quarters of 2012.
Material changes and management commentary
- Regulated revenue increased $68.4 in Q3 and $155.1 for the nine-month period. Management attributed the increases to rate actions, higher consumption—associated primarily with warmer, drier weather—and acquisitions. Nine-month billed water volume increased 4.8% overall.
- Rate authorizations granted during the first nine months represented $115.3 of annualized general rate increases and $9.2 of annualized infrastructure charges. Further rate actions were pending or became effective after September 30; authorized or requested amounts are not equivalent to realized revenue.
- Operation and maintenance expense rose 4.3% in Q3 and 1.5% year to date. Higher purchased-water, contracted-service and operating-supply costs were partly offset by lower employee-related expense.
- The company spent $235.9 on its business transformation project through September 30, including $96.1 in 2012. Phase I ERP systems went live August 1; Phase II asset-management and customer-information systems were expected to be substantially complete by December 31, 2013. Estimated capital investment spending was $925 for 2012 and $800–$1,000 for 2013.
Outlook, risks, contingencies and unusual items
- The filing provides capital-spending expectations but no clear full-year earnings or revenue guidance. Management cited seasonality, regulatory outcomes and weather-related demand as factors affecting results.
- Hurricane Sandy affected East Coast operations after quarter-end. Management’s initial assessment was that damage was not significant and would not materially affect results, financial position or cash flows; insurance claims and possible recovery through rates remained under evaluation.
- A labor matter remained under appeal after an administrative law judge found the company had failed to notify certain state agencies before implementing its final labor offer. If upheld, estimated cash impact was $2.5–$3.5 annually, with total exposure depending on resolution timing.
- For routine legal matters, the company accrued approximately $1.7 and said additional losses could range up to $33.3; for some matters, losses could not be estimated. In a separate Monterey water-supply project dispute, the company asserted claims potentially exceeding $20, including an unrepaid $6 loan. Outcomes and project approvals were uncertain.
- Environmental remediation accruals were $4.4 at September 30. The company also disclosed risks from regulation, rate-case timing, financing access and ratings, pension obligations, and possible goodwill impairment. It was testing financial-reporting controls following the ERP implementation and could not assure all impacts had been mitigated.
- Discontinued operations generated a nine-month after-tax loss of $17.4, including divestiture-related effects. The filing also describes correction of prior-period 2011 discontinued-operation calculations, with $24.6 of after-tax charges recorded in 2011.
Most important facts for investors to verify
- Whether reported earnings growth is sustained by rate increases and durable demand, rather than weather or acquisition contributions.
- Actual capital spending, project costs and operating benefits as the ERP and Phase II systems are completed, including any control or service disruptions.
- Final regulatory outcomes and timing for pending rate cases and infrastructure charges, and the extent of any rate lag.
- Debt refinancing, commercial-paper access, covenant headroom and the terms and availability of the replacement revolving credit facility.
- Final costs or recoveries related to Hurricane Sandy, the labor decision and the Monterey project claims, along with any changes to legal or environmental accruals.