American Water Works Company, Inc. — Q1 2017 10-Q
Reporting period: Three months ended March 31, 2017. American Water provides regulated water and wastewater utility services and complementary market-based services. Amounts below are in millions of dollars, except per-share data and percentages.
Financial performance and condition
| Metric | Q1 2017 | Q1 2016 or prior date |
|---|---|---|
| Operating revenue | $756 | $743 |
| Operating income | $227 | $214 |
| Net income attributable to common stockholders | $93 | $82 |
| Diluted earnings per share | $0.52 | $0.46 |
| Net cash provided by operations | $277 | $260 |
| Capital expenditures | $270 | $284 |
| Cash and cash equivalents at period end | $78 | $75 at Dec. 31, 2016 |
| Short-term debt | $980 | $849 at Dec. 31, 2016 |
| Long-term debt, including current portion | $6,318 | $6,323 at Dec. 31, 2016 |
Revenue rose 1.7%, operating income 6.1%, and common-stockholder net income 13.4% year over year. Operating expenses were $529, unchanged; O&M fell $11 to $337, while depreciation and amortization increased $8 to $124. Net interest expense increased $5 to $85, reflecting higher long-term debt and increased short-term borrowing and rates. The effective tax rate was 35.9%, down from 39.7%; the 2017 rate included a $5 tax benefit from the new employee share-based payment accounting standard.
Regulated Businesses revenue increased $25 to $659, with segment net income of $94 versus $87. Market-Based Businesses revenue declined $11 to $103, mainly because of reduced military-base capital upgrades and completion of a large Fort Polk project; segment net income was $7 versus $6. Regulated rate increases and acquisitions supported growth, partly offset by lower water demand and consumption.
Operating cash flow exceeded investing outflows of $288, which included $270 of capital expenditures and $2 of acquisitions. Financing provided $14, including $131 of net short-term borrowings, offset in part by $67 of dividends paid and $54 of stock repurchases. The company reported $1,673 of available credit-facility capacity and $620 of available commercial-paper capacity. Its debt-to-capitalization covenant ratio was 0.58, below the 0.70 maximum; the company reported compliance. Cash flow is seasonal, with operating cash flows generally higher in the third quarter.
Material changes and operating developments
- Regulated revenue growth reflected $25 of rate increases and $8 from acquisitions and organic growth, partly offset by a $7 decline attributed to demand and consumption.
- For the 12 months ended March 31, adjusted regulated O&M efficiency ratio improved to 34.6% from 35.6%. This is a non-GAAP measure and excludes specified items, including the Freedom Industries settlement impact.
- Q1 capital expenditures were $270; the company said 2017 capital investment, including acquisitions, was expected to be approximately $1.5 billion.
- The company closed two small water-system acquisitions in Q1. Shorelands Water Company was acquired on April 3 for $33 million in stock, adding about 11,000 customers. A McKeesport wastewater-system acquisition, expected to close in Q4 2017, was pending regulatory approval.
- The company began construction of a new Camden headquarters, estimated to cost up to $165, with $77 expected to be incurred in 2017.
Outlook, risks and contingencies
- Q1 results are not necessarily indicative of full-year results, partly because of seasonal demand. Management cited safety, customer service, growth, technology and operational efficiency as priorities.
- Rate authorizations that took effect during Q1 represented annualized incremental revenue of $34 from general rate cases and $13 from infrastructure surcharges. Additional rate requests were pending, including a Pennsylvania filing for $108 of annualized revenue; the company cautioned that approvals were not assured.
- The proposed global settlement of Freedom Industries chemical-spill claims was $126 before tax. The company recorded a $65 after-tax charge in Q3 2016, net of insurance receivables. Court approval remained pending; two insurers with $50 of aggregate coverage had not agreed to participate, and the company was pursuing coverage. The settlement would bar recovery through West Virginia customer rates for settlement payments and certain response costs.
- In California, a proceeding concerning residential tariff administration included a potential penalty range described by the administrative law judge of approximately $3 million to $179 million. The proposed resolution included a $0.5 waiver of cost recovery, but approval was pending; the company said the outcome could not then be determined.
- Other exposures include routine legal matters, environmental and water-quality obligations, regulatory decisions, weather and demand variability, infrastructure and cybersecurity risks, interest rates, and access to capital. The company reported approximately $138 of accrued probable loss contingencies and an estimated maximum $28 for reasonably possible contingencies that could be reasonably estimated; some matters could not be estimated.
- New York tax legislation was expected to result in a Q2 2017 deferred-tax adjustment, with an estimated $5–$7 recorded as income tax expense after amounts recoverable through future rates. The company also noted that it was evaluating the effects of several forthcoming accounting standards.
Key facts for investors to verify
- Whether the Freedom Industries settlement receives preliminary and final court approval, and whether the disputed insurance coverage is recovered.
- The outcome and potential financial impact of the California tariff-administration proceeding and other pending rate cases.
- Execution and funding of the approximately $1.5 billion 2017 capital-investment plan, including the headquarters project and pending acquisitions.
- Whether regulated rate increases and investment growth continue to offset demand softness, higher depreciation and financing costs, and weakness in military-services revenues.
- Short-term borrowing levels, liquidity availability, covenant compliance, and the timing of seasonally variable operating cash flows.