American Water Works Company, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012; filed August 2, 2012. Interim financial statements are unaudited. Unless otherwise noted, dollar amounts below are in millions.
Business context and reporting period
American Water operates regulated water and wastewater utilities and market-based services, including homeowner services and military and municipal contracts. Results discussed below are from continuing operations unless stated otherwise. The company completed the sales of its Arizona and New Mexico subsidiaries in January 2012 and Ohio subsidiary in May 2012, and acquired regulated New York systems on May 1, adding approximately 50,000 customers. These businesses’ results are reported as discontinued operations where applicable.
Financial performance and liquidity
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Operating revenue | $745.6 | $668.9 | $1,364.2 | $1,265.6 |
| Operating income | $270.6 | $201.4 | $430.4 | $344.6 |
| Income from continuing operations | $116.7 | $74.8 | $165.9 | $115.5 |
| Net income, including discontinued operations | $107.0 | $81.1 | $148.8 | $107.3 |
| Diluted EPS | $0.60 | $0.46 | $0.84 | $0.61 |
| Operating margin | 36.3% | 30.1% | 31.5% | 27.2% |
| Operating cash flow | — | $316.9 | $262.4 | |
| Capital expenditures | — | $476.3 | $391.8 |
- Q2 revenue rose 11.5%; operating income increased $69.2 million. For the first half, revenue increased 7.8% and operating income rose $85.7 million.
- Management attributed regulated revenue growth mainly to rate increases and higher demand, including warmer, drier weather; the New York acquisition also contributed. First-half regulated revenue included $52.2 million from rate increases and about $21 million from higher demand.
- Regulated O&M efficiency ratio, a non-GAAP measure, improved to 37.9% in Q2 from 43.2%, and to 41.2% for the first half from 45.5%. Consolidated depreciation and amortization and general taxes increased, partly offsetting O&M savings.
- First-half operating cash flow less capital expenditures was negative approximately $159.4 million. Investing cash flow was positive $29.7 million, principally reflecting $560.0 million of asset-sale proceeds; financing cash flow was negative $347.8 million. Cash ended June at $12.9 million.
- At June 30, total assets were $14.41 billion and stockholders’ equity was $4.33 billion. Balance-sheet debt comprised $5.20 billion long-term debt, $120.3 million current long-term debt and $362.0 million short-term debt. The company reported $361.97 million of commercial paper outstanding, no revolver borrowings and $804.8 million of available revolver capacity. It was in compliance with debt covenants; the debt-to-capitalization covenant ratio was 0.57 versus a 0.70 maximum.
- Cash dividends paid were $0.23 per share in each of the first two quarters. A $0.25-per-share dividend was declared for payment in September 2012.
Material changes versus the prior comparable period
- Revenue and earnings from continuing operations improved substantially, led by regulated rate increases, increased usage and acquisitions. Six-month market-based revenue also increased $5.6 million, reflecting homeowner-services growth and military contract work.
- Regulated O&M expense declined $8.4 million in the first half, while consolidated depreciation and amortization increased $10.2 million. Interest expense, net, increased $4.7 million for the first half.
- First-half net income includes a $17.1 million loss from discontinued operations, versus an $8.2 million loss in the 2011 comparative period. The 2012 losses include Ohio sale costs and Arizona/New Mexico divestiture-related items. Comparisons are affected by 2011 discontinued-operation results and prior-period write-downs; the company disclosed that it corrected 2011 discontinued-operation calculations, including after-tax charges of $21.1 million in Q1 and $3.5 million in Q2.
- Long-term capital investment increased: first-half capital expenditures were $476.3 million versus $391.8 million a year earlier. The company also used sale proceeds to repay debt; short-term debt fell from $515.1 million at year-end to $362.0 million.
Outlook, management commentary, risks and contingencies
- The filing provides no specific earnings or EPS guidance. Estimated capital investment is $900 million for 2012 and $800 million to $1.0 billion for 2013. Management’s stated priorities include portfolio optimization, addressing regulatory lag and declining usage, controlling regulated O&M, and growing selected market-based operations.
- Rate actions: the company reported $60.4 million of additional annualized general-rate-case revenue granted in Q2 and $93.0 million for the first half, plus $2.0 million in infrastructure charges. As of July 31, it awaited final orders in three states on requests totaling $54.1 million annually; approval is not assured. A Tennessee filing sought about $10.6 million in annualized revenue.
- Business transformation: Phase I systems went live August 1, 2012. The project had cost $211.5 million through June 30, including $71.7 million in 2012, and is included in the capital-investment estimates. Phase II is expected by December 31, 2013. The company warned of possible incremental expenses and potential effects on its control environment.
- Legal matters: approximately $3.2 million was accrued for routine legal matters, with reasonably possible additional losses up to $32.2 million; some matters could not be estimated. California-American Water’s proposed Monterey Peninsula water-supply project faces administrative, permitting and county-ordinance challenges. A CPUC decision authorized recovery of $49 million in prospective San Clemente Dam project costs over 20 years and approximately $27 million of historical costs; a rehearing application challenging the authorized return was pending.
- A June 29 collapse of a pipe bridge serving a New Jersey treatment plant temporarily reduced capacity, caused a brief outage for some customers and led to a boil-water advisory. Service capacity was restored by July 4; investigations into the cause were ongoing, and the financial outcome was not yet predictable.
- Management cited seasonality, weather-sensitive demand, regulatory outcomes, financing-market access, interest rates, potential goodwill impairment and execution of major systems changes as risks. No material change to previously disclosed risk factors or market risk was reported. Disclosure controls were judged effective at a reasonable level of assurance, while the transformation project was considered reasonably likely to materially affect internal controls over financial reporting.
Important facts for investors to verify
- Whether granted and pending rate increases, including any amounts subject to refund, translate into realized revenue and cash flow.
- The durability of unusually strong Q2 water demand and the contribution of weather, rate changes and acquisitions to revenue growth.
- Capital-spending requirements, cash generation and funding needs relative to the planned 2012–2013 investment program and debt maturities.
- Final purchase-price adjustments and divestiture-related costs, and the remaining effects of discontinued operations on reported earnings.
- Resolution and potential costs of the New Jersey pipe-bridge investigation, Monterey project proceedings and other legal or environmental matters.
- Transformation-project cost, schedule and control risks; the filing does not quantify expected future savings.