American Water Works Company, Inc. quarterly report, Q1 FY2012

American Water Works Company, Inc. — Q1 2012 Form 10-Q

Reporting period: Three months ended March 31, 2012; comparisons are with Q1 2011 unless stated otherwise. American Water is a U.S. investor-owned water and wastewater utility, reporting Regulated Businesses and Market-Based Operations. Financial statements are unaudited, and management cautions that interim results are seasonal and not necessarily indicative of full-year results. Dollar amounts below are in millions unless noted.

Financial performance and position

Metric	Q1 2012	Q1 2011 / prior date
Operating revenue	$618.6	$596.7
Operating income	$159.7	$143.3
Operating margin	25.8%	24.0%
Continuing-operations income	$49.3	$40.7
Net income, including discontinued operations	$41.8	$26.2
Diluted EPS	$0.24 ($0.28 continuing operations)	$0.15 ($0.23 continuing operations)
Operating cash flow	$148.1	$161.5
Capital expenditures	$233.4	$176.4
Cash and cash equivalents at period end	$9.5	$14.2 at Dec. 31, 2011
Long-term debt at period end	$5,350.5	$5,339.9 at Dec. 31, 2011
Short-term debt and current long-term debt	$177.3	$543.9 at Dec. 31, 2011

Revenue increased 3.7%; operating income rose 11.5%. Continuing-operations income increased 21.0%. Management attributed the improvement chiefly to rate increases, partly offset by lower water consumption; Market-Based revenue also increased.
Operating expenses rose $5.4 million overall. Depreciation and amortization increased $5.2 million, mainly as additional utility plant entered service; net interest expense increased $3.5 million. Regulated O&M expense fell $7.0 million, while Market-Based O&M increased $3.2 million.
Regulated revenue was $541.9 million, up $13.6 million; segment pretax income increased to $90.4 million from $77.1 million. Market-Based revenue was $80.6 million, up $5.2 million, and segment pretax income was $10.5 million versus $7.7 million.
Regulated O&M efficiency ratio, a non-GAAP measure, improved to 45.3% from 48.1%. Management cited cost reductions, including lower employee-related costs and fewer weather-related repairs; the company also reported $2.4 million in severance costs associated with organizational realignment.
Cash from operations declined $13.4 million, primarily due to working-capital changes. Investing cash flow was positive $229.6 million, mainly reflecting $461.1 million in proceeds from the Arizona and New Mexico divestitures; financing cash flow was negative $382.4 million, including short-term debt repayments and $40.4 million of dividends paid.
Capital spending increased $57.0 million, reflecting infrastructure replacement, business transformation spending, and replacement of a New Jersey water treatment facility. The filing does not provide a full-year capital-spending forecast.

Material developments and outlook

Q1 2012 net income includes a $7.5 million after-tax loss from discontinued operations, including a $9.7 million tax charge associated with the Arizona and New Mexico divestitures. Q1 2011 discontinued-operations loss was revised to include a $21.1 million after-tax impairment; the filing describes a broader $24.6 million correction recorded in 2011 for errors in discontinued-operations gain/loss calculations.
Arizona and New Mexico operations were sold on January 31, 2012. After quarter-end, on May 1, the company completed the Ohio subsidiary sale for approximately $101 million plus assumed liabilities of approximately $19 million, and acquired seven New York water systems for approximately $39 million cash plus assumed liabilities.
Rate authorizations granted in Q1 represented $32.6 million of additional annualized revenue. After quarter-end, New Jersey rates were approved for an additional $30.0 million annualized revenue; Pennsylvania infrastructure charges of $1.7 million became effective in April. As of May 2, requests totaling $101.2 million in annualized revenue remained pending across four states. A Virginia rate case requested $5.7 million.
Management’s stated 2012 priorities include portfolio optimization, addressing regulatory lag and declining usage, capital efficiency, improving regulated O&M efficiency, and expanding Market-Based Operations, particularly homeowners services and military contract operations. No formal earnings or EPS guidance is provided in the supplied filing text.
The company expects 2012 pension contributions of approximately $97.9 million, revised down from $126.7 million previously disclosed, subject to a third-quarter valuation. It also expected $64.9 million of further defined-benefit pension contributions and $22.5 million for other postretirement plans during the balance of 2012.
After quarter-end, the company gave notice to redeem $150.4 million of bonds, which will mature in Q2; it intended to refinance them with commercial paper or long-term debt. At March 31, it had $147.2 million of short-term debt, no revolving-credit borrowings, and $803.2 million of available facility capacity after letters of credit. Management said operating cash flow, capital-market access, and the $840 million revolver were expected to fund short-term needs, while warning access to markets and lender commitments cannot be assured.
Debt covenants were in compliance at March 31; the reported indebtedness-to-capitalization ratio was 0.57 against a 0.70 maximum. Moody’s senior unsecured rating was Baa2 and S&P’s was BBB+, with stable outlooks. Management reported no significant market-risk changes from year-end.

Risks, contingencies, and unusual items

Legal matters had approximately $2.8 million accrued as probable costs; additional losses could range up to $30.4 million, with some exposures not estimable. The company said it did not expect the matters described to materially affect results, financial position, or cash flows, but acknowledged litigation outcomes are uncertain.
California-American Water’s proposed Monterey Peninsula water supply project includes a desalination plant and related facilities estimated at $367 million, or $320 million if reduced in size. It requires extensive regulatory and other approvals; the company cannot assure approval or completion. Related claims and reimbursement demands concerning an earlier project were raised or indicated by local entities.
A CPUC alternate proposed decision on the San Clemente Dam project would allow recovery of approximately $27 million in historical costs and recovery of authorized and estimated costs over 20 years, including a proposed $49 million of prospective costs. No final decision date was set; the outcome and recoverability remain uncertain.
Goodwill was $1,195.1 million at March 31. The company cautioned that changes in stock valuation, rate-case outcomes, capital plans, interest rates, or forecasts could trigger impairment, potentially affecting reported results, capitalization, credit ratings, financing access, and covenant compliance.
Water demand is exposed to conservation and usage trends: regulated billed water volume declined year over year, including a 1.7% decline in residential volume. Operations are also subject to seasonal cash flows, regulation, environmental requirements, and changing project and capital costs.

Most important facts for investors to verify

Whether authorized and pending rate increases are implemented on schedule and translate into realized revenue despite declining usage.
Final Ohio sale adjustments, proceeds and liabilities, and the financial effects of the New York acquisition and other portfolio actions.
Cash generation relative to elevated infrastructure investment, pension funding, dividends, and the planned refinancing of $150.4 million in bonds.
Final regulatory decisions, cost recovery, approvals, and potential claims involving the Monterey Peninsula water supply and San Clemente Dam projects.
Whether discontinued-operation estimates, divestiture tax charges, and the prior-period correction result in further adjustments.
Future goodwill impairment indicators, debt covenant compliance, credit ratings, and continued access to commercial paper and revolving-credit facilities.