Essential Utilities, Inc. annual report, FY2020

Essential Utilities, Inc. — 2020 Form 10-K

Reporting period: Fiscal year ended December 31, 2020. Filed March 1, 2021. Unless stated otherwise, financial amounts below are in millions of dollars.

Business context and reporting period

Essential Utilities operates regulated water and wastewater utilities across eight states and, following its March 16, 2020 acquisition of Peoples, regulated natural gas utilities in Pennsylvania, West Virginia, and Kentucky. The company serves an estimated five million people. 2020 results include Peoples only from the acquisition date, so year-over-year comparisons are not like-for-like. The company changed its name from Aqua America to Essential Utilities in February 2020.

Financial and operating highlights

Metric	2020	2019
Operating revenue	$1,462.7	$889.7
Operating income	$434.7	$340.2
Net income	$284.8	$224.5
Diluted EPS	$1.12	$1.04
Operating cash flow	$508.0	$338.5
Capital expenditures	$835.6	$550.3
Long-term debt, including current portion	$5,630.2	$3,077.4

Revenue rose about 64%, driven chiefly by the acquired gas business; regulated water revenue was $938.5, while regulated natural gas revenue was $506.6 for the post-acquisition period.
Operating margin was approximately 29.7% of revenue, compared with 38.2% in 2019; net margin was 19.5%, compared with 25.2%. Acquisition-related costs, added operating costs, and the change in business mix affect comparison.
Net income increased about 27% and diluted EPS rose from $1.04 to $1.12. 2020 included $25.4 of Peoples transaction expenses and $23.0 of one-time customer rate credits.
Operating cash flow increased from 2019, partly because 2019 included an $83.5 payment to settle interest-rate swaps. Capital expenditures were $835.6; cash used for acquisitions was $3,501.8, primarily reflecting Peoples.
Cash and equivalents were $4.8 at year-end, versus $1,868.9 in 2019, as funds raised for the acquisition were deployed. Current assets of $380.2 were below current liabilities of $603.9. Management said available operating cash, credit facilities, and planned capital-market funding were expected to meet needs for at least 12 months.
At year-end, $385.0 was drawn on the $1,000.0 revolving facility, with $591.5 available; short-term credit lines had $157.3 available. Debt represented 54.7% of capitalization, up from 44.2%.
Dividends paid totaled $232.6, or $0.97 per share; the reported payout was 81.6% of net income. The annualized dividend rate increased to $1.0028 beginning in September 2020.

Material changes versus the prior period

The Peoples acquisition added approximately 750,000 gas customers and materially expanded revenue, assets, debt, capital spending, and employee and system integration requirements. Peoples reported $520.9 in revenue and $57.4 in earnings from the acquisition date through year-end; segment revenue is reported separately as $506.6.
Total utility customers increased 42.9%, primarily due to the acquisition. Reported goodwill rose to $2,324.5, including preliminary acquisition goodwill of $2,261.0.
Interest expense increased to $188.4 from $125.4, reflecting higher average borrowings and acquired debt, partly offset by lower borrowing rates. The weighted-average cost of fixed and variable long-term debt was 3.56% at year-end.
The company recorded a $19.9 income tax benefit, principally reflecting deductions for qualifying infrastructure investment. A $160.7 regulatory liability for Peoples pre-acquisition tax benefits remained pending regulatory guidance.
The company sold its 49% interest in a water-supply joint venture in October, recording a $3.7 loss.

Outlook, risks, contingencies, and unusual items

Management planned approximately $1,000 of infrastructure investment in 2021, including $504 for surcharge-qualified projects, and estimated approximately $1,860 of construction spending for 2022–2023. Funding is expected from operations, credit facilities, and long-term debt; less than half of the 2022–2023 amount was expected to require external financing.
Two rate requests were pending at year-end, seeking $1.8 in aggregate annual revenue; seven additional filings were planned for 2021. Rate recovery depends on regulatory decisions and timing.
Management said it did not then anticipate a significant COVID-19 impact on financial position, results, or cash flows. Risks included lower commercial and industrial demand, collection delays and bad debt, limits on disconnections, and possible delays or increased costs for maintenance and capital work.
Key risks include Peoples integration and acquisition financing, higher debt and refinancing needs, regulatory lag or disallowance of costs, interest-rate exposure, weather and conservation effects, gas supply and pipeline reliability, environmental compliance, and cyber or operational disruptions.
The company estimated approximately $95.4 of outstanding water and wastewater environmental compliance capital needs over five years. It also planned PFAS mitigation investment in the tens of millions over several years, with recovery dependent on regulatory treatment.
An Illinois water do-not-consume advisory continued to affect revenue and remediation costs into 2021. A potential fine or penalty could not be estimated and was not accrued; related litigation remained in discovery, without class certification. Management did not expect the disclosed claim to materially affect the company, but the outcome was uncertain.
The Peoples purchase-price allocation remained preliminary, and a dispute over the seller’s utility capital-expenditure adjustment was unresolved. The DELCORA acquisition faced regulatory uncertainty: administrative law judges recommended denial, with the matter pending before the Pennsylvania commission.
The auditor issued an unqualified opinion on the financial statements and internal controls. However, Peoples, representing approximately 23% of consolidated assets and 36% of 2020 revenue, was excluded from the 2020 internal-control assessment and audit while integration continued.

Important facts for investors to verify

How much of 2020’s earnings and cash-flow growth reflects Peoples versus existing water operations, and whether reported comparisons are adjusted for acquisition timing and one-time items.
The final Peoples purchase-price allocation, capital-expenditure adjustment, integration costs, and realization of anticipated benefits.
Regulatory guidance and rate recovery for the $160.7 tax-related liability, infrastructure investment, and future rate requests.
Liquidity and refinancing needs given year-end debt, planned capital spending, dividend commitments, and the dependence on continued access to credit and equity markets.
Developments in the Illinois advisory and litigation, PFAS mitigation and cost recovery, DELCORA approval, and other environmental or regulatory contingencies.
Progress integrating Peoples’ financial controls and systems, which were excluded from the year-end internal-control audit.