American Water Works Company, Inc. quarterly report, Q2 FY2010

American Water Works Company, Inc. — Q2 2010 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2010. Unaudited consolidated results; dollar figures below are in millions unless stated otherwise. The company owns regulated water and wastewater utilities and also provides non-regulated services.

Financial performance and condition

Metric	Q2 2010	Q2 2009	Six months 2010	Six months 2009
Operating revenue	$671.2	$612.7	$1,259.3	$1,162.9
Operating income (loss)	$196.0	$157.2	$322.0	$(178.2)
Net income (loss)	$72.8	$52.0	$103.6	$(361.1)
Diluted EPS	$0.42	$0.32	$0.59	$(2.23)

Q2 operating margin was approximately 29.2%, versus 25.7% a year earlier; net margin was approximately 10.8%, versus 8.5%.
Six-month 2010 operating margin was approximately 25.6%. The prior-year loss included a $450.0 million goodwill impairment charge ($443.0 million net of tax); no impairment was recorded in 2010.
Operating cash flow for the first half was $297.5 million, compared with $228.7 million. Investing cash use was $331.2 million, including $327.3 million of capital expenditures; financing cash provided was $32.1 million. Cash ended at $20.6 million.
At June 30, total assets were $13.77 billion and stockholders’ equity was $4.04 billion. Balance-sheet long-term debt was $5.31 billion, its current portion $44.0 million, and short-term debt $265.8 million. Short-term debt increased from $119.5 million at year-end 2009.
Current assets of $590.1 million were below current liabilities of $753.4 million, a reported working-capital deficit of $163.3 million. The company reported $850 million of revolving credit commitments and $807.5 million available at June 30; it had no borrowings on the revolving credit line then. Cash and commercial-paper capacity figures also vary by date in the filing.

Material changes versus prior comparable periods

Q2 revenue rose $58.5 million (9.5%); first-half revenue rose $96.4 million (8.3%). Rate increases were the main regulated-business driver, with higher demand also contributing. Regulated revenue increased $47.3 million in Q2 and $69.5 million for the first half.
Non-regulated revenue grew $11.1 million in Q2 and $28.0 million in the first half, largely reflecting the December 2009 Contract Operations acquisition and higher military contract activity.
Operating expenses increased $19.7 million in Q2. First-half expenses excluding the prior-year impairment increased $46.1 million, driven by acquisition-related costs, employee expenses, maintenance, depreciation and taxes.
Net interest expense rose $5.0 million in Q2 and $11.8 million for the first half, primarily due to 2009 refinancing of short-term borrowing into higher-rate long-term debt and borrowing for capital investment.
First-half water sales volume declined 2.4% for residential customers, while commercial and industrial volumes increased 1.2% and 9.8%, respectively. Management cited possible effects from economic conditions, weather and conservation, but said individual effects were difficult to measure.
Quarterly dividends increased from $0.20 to $0.21 per share in 2010. A $0.22-per-share dividend was declared July 30, payable September 1, 2010.

Outlook, management commentary, risks and contingencies

Management estimated 2010 company-funded capital investment of $800 million to $1 billion and expected to be near the lower end of the range based on then-current projections. Capital spending was delayed by severe weather and lower treatment-plant expenditures than in 2009.
The company reported $118.6 million of annualized general rate increases authorized in Q2, plus $2.0 million of infrastructure charges. As of August 3, it awaited final orders in eight states on requests for $223.9 million of additional annualized revenue; requested increases are not assured.
A planned enterprise-systems initiative, with SAP selected for three systems, could cost up to $280 million over approximately five years. The program was included in the capital-investment outlook.
Seasonality makes interim results not necessarily indicative of full-year results; operating cash flows are typically weighted toward the third quarter. The company cited rate-regulatory recovery and timing, customer usage, weather, economic conditions, capital needs and access to financing as factors affecting results and liquidity.
Management expected higher future medical benefit expense from health-care reform and claims experience. The legislation prompted a $27.1 million reduction in deferred tax assets and increase in regulatory assets during the first half.
Legal matters had approximately $3.5 million accrued as probable costs; reasonably possible additional losses were estimated up to $13.3 million, with some matters not estimable. Environmental remediation accruals were $6.8 million. The company said it did not expect claims to materially harm results, financial position or cash flows.
The national benefits agreement with most regulated-business unions expired July 31, 2010; negotiations were continuing. Management had contingency plans and did not expect a work stoppage to have a material adverse impact.
The company was in compliance with its debt covenants at June 30, including a 0.58 debt-to-capitalization ratio against a 0.70 limit. California and Ohio subsidiaries failed a mortgage-indenture interest-coverage test and therefore could not issue new secured debt. Credit ratings were Moody’s Baa2/P2 and S&P BBB+/A-2.
Post-quarter financing included a $150 million New Jersey bond refunding, with estimated annual interest savings of $1.2 million, and a $100 million interest-rate swap converting fixed-rate debt to a variable rate. The filing identifies derivative valuation, hedge effectiveness and counterparty performance as risks.

Important facts for investors to verify

Progress and final outcomes of pending rate cases, including how much of the $223.9 million request is ultimately approved and when rates become effective.
Whether capital spending remains near the lower end of the $800 million–$1 billion estimate, and the costs and schedule of the systems program.
Commercial-paper use, available credit capacity, refinancing costs, debt maturities and compliance with subsidiary-level debt tests.
Whether revenue growth persists despite lower residential water volumes, and whether acquisition-related operating costs and expected synergies develop as planned.
Future pension, postretirement medical, environmental and legal obligations, as well as outcomes of labor negotiations and the interest-rate swap.