Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission file: number 001-34028

 

 

AMERICAN WATER WORKS COMPANY, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   51-0063696

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1025 Laurel Oak Road, Voorhees, NJ   08043
(Address of principal executive offices)   (Zip Code)

(856) 346-8200

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at November 1, 2012

Common Stock, $0.01 par value per share   176,756,790 shares

 

 

 


Table of Contents

TABLE OF CONTENTS

AMERICAN WATER WORKS COMPANY, INC.

REPORT ON FORM 10-Q

FOR THE QUARTER ENDED September 30, 2012

INDEX

 

PART I. FINANCIAL INFORMATION

     3   

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

     3   

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     23 – 36   

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     37   

ITEM 4. CONTROLS AND PROCEDURES

     37   

PART II. OTHER INFORMATION

     38   

ITEM 1. LEGAL PROCEEDINGS

     38   

ITEM 1A. RISK FACTORS

     40   

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     40   

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     40   

ITEM 4. MINE SAFETY DISCLOSURE

     40   

ITEM 5. OTHER INFORMATION

     40   

ITEM 6. EXHIBITS

     40   

SIGNATURES

     41   

EXHIBITS INDEX

  

EXHIBIT 31.1

  

EXHIBIT 31.2

  

EXHIBIT 32.1

  

EXHIBIT 32.2

  

EXHIBIT 101

  

 

i


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Balance Sheets (Unaudited)

(In thousands, except per share data)

 

     September 30,
2012
    December 31,
2011
 
ASSETS   

Property, plant and equipment

    

Utility plant—at original cost, net of accumulated depreciation of $3,591,216 at September 30 and $3,360,005 at December 31

   $ 11,380,259      $ 10,872,042   

Nonutility property, net of accumulated depreciation of $189,634 at September 30 and $164,417 at December 31

     154,068        149,056   
  

 

 

   

 

 

 

Total property, plant and equipment

     11,534,327        11,021,098   
  

 

 

   

 

 

 

Current assets

    

Cash and cash equivalents

     18,531        14,207   

Restricted funds

     87,705        32,438   

Utility customer accounts receivable

     219,157        150,720   

Allowance for uncollectible accounts

     (16,082     (15,319

Unbilled utility revenues

     151,124        134,938   

Other receivables, net

     61,462        60,413   

Income taxes receivable

     7,815        7,672   

Materials and supplies

     31,925        28,598   

Assets of discontinued operations

     0        929,858   

Other

     80,888        54,134   
  

 

 

   

 

 

 

Total current assets

     642,525        1,397,659   
  

 

 

   

 

 

 

Regulatory and other long-term assets

    

Regulatory assets

     1,134,260        1,079,661   

Restricted funds

     21,137        25,503   

Goodwill

     1,207,572        1,195,069   

Other

     59,714        57,401   
  

 

 

   

 

 

 

Total regulatory and other long-term assets

     2,422,683        2,357,634   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 14,599,535      $ 14,776,391   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3


Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Balance Sheets (Unaudited)

(In thousands, except per share data)

 

     September 30,
2012
    December 31,
2011
 
CAPITALIZATION AND LIABILITIES   

Capitalization

    

Common stock ($.01 par value, 500,000 shares authorized, 176,748 and 175,664 shares outstanding at September 30 and December 31, respectively)

   $ 1,767      $ 1,757   

Paid-in-capital

     6,213,038        6,180,558   

Accumulated deficit

     (1,675,678     (1,848,801

Accumulated other comprehensive loss

     (91,507     (97,677
  

 

 

   

 

 

 

Common stockholders’ equity

     4,447,620        4,235,837   

Preferred stock without mandatory redemption requirements

     1,720        4,547   
  

 

 

   

 

 

 

Total stockholders’ equity

     4,449,340        4,240,384   
  

 

 

   

 

 

 

Long-term debt

    

Long-term debt

     5,184,546        5,339,947   

Redeemable preferred stock at redemption value

     19,321        21,137   
  

 

 

   

 

 

 

Total capitalization

     9,653,207        9,601,468   
  

 

 

   

 

 

 

Current liabilities

    

Short-term debt

     297,859        515,050   

Current portion of long-term debt

     34,964        28,858   

Accounts payable

     202,283        243,709   

Taxes accrued

     43,670        36,606   

Interest accrued

     106,074        59,067   

Liabilities of discontinued operations

     0        382,218   

Other

     321,024        223,597   
  

 

 

   

 

 

 

Total current liabilities

     1,005,874        1,489,105   
  

 

 

   

 

 

 

Regulatory and other long-term liabilities

    

Advances for construction

     378,446        386,970   

Deferred income taxes

     1,534,741        1,288,797   

Deferred investment tax credits

     28,288        29,427   

Regulatory liabilities

     355,720        325,829   

Accrued pension expense

     375,726        411,998   

Accrued postretirement benefit expense

     233,810        237,086   

Other

     39,710        38,963   
  

 

 

   

 

 

 

Total regulatory and other long-term liabilities

     2,946,441        2,719,070   
  

 

 

   

 

 

 

Contributions in aid of construction

     994,013        966,748   

Commitments and contingencies (See Note 10)

     —          —     
  

 

 

   

 

 

 

TOTAL CAPITALIZATION AND LIABILITIES

   $ 14,599,535      $ 14,776,391   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4


Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Statements of Operations and Comprehensive Income (Unaudited)

(In thousands, except per share data)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Operating revenues

   $ 831,815      $ 760,869      $ 2,195,976      $ 2,026,457   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

        

Operation and maintenance

     355,126        340,339        992,707        978,317   

Depreciation and amortization

     96,219        88,323        280,652        262,543   

General taxes

     52,861        52,433        165,264        160,882   

(Gain) loss on asset dispositions and purchases

     (31     (1,635     (657     (1,339
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses, net

     504,175        479,460        1,437,966        1,400,403   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     327,640        281,409        758,010        626,054   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expenses)

        

Interest, net

     (76,616     (78,562     (236,000     (233,222

Allowance for other funds used during construction

     3,735        3,696        13,173        9,059   

Allowance for borrowed funds used during construction

     1,548        1,586        5,942        3,988   

Amortization of debt expense

     (1,322     (1,251     (3,949     (3,798

Other, net

     39        12        (242     (463
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expenses)

     (72,616     (74,519     (221,076     (224,436
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     255,024        206,890        536,934        401,618   

Provision for income taxes

     100,913        78,395        216,908        157,607   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     154,111        128,495        320,026        244,011   

Income (loss) from discontinued operations, net of tax

     (299     8,927        (17,434     754   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 153,812      $ 137,422      $ 302,592      $ 244,765   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax:

        

Pension plan amortized to periodic benefit cost:

        

Prior service cost, net of tax of $28 and $28 for the three months ended and $84 and $84 for the nine months ended, respectively

   $ 44      $ 44      $ 132      $ 131   

Actuarial loss, net of tax of $1,167 and $720 for the three months ended and $3,501 and $2,160 for the nine months ended, respectively

     1,825        1,126        5,476        3,378   

Foreign currency translation adjustment

     514        (1,029     562        (618
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     2,383        141        6,170        2,891   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 156,195      $ 137,563      $ 308,762      $ 247,656   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share: (a)

        

Income from continuing operations

   $ 0.87      $ 0.73      $ 1.81      $ 1.39   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (0.00   $ 0.05      $ (0.10   $ 0.00   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 0.87      $ 0.78      $ 1.72      $ 1.39   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share: (a)

        

Income from continuing operations

   $ 0.87      $ 0.73      $ 1.80      $ 1.38   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (0.00   $ 0.05      $ (0.10   $ 0.00   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 0.86      $ 0.78      $ 1.70      $ 1.39   
  

 

 

   

 

 

   

 

 

   

 

 

 

Average common shares outstanding during the period:

        

Basic

     176,621        175,547        176,290        175,426   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     177,841        176,593        177,486        176,422   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends per common share

   $ 0.25      $ 0.23      $ 0.73      $ 0.90   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) Amounts may not sum due to rounding.

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Statements of Cash Flows (Unaudited)

(In thousands, except per share data)

 

     Nine Months Ended
September 30,
 
     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net income

   $ 302,592      $ 244,765   

Adjustments

    

Depreciation and amortization

     280,652        262,543   

Provision for deferred income taxes

     197,001        144,627   

Amortization of deferred investment tax credits

     (1,139     (1,156

Provision for losses on utility accounts receivable

     12,822        13,340   

Allowance for other funds used during construction

     (13,173     (9,059

Gain on asset dispositions and purchases

     (657     (1,339

Pension and non-pension post retirement benefits

     60,426        53,579   

Other, net

     (6,740     32,363   

Changes in assets and liabilities

    

Receivables and unbilled utility revenues

     (96,978     (55,647

Income taxes receivable

     (143     (134

Other current assets

     (22,480     (32,689

Pension and non-pension post retirement benefit contributions

     (96,036     (134,821

Accounts payable

     (47,121     (14,385

Taxes accrued, including income taxes

     33,721        17,289   

Interest accrued

     46,617        42,626   

Change in book overdraft

     36,206        0   

Other current liabilities

     49,444        14,142   
  

 

 

   

 

 

 

Net cash provided by operating activities

     735,014        576,044   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

    

Capital expenditures

     (680,357     (621,940

Acquisitions

     (44,333     (6,381

Proceeds from sale of assets and securities

     560,095        7,044   

Removal costs from property, plant and equipment retirements, net

     (38,606     (38,915

Net restricted funds released

     17,845        54,191   
  

 

 

   

 

 

 

Net cash used in investing activities

     (185,356     (606,001
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from long-term debt

     14,730        12,350   

Repayment of long-term debt

     (261,309     (68,689

Net (repayments) borrowings under short-term debt agreements

     (183,190     211,543   

Proceeds from issuances of employee stock plans and DRIP

     22,062        10,363   

Advances and contributions for construction, net of refunds of $10,748 and $15,142 at September 30, 2012 and 2011, respectively

     22,182        15,767   

Change in bank overdraft position

     (34,812     (31,111

Debt issuance costs

     0        (552

Redemption of preferred stock

     (3,927     (140

Dividends paid

     (125,023     (117,463

Other

     3,953        398   
  

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (545,334     32,466   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     4,324        2,509   

Cash and cash equivalents at beginning of period

     14,207        13,112   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 18,531      $ 15,621   
  

 

 

   

 

 

 

Non-cash investing activity:

    

Capital expenditures acquired on account but unpaid at quarter-end

   $ 118,215      $ 107,477   

Non-cash financing activity:

    

Long-term debt

   $ 68,746      $ 0   

Dividends accrued

   $ 44,187      $ 40,367   

Advances and contributions

   $ 9,185      $ 16,356   

The accompanying notes are an integral part of these consolidated financial statements.

 

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Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)

(In thousands, except per share data)

 

                                  Preferred
Stock

of
Subsidiary
Companies
Without
Mandatory
Redemption

Requirements
       
   

 

Common Stock

    Paid-in
Capital
    Accumulated
Deficit
   

 

Accumulated
Other
Comprehensive
Loss

    Treasury Stock       Total
Stockholders’
Equity
 
    Shares     Par
Value
          Shares     At Cost      

Balance at December 31, 2011

    175,664      $ 1,757      $ 6,180,558      $ (1,848,801   $ (97,677     0      $ 0      $ 4,547      $ 4,240,384   

Net income

    —          —          —          302,592        —          —          —          —          302,592   

Direct stock reinvestment and purchase plan, net of expense of $14

    42        0        1,445        —          —          —          —          —          1,445   

Employee stock purchase plan

    57        0        2,161        —          —          31        1,046        —          3,207   

Stock-based compensation activity

    985        10        28,874        (662     —          (31     (1,046     —          27,176   

Other comprehensive income, net of tax of $3,585

    —          —          —          —          6,170        —          —          —          6,170   

Preferred stock redemptions

    —          —          —          —          —          —          —          (2,827     (2,827

Dividends

    —          —          —          (128,807     —          —          —          —          (128,807
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

    176,748      $ 1,767      $ 6,213,038      $ (1,675,678   $ (91,507     0      $ 0      $ 1,720      $ 4,449,340   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

                                  Preferred
Stock

of
Subsidiary
Companies
Without
Mandatory
Redemption

Requirements
       
   

 

Common Stock

    Paid-in
Capital
    Accumulated
Deficit
   

 

Accumulated
Other
Comprehensive
Loss

    Treasury Stock       Total
Stockholders’
Equity
 
    Shares     Par
Value
          Shares     At Cost      

Balance at December 31, 2010

    174,996      $ 1,750      $ 6,156,675      $ (1,959,235   $ (71,446     (1   $ (19   $ 4,547      $ 4,132,272   

Net income

    —          —          —          244,765        —          —          —          —          244,765   

Direct stock reinvestment and purchase plan, net of expense of $14

    52        1        1,451        —          —          —          —          —          1,452   

Employee stock purchase plan

    91        1        2,604        —          —          —          —          —          2,605   

Stock-based compensation activity

    369        3        13,051        (593     —          1        19        —          12,480   

Other comprehensive income, net of tax of $2,244

    —          —          —          —          2,891        —          —          —          2,891   

Dividends

    —          —          —          (157,830     —          —          —          —          (157,830
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

    175,508      $ 1,755      $ 6,173,781      $ (1,872,893   $ (68,555     0      $ 0      $ 4,547      $ 4,238,635   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

7


Table of Contents

American Water Works Company, Inc. and Subsidiary Companies

Notes to Consolidated Financial Statements (Unaudited)

(In thousands, except per share data)

Note 1: Basis of Presentation

The accompanying Consolidated Balance Sheet of American Water Works Company, Inc. and Subsidiary Companies (the “Company”) at September 30, 2012, the Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2012 and 2011, the Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011, and the Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2012 and 2011, are unaudited, but reflect all adjustments, which are, in the opinion of management, necessary to present fairly the consolidated financial position, the consolidated changes in stockholders’ equity, the consolidated results of operations and comprehensive income, and the consolidated cash flows for the periods presented. All adjustments are of a normal, recurring nature, except as otherwise disclosed. Because they cover interim periods, the unaudited consolidated financial statements and related notes to the consolidated financial statements do not include all disclosures and notes normally provided in annual financial statements and, therefore, should be read in conjunction with the Company’s Consolidated Financial Statements and related Notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the year, due primarily to the seasonality of the Company’s operations.

During the fourth quarter of 2011, the Company discovered errors in the Company’s calculations of gains or losses on discontinued operations that originated in the first and second quarters of 2011. As a result, the Company recorded after-tax charges totaling $24,555, which included associated parent company goodwill, to reduce the net asset values of those businesses to their net realizable values. These charges were recognized within discontinued operations and net income and included in the operating results for the year ended December 31, 2011. In the footnotes to the Consolidated Financial Statements for the period ended December 31, 2011, the Company corrected the presentation of the first and second quarters of 2011. Additionally the Company reflected this correction in the corresponding prior periods presented in the Consolidated Statements of Operations and Comprehensive Income for the three and nine-month periods ended September 30, 2012. The write-downs included in the first and second quarters of 2011 totaled $21,099 and $3,456, respectively.

On August 1, 2012, the Company’s new business systems associated with Phase I of its business transformation project went live. Phase I consisted of the roll-out of the Enterprise Resource Planning systems, which encompass applications that handle human resources, finance, and supply chain/procurement management. Phase II consists of the roll-out of a new Enterprise Asset Management system, which will manage an asset’s lifecycle, and a Customer Information system, which contains all billing and data pertinent to the Company’s regulated segment customers. Phase II is expected to be completed in 2013. Costs incurred to acquire and internally develop computer software for internal use are capitalized as a unit of property. The carrying value of these costs amounted to $154,697 and $49,241 at September 30, 2012 and December 31, 2011, respectively.

Note 2: New Accounting Pronouncements

The following recently announced accounting standards have been adopted by the Company and have been included in the consolidated results of operations, financial position or footnotes of the accompanying Consolidated Financial Statements:

Fair Value Measurements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued updated accounting guidance related to fair value measurements and disclosures that result in common fair value measurements and disclosures between U.S. Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards. This new guidance amends current fair value measurement and disclosure guidance to increase transparency around valuation inputs and investment categorization. This guidance is effective for interim and annual periods beginning on January 1, 2012 and is required to be applied prospectively. The adoption of this guidance did not have a significant impact on the Company’s results of operations, financial position or cash flows.

Comprehensive Income

In June 2011, the FASB issued guidance on the presentation of comprehensive income. The new guidance allows an entity to present components of net income and other comprehensive income in either one continuous statement or two separate but consecutive statements. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. In December 2011, the FASB deferred the requirement to present reclassification adjustments of other comprehensive income on the face of the

 

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income statement. The new guidance is effective for the Company beginning on January 1, 2012. As the Company already presents the components of net income and other comprehensive income in one continuous statement, the adoption of the new guidance did not have an impact on its results of operations, financial position or cash flows.

Testing Goodwill for Impairment

In September 2011, the FASB updated the accounting guidance related to testing goodwill for impairment. This update permits an entity to assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test that is currently in place. Under the new guidance, an entity will not be required to calculate the fair value of a reporting unit unless the entity determines, based on the qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This update is effective for annual and interim goodwill impairment tests performed by the Company beginning on January 1, 2012. The adoption of this update is not expected to have a significant impact on its results of operations, financial position or cash flows.

The following recently issued accounting standards are not yet required to be adopted by the Company or included in the consolidated results of operations or financial position of the Company:

Testing Indefinite-Lived Intangible Assets for Impairment

In July 2012, the FASB updated the accounting guidance related to testing indefinite-lived intangible assets for impairment. This update permits an entity to perform a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test under current guidance. This update is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The Company is evaluating the specific provisions of the updated guidance, but does not expect the adoption of this guidance to have a significant impact on the Company’s results of operations, financial position or cash flows.

Note 3: Acquisitions and Divestitures

Acquisitions

As of September 30, 2012, the Company closed on six acquisitions of various regulated water and wastewater systems for a total aggregate purchase price of $44,333. Included in this total was the Company’s May 1, 2012 acquisition of all of the capital stock of Aqua New York, Inc. (the “Acquisition”) for a total cash purchase price of $39,273 plus assumed liabilities, subject to post-closing purchase price adjustments that may occur during the fourth quarter of 2012. The Acquisition, which expanded the Company’s service area in the state of New York, added approximately fifty thousand customers to Regulated operations.

The Acquisition was accounted for as a business combination; accordingly, operating results from May 1, 2012 were included in the Company’s results of operations. The preliminary purchase price was allocated to the net tangible and intangible assets based upon their estimated fair values at the date of acquisition. The Company’s regulatory practice has been followed, whereby property, plant and equipment (rate base) is considered fair value for business combination purposes. Similarly, regulatory assets and liabilities acquired have been recorded at book value and are subject to regulatory approval where applicable. The acquired debt and employee benefit plans have been fair-valued using common valuation techniques. The acquired debt has been valued in a manner consistent with the Company’s Level 2 and Level 3 pre-acquisition debt. (see Note 13) The Company has recognized employee benefit plan liabilities on the acquisition date for the funded status of defined-benefit plans assumed as part of the business combination. The pro forma impact of this acquisition would not have been material to the Company’s results of operations for the three and nine months ended September 30, 2012 and 2011, respectively. Total assets acquired in the Acquisition were $107,784, including $59,165 of plant, $32,884 of regulatory assets, $3,232 of other assets and $12,503 of goodwill; liabilities assumed totaled $68,511, including long-term debt of $25,215, $15,377 of regulatory liabilities, $15,029 of deferred taxes, $3,180 of other liabilities and $9,710 of pension and postretirement welfare liabilities.

Divestitures

As part of the Company’s strategic review of its business investments, it has previously entered into agreements to sell assets or stock of certain subsidiaries.

In January 2012, the Company completed the close of the sale of its Arizona and New Mexico subsidiaries. Initial sales proceeds were $461,057, and the Company recorded no gain or loss at the time of the sale closing. In June 2012, as part of post-closing adjustments to finalize the sale, the Company remitted $2,448 to the purchaser, and recorded a pretax loss on sale for the same amount.

 

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In May 2012, the Company completed the close of the sale of its Ohio subsidiary. Initial sales proceeds were $101,083 and are subject to post-closing adjustments. The Company recorded a pretax loss on sale of $5,166, primarily due to pension settlement costs calculated at closing.

As disclosed in Note 1 included herein, the Company previously revised its 2011 first quarter results for an after-tax impairment charge of $21,099, which was recorded as an asset impairment charge to reduce parent company goodwill that had been allocated to the Arizona and New Mexico subsidiaries. An additional $3,456 after-tax asset impairment charge was recorded in the Company’s 2011 second quarter results for parent company goodwill allocated to the Ohio subsidiary transaction.

In June 2011, the Company completed the sale of the assets of its Texas subsidiary for sale proceeds of $6,245. In the first quarter of 2011, the Company had previously recognized an after-tax impairment charge of $552 for parent company goodwill allocated to the Texas subsidiary.

Charges recorded in connection with the discontinued operations include estimates that are subject to subsequent adjustments.

A summary of discontinued operations presented in the Consolidated Statements of Operations and Comprehensive Income follows:

 

     Three Months  Ended
September 30,
     Nine Months  Ended
September 30,
 
     2012     2011      2012     2011  

Operating revenues

   $ 0      $ 48,404       $ 19,377      $ 131,860   

Total operating expenses, net

     493        34,306         28,411        115,572   
  

 

 

   

 

 

    

 

 

   

 

 

 

Operating income (loss)

     (493     14,098         (9,034     16,288   

Other income (expenses), net

     0        67         (167     477   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations before income taxes

     (493     14,165         (9,201     16,765   

Provision (benefit) for income taxes

     (194     5,238         8,233        16,011   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (299   $ 8,927       $ (17,434   $ 754   
  

 

 

   

 

 

    

 

 

   

 

 

 

There were no assets or liabilities of discontinued operations at September 30, 2012. Assets and liabilities of discontinued operations at December 31, 2011 include the following:

 

Assets:

  

Total property, plant and equipment

   $ 833,023   

Current assets

     21,906   

Regulatory assets

     43,849   

Goodwill

     29,608   

Other

     1,472   
  

 

 

 

Total assets of discontinued operations

   $ 929,858   
  

 

 

 

Liabilities:

  

Long-term debt

   $ 11,697   

Current portion of long-term debt

     12,839   

Other current liabilities

     29,530   

Advances for construction

     205,034   

Regulatory liabilities

     4,617   

Other

     15,540   

Contributions in aid of construction

     102,961   
  

 

 

 

Total liabilities of discontinued operations

   $ 382,218   
  

 

 

 

Note 4: Goodwill

The Company’s annual goodwill impairment test is conducted at November 30 of each calendar year. Interim reviews are performed when the Company determines that a triggering event that would more likely than not reduce the fair value of a reporting unit below its carrying value has occurred.

In the first quarter of 2011, the Company assessed fair value, including allocated goodwill, and recorded impairments of $21,099 for the pending sales of its Arizona and New Mexico subsidiaries, and $552 for the pending sale of the Company’s assets of its Texas subsidiary. These impairment charges were included in operating results of discontinued operations. (see Note 3 above)

 

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The following table summarizes the nine-month changes in goodwill of the Company’s continuing operations by reporting unit:

 

     Regulated Unit     Market-Based Operations     Consolidated  
     Cost     Accumulated
Impairment
    Cost      Accumulated
Impairment
    Cost     Accumulated
Impairment
    Total Net  

Balance at January 1, 2012

   $ 3,399,368      $ (2,332,670   $ 235,990       $ (107,619   $ 3,635,358      $ (2,440,289   $ 1,195,069   

Goodwill from acquisitions

     12,503        0        0         0        12,503        0        12,503   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 3,411,871      $ (2,332,670   $ 235,990       $ (107,619   $ 3,647,861      $ (2,440,289   $ 1,207,572   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 1, 2011

   $ 3,399,884      $ (2,332,670   $ 235,990       $ (107,619   $ 3,635,874      $ (2,440,289   $ 1,195,585   

Reclassifications and other activity

     (75     0        0         0        (75     0        (75
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

   $ 3,399,809      $ (2,332,670   $ 235,990       $ (107,619   $ 3,635,799      $ (2,440,289   $ 1,195,510   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

The Company may be required to recognize an impairment of goodwill in the future due to market conditions or other factors related to the Company’s performance. These market events could include a decline over a period of time of the Company’s stock price, a decline over a period of time in valuation multiples of comparable water utilities, the lack of an increase in the Company’s market price consistent with its peer companies, or decreases in control premiums. A decline in the forecasted results in the Company’s business plan, such as changes in rate case results or capital investment budgets or changes in the Company’s interest rates, could also result in an impairment charge. Recognition of impairments of a significant portion of goodwill would negatively affect the Company’s reported results of operations and total capitalization, the effect of which could be material and could make it more difficult to maintain its credit ratings, secure financing on attractive terms, maintain compliance with debt covenants and meet expectations of the Company’s regulators.

Note 5: Stockholders’ Equity

Common Stock

In March 2010, the Company established American Water Stock Direct, a dividend reinvestment and direct stock purchase plan (the “DRIP”). Under the DRIP, stockholders may reinvest cash dividends and purchase additional Company common stock, up to certain limits, through a transfer agent without commission fees. The Company’s transfer agent may buy newly issued shares directly from the Company or shares held in the Company’s treasury. The transfer agent may also buy shares in the public markets or in privately negotiated transactions. Purchases generally will be made and credited to DRIP accounts once each week. As of September 30, 2012, there were 4,831 shares available for future issuance under the DRIP. The following table summarizes information regarding issuances under the DRIP for the nine months ended September 30, 2012 and 2011:

 

     2012      2011  

Shares of common stock issued

     42         52   

Cash proceeds received

   $ 1,459       $ 1,466   

Cash dividend payments made during the three-month periods ended March 31, June 30, and September 30 were as follows:

 

     2012      2011  

Dividends per share, three months ended:

     

March 31

   $ 0.23       $ 0.22   

June 30

     0.23         0.22   

September 30

     0.25         0.23   

Total dividends paid, three months ended:

     

March 31

   $ 40,414       $ 38,525   

June 30

     40,529         38,580   

September 30

     44,080         40,358   

 

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On September 20, 2012, the Company declared a quarterly cash dividend payment of $0.25 per share payable on December 3, 2012 to all shareholders of record as of November 16, 2012. As of September 30, 2012, the Company had accrued dividends totaling $44,187 included in other current liabilities in the accompanying Consolidated Balance Sheets.

Stock-Based Compensation

The Company has granted stock option and restricted stock unit awards to non-employee directors, officers and other key employees of the Company pursuant to the terms of its 2007 Omnibus Equity Compensation Plan (the “Plan”). As of September 30, 2012, a total of 10,253 shares were available for grant under the Plan. Shares issued under the Plan may be authorized but unissued shares of Company stock or reacquired shares of Company stock, including shares purchased by the Company on the open market for purposes of the Plan.

The Company recognizes compensation expense for stock awards over the vesting period of the award. The following table presents stock-based compensation expense recorded in operation and maintenance expense in the accompanying Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2012 and 2011:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Stock options

   $ 783      $ 810      $ 2,489      $ 2,438   

Restricted stock units

     2,365        1,275        5,669        4,179   

Employee stock purchase plan

     138        135        391        343   
  

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation in operation and maintenance expense

     3,286        2,220        8,549        6,960   

Income tax benefit

     (1,281     (865     (3,334     (2,714
  

 

 

   

 

 

   

 

 

   

 

 

 

After-tax stock-based compensation expense

   $ 2,005      $ 1,355      $ 5,215      $ 4,246   
  

 

 

   

 

 

   

 

 

   

 

 

 

There were no significant stock-based compensation costs capitalized during the nine months ended September 30, 2012 and 2011, respectively.

Stock Options

In the first nine months of 2012, the Company granted non-qualified stock options to certain employees under the Plan. The stock options vest ratably over the three-year service period beginning January 1, 2012. These awards have no performance vesting conditions and the grant date fair value is amortized through expense over the requisite service period using the straight-line method. The following table presents the weighted-average assumptions used in the pricing model for 2012 grants and the resulting weighted-average grant date fair value per share of stock options granted:

 

Dividend yield

     2.70

Expected volatility

     28.35

Risk-free interest rate

     0.78

Expected life (years)

     4.4   

Exercise price

   $ 34.14   

Grant date fair value per share

   $ 6.11   

Stock options granted under the Plan have maximum terms of seven years, vest over periods ranging from one to three years, and are granted with exercise prices equal to the market value of the Company’s common stock on the date of grant. As of September 30, 2012, $4,346 of total unrecognized compensation cost related to the non-vested stock options is expected to be recognized over the weighted-average period of 1.6 years.

The following table summarizes stock option activity for the nine months ended September 30, 2012:

 

     Shares     Weighted-
Average
Exercise Price
(per share)
     Weighted-
Average
Remaining
Life (years)
     Aggregate
Intrinsic
Value
 

Options outstanding at January 1, 2012

     3,112      $ 22.70         

Granted

     649        34.14         

Forfeited or expired

     (99     27.73         

Exercised

     (832     21.59         
  

 

 

         

Options outstanding at September 30, 2012

     2,830      $ 25.48         4.4       $ 32,787   
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable at September 30, 2012

     1,571      $ 22.09         3.4       $ 23,522   
  

 

 

   

 

 

    

 

 

    

 

 

 

 

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The following table summarizes additional information regarding stock options exercised during the nine months ended September 30, 2012 and 2011:

 

     2012      2011  

Intrinsic value

   $ 11,433       $ 1,944   

Exercise proceeds

     17,966         6,645   

Income tax benefit

     3,124         263   

Restricted Stock Units

In the first nine months of 2012, the Company granted restricted stock units to certain employees and non-employee directors under the Plan. The restricted stock units vest ratably over the three-year performance period beginning January 1, 2012 (the “Performance Period”); however, distribution of the shares is contingent upon the achievement of internal performance measures and, separately, certain market thresholds over the Performance Period. The restricted stock units granted with performance and service conditions are valued at the market value of the Company’s common stock on the date of grant. The restricted stock units granted with market and service conditions are valued using a Monte Carlo model. Weighted-average assumptions used in the Monte Carlo simulation for the 2012 grants are as follows:

 

Expected volatility

     22.47

Risk-free interest rate

     0.43

Expected life (years)

     3   

The grant date fair value of the restricted stock awards that vest ratably and have market and/or performance and service conditions is amortized through expense over the requisite service period using the graded-vesting method. As of September 30, 2012, $5,208 of total unrecognized compensation cost related to the non-vested restricted stock units is expected to be recognized over the weighted-average remaining life of 0.9 years.

The following table summarizes restricted stock unit activity for the nine months ended September 30, 2012:

 

     Shares     Weighted-Average
Grant  Date
Fair Value
(per share)
 

Nonvested total at January 1, 2012

     577      $ 25.09   

Granted

     172        37.40   

Vested

     (182     23.01   

Forfeited

     (25     30.36   

Cancelled

     (2     22.08   
  

 

 

   

Nonvested total at September 30, 2012

     540      $ 29.48   
  

 

 

   

The following table summarizes additional information regarding restricted stock units distributed during the nine months ended September 30, 2012 and 2011:

 

     2012      2011  

Intrinsic value

   $ 6,159       $ 1,980   

Income tax benefit

     799         99   

If dividends are declared with respect to shares of the Company’s common stock before the restricted stock units are distributed, the Company credits a liability for the value of the dividends that would have been paid if the restricted stock units were shares of Company common stock. When the restricted stock units are distributed, the Company pays the participant a lump sum cash payment equal to the value of the dividend equivalents accrued. The Company accrued dividend equivalents totaling $662 and $593 to retained earnings during the nine months ended September 30, 2012 and 2011, respectively.

 

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Employee Stock Purchase Plan

Under the Nonqualified Employee Stock Purchase Plan (the “ESPP”), employees can use payroll deductions to acquire Company stock at the lesser of 90% of the fair market value of (a) the beginning or (b) the end of each three-month purchase period. As of September 30, 2012 there were 1,504 shares of common stock reserved for issuance under the ESPP. During the nine months ended September 30, 2012, the Company issued 88 shares under the ESPP.

Note 6: Long-Term Debt

The Company primarily issues long-term debt to fund capital expenditures at the regulated subsidiaries. The components of long-term debt are as follows:

 

     Rate    Weighted-
Average Rate
    Maturity
Date
   September 30,
2012
     December 31,
2011
 

Long-term debt of American Water Capital Corp. (“AWCC”) (a)

             

Private activity bonds and government funded debt

             

Fixed rate

   4.85%-6.75%      5.72   2018-2040    $ 322,610       $ 322,610   

Senior notes

             

Fixed rate

   5.39%-10.00%      6.25   2013-2040      3,089,409         3,089,409   

Long-term debt of other subsidiaries

             

Private activity bonds and government funded debt

             

Fixed rate

   0.00%-6.20%      4.78   2012-2041      1,056,460         1,206,332   

Mortgage bonds

             

Fixed rate

   5.48%-9.71%      7.40   2012-2039      697,800         697,800   

Mandatory redeemable preferred stock

   8.47%-9.75%      8.61   2019-2036      21,001         22,101   

Notes payable and other (b)

   9.49%-12.17%      11.65   2013-2026      1,416         1,691   
          

 

 

    

 

 

 

Long-term debt

             5,188,696         5,339,943   

Unamortized debt discount, net (c)

             41,952         43,888   

Fair value adjustment to interest rate hedge

             8,183         6,111   
          

 

 

    

 

 

 

Total long-term debt

           $ 5,238,831       $ 5,389,942   
          

 

 

    

 

 

 

 

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(a) AWCC, which is a wholly-owned subsidiary of the Company, has a strong support agreement with its parent that, under certain circumstances, is the functional equivalent of a guarantee.
(b) Includes capital lease obligations of $1,089 and $1,264 at September 30, 2012 and December 31, 2011, respectively.
(c) Includes fair value adjustments recognized in acquisition purchase accounting.

The following long-term debt was issued in 2012:

 

Company

 

Type

   Interest Rate    Maturity    Amount  

Other subsidiaries (1)

 

Private activity bonds and government funded debt – fixed rate

   0.00%-5.00%    2013-2041    $ 83,476   
          

 

 

 

Total issuances

           $ 83,476   
          

 

 

 

 

(1) Included in the issuance amount above was $68,746, which was initially kept in Trust pending the Company’s certification that it has incurred qualifying capital expenditures. These issuances have been presented as non-cash in the accompanying Consolidated Statements of Cash Flows. Subsequent releases of all or a lesser portion of these funds by the applicable Trust are reflected as the release of restricted funds and are included in investing activities in the accompanying Consolidated Statements of Cash Flows.

The following long-term debt was retired through optional redemption or payment at maturity during 2012:

 

Company

 

Type

   Interest Rate     Maturity      Amount  

Other subsidiaries

 

Mortgage bonds – fixed rate

     7.95     2012       $ 4,200   

Other subsidiaries

 

Private activity bonds and government funded debt – fixed rate

     0.00%-6.00%        2012-2041         256,834   

Other subsidiaries

 

Mandatory redeemable preferred stock

     4.60%-6.00%        2013-2019         1,100   

Other

 

Capital leases and other

          275   
         

 

 

 

Total retirements and redemptions

          $ 262,409   
         

 

 

 

Other activity of long-term debt during the first nine months of 2012 includes debt assumed in an acquisition totaling $25,215. (see Note 3)

On October 31, 2012, the Company issued notices of redemption for $129,000 of outstanding private activity bonds with maturity dates ranging from 2022 to 2032 and interest rates ranging from 5.00% to 5.25%.

Interest income included in interest, net is summarized below:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Interest income

   $ 2,837       $ 2,641       $ 8,470       $ 8,044   

The Company previously entered into an interest-rate swap to hedge $100,000 of its 6.085% fixed-rate debt maturing 2017. The Company pays variable interest of six-month LIBOR plus 3.422%. This fixed rate and variable rate interest swap is accounted for as a fair value hedge. The swap matures with the fixed-rate debt in 2017. The Company uses a combination of fixed-rate and variable-rate debt to manage interest rate exposure.

 

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At September 30, 2012 and December 31, 2011, the Company had a $100,000 notional amount variable interest-rate swap fair value hedge outstanding. The following table provides a summary of the derivative fair value balance recorded by the Company and the line item in the Consolidated Balance Sheets in which such amount is recorded:

 

     September 30,
2012
     December 31,
2011
 

Regulatory and other long-term assets

     

Other

   $ 8,209       $ 5,824   

Long-term debt

     

Long-term debt

     8,183         6,111   

For derivative instruments that are designated as and qualify as fair value hedges, the gain or loss on the hedge instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current net income. The Company includes the gain or loss on the derivative instrument and the offsetting loss or gain on the hedged item in interest expense as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Interest, net

        

Gain (loss) on swap

   $ 1,121      $ 4,896      $ 2,384      $ 6,510   

Gain (loss) on borrowing

     (800     (4,797     (2,072     (6,230

Hedge ineffectiveness

     321        99        312        280   

Note 7: Short-Term Debt

The components of short-term debt are as follows:

 

     September 30,
2012
     December 31,
2011
 

Commercial paper, net of $50 and $52 discount at September 30 and December 31, respectively

   $ 297,859       $ 481,048   

Bank overdraft

     0         34,002   
  

 

 

    

 

 

 

Total short-term debt

   $ 297,859       $ 515,050   
  

 

 

    

 

 

 

Prior to January 1, 2012, the Company had overdraft protection provided by a revolving credit line with PNC Bank, N.A. The Company did not renew this credit line at December 31, 2011. Accordingly, the Company’s outstanding checks on its cash accounts with PNC Bank, N.A. are classified, as of January 1, 2012, as other current liabilities in the accompanying Consolidated Balance Sheets, and changes in those accounts are included in operating activities for 2012 in the accompanying Consolidated Statements of Cash Flows.

On October 29, 2012, AWCC, the Company’s financing subsidiary, entered into a new revolving credit facility agreement with $1,000,000 in aggregate total commitments from a diversified group of 14 banks. The agreement includes a $150,000 sublimit for letters of credit and a $100,000 sublimit for swing loans. The new agreement expires in October 2017 and replaces AWCC’s previous credit agreement that would have expired in September 2013. Interest on borrowings under the new agreement will be based, at AWCC’s option, upon either: (i) a fixed base rate or (ii) a LIBOR-based rate, plus an applicable margin. Debt covenants under the new facility are consistent with that of the terminated facility.

Note 8: Income Taxes

The Company’s estimated annual effective tax rate for the nine months ended September 30, 2012 was 40.2% compared to 40.2% for the nine months ended September 30, 2011, excluding various discrete items. The Company’s actual effective tax rates on continuing operations were as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Actual effective tax rate on continuing operations

     39.6     37.9     40.4     39.2

 

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Note 9: Pension and Other Postretirement Benefits

The following table provides the components of net periodic benefit costs:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Components of net periodic pension benefit cost

        

Service cost

   $ 8,507      $ 8,410      $ 25,521      $ 25,231   

Interest cost

     17,522        17,262        52,564        51,785   

Expected return on plan assets

     (19,619     (18,027     (58,856     (54,081

Amortization of:

        

Prior service cost

     181        180        542        541   

Actuarial loss

     7,402        4,638        22,207        13,913   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic pension benefit cost

   $ 13,993      $ 12,463      $ 41,978      $ 37,389   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Components of net periodic other postretirement benefit cost

        

Service cost

   $   3,526      $   3,484      $ 10,577      $ 10,453   

Interest cost

     7,859        7,805        23,575        23,414   

Expected return on plan assets

     (7,140      (7,195     (21,421     (21,584

Amortization of:

        

Prior service credit

     (479     (481     (1,436     (1,443

Actuarial loss

     2,384        1,783        7,153        5,350   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic other postretirement benefit cost

   $   6,150      $   5,396      $ 18,448      $ 16,190   
  

 

 

   

 

 

   

 

 

   

 

 

 

The Company contributed $73,549 to its defined benefit pension plans in the first nine months of 2012 and expects to contribute $23,979 during the balance of 2012. In addition, the Company contributed $22,487 for the funding of its other postretirement plans in the first nine months of 2012 and expects to contribute $7,496 during the balance of 2012.

Note 10: Commitments and Contingencies

The Company is routinely involved in legal actions incident to the normal conduct of its business. At September 30, 2012, the Company has accrued approximately $1,700 as probable costs and it is reasonably possible that additional losses could range up to $33,300 for these matters. For certain matters, the Company is unable to estimate possible losses. The Company believes that damages or settlements recovered by plaintiffs in such claims or actions, if any, will not have a material adverse effect on the Company’s results of operations, financial position or cash flows.

The Company enters into agreements for the provision of services to water and wastewater facilities for the United States military, municipalities and other customers. The Company’s military services agreements expire between 2051 and 2060 and have remaining performance commitments as measured by estimated remaining contract revenue of $1,979,000 at September 30, 2012. The military contracts are subject to customary termination provisions held by the U.S. Federal Government prior to the agreed upon contract expiration. The Company’s Operations and Maintenance agreements with municipalities and other customers expire between 2012 and 2048 and have remaining performance commitments as measured by estimated remaining contract revenue of $1,040,000 at September 30, 2012. Some of the Company’s long-term contracts to operate and maintain a municipality’s, federal government’s or other party’s water or wastewater treatment and delivery facilities include responsibility for certain maintenance for some of those facilities, in exchange for an annual fee. Unless specifically required to perform certain maintenance activities, the maintenance costs are recognized when the maintenance is performed.

Note 11: Environmental Matters

The Company’s water and wastewater operations are subject to federal, state, local and foreign requirements relating to environmental protection, and as such, the Company periodically becomes subject to environmental claims in the normal course of business. Environmental expenditures that relate to current operations or provide a future benefit are expensed or capitalized as appropriate. Remediation costs that relate to an existing condition caused by past operations are accrued, on an undiscounted basis, when it is probable that these costs will be incurred and can be reasonably estimated. Remediation costs accrued amounted to $4,400 and $5,500 at September 30, 2012 and December 31, 2011, respectively. The accrual relates to a conservation agreement entered into

 

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by a subsidiary of the Company with the National Oceanic and Atmospheric Administration (“NOAA”) requiring the Company to, among other provisions, implement certain measures to protect the steelhead trout and its habitat in the Carmel River watershed in the state of California. The Company has agreed to pay $1,100 annually from 2010 through 2016. The Company pursues recovery of incurred costs through all appropriate means, including regulatory recovery through customer rates. The Company’s regulatory assets at September 30, 2012 and December 31, 2011 include $8,814 and $9,187 respectively, related to the NOAA agreement.

Note 12: Earnings per Common Share

Earnings per share is calculated using the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security. The Company has participating securities related to restricted stock units, granted under the Company’s 2007 Omnibus Equity Compensation Plan, that earn dividend equivalents on an equal basis with common shares. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities. The following is a reconciliation of the Company’s income from continuing operations, income (loss) from discontinued operations, and net income and weighted-average common shares outstanding for calculating basic earnings per share:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012     2011      2012     2011  

Basic:

         

Income from continuing operations

   $ 154,111      $ 128,495       $ 320,026      $ 244,011   

Income (loss) from discontinued operations, net of tax

     (299     8,927         (17,434     754   

Net income

     153,812        137,422         302,592        244,765   

Less: Distributed earnings to common shareholders

     44,323        40,543         125,634        118,004   

Less: Distributed earnings to participating securities

     20        17         51        52   
  

 

 

   

 

 

    

 

 

   

 

 

 

Undistributed earnings

     109,469        96,862         176,907        126,709   

Undistributed earnings allocated to common shareholders

     109,423        96,818         176,834        126,653   

Undistributed earnings allocated to participating securities

     46        44         73        56   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total income from continuing operations available to common shareholders, basic

   $ 154,045      $ 128,434       $ 319,902      $ 243,903   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total income available to common shareholders, basic

   $ 153,746      $ 137,361       $ 302,468      $ 244,657   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted-average common shares outstanding, basic

     176,621        175,547         176,290        175,426   
  

 

 

   

 

 

    

 

 

   

 

 

 

Basic earnings per share: (a)

         

Income from continuing operations

   $ 0.87      $ 0.73       $ 1.81      $ 1.39   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (0.00   $ 0.05       $ (0.10   $ 0.00   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 0.87      $ 0.78       $ 1.72      $ 1.39   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(a) Amounts may not sum due to rounding.

 

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Diluted earnings per common share is based on the weighted-average number of common shares outstanding, adjusted for the dilutive effect of common stock equivalents related to the restricted stock units, stock options, and employee stock purchase plan. The dilutive effect of the common stock equivalents is calculated using the treasury stock method and expected proceeds on vesting of the restricted stock units, exercise of the stock options and purchases under the employee stock purchase plan. The following is a reconciliation of the Company’s income from continuing operations, income (loss) from discontinued operations and net income and weighted-average common shares outstanding for calculating diluted earnings per share:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012     2011      2012     2011  

Diluted:

         

Total income from continuing operations available to common shareholders, basic

   $ 154,045      $ 128,434       $ 319,902      $ 243,903   

Income (loss) from discontinued operations, net of tax

     (299     8,927         (17,434     754   

Total income available to common shareholders, basic

     153,746        137,361         302,468        244,657   

Undistributed earnings allocated to participating securities

     46        44         73        56   

Total income from continuing operations available to common shareholders, diluted

   $ 154,091      $ 128,478       $ 319,975      $ 243,959   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total income available to common shareholders, diluted

   $ 153,792      $ 137,405       $ 302,541      $ 244,713   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted-average common shares outstanding, basic

     176,621        175,547         176,290        175,426   

Stock-based compensation:

         

Restricted stock units

     608        561         585        524   

Stock options

     610        484         610        471   

Employee stock purchase plan

     2        1         1        1   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted-average common shares outstanding, diluted

     177,841        176,593         177,486        176,422   
  

 

 

   

 

 

    

 

 

   

 

 

 

Diluted earnings per share: (a)

         

Income from continuing operations

   $ 0.87      $ 0.73       $ 1.80      $ 1.38   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ (0.00   $ 0.05       $ (0.10   $ 0.00   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 0.86      $ 0.78       $ 1.70      $ 1.39   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(a) Amounts may not sum due to rounding.

The following potentially dilutive common stock equivalents were not included in the earnings per share calculations because they were anti-dilutive:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Stock options

     620         728         620         728   

Restricted stock units where certain performance conditions were not met

     36         74         37         74   

Note 13: Fair Value of Assets and Liabilities

Fair Value of Financial Instruments

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Current assets and current liabilities: The carrying amounts reported in the accompanying Consolidated Balance Sheets for current assets and current liabilities, including revolving credit debt, due to the short-term maturities and variable interest rates, approximate their fair values.

Preferred stock with mandatory redemption requirements and long-term debt: The fair values of preferred stock with mandatory redemption requirements and long-term debt are categorized within the fair value hierarchy based on the inputs that are used to value each instrument. The fair value of long-term debt classified as Level 1 is calculated using quoted prices in active markets. Level 2 instruments are valued using observable inputs and Level 3 instruments are valued using observable and unobservable inputs. The fair

 

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values of instruments classified as Level 2 and 3 are determined by a valuation model that is based on a conventional discounted cash flow methodology and utilizes assumptions of current market rates. The Company calculated a base yield curve using a risk-free rate (a U.S. Treasury securities yield curve) plus a credit spread that is based on the following two factors: an average of the Company’s own publicly-traded debt securities and the current market rates for U.S. Utility BBB+ debt securities. The Company used these yield curve assumptions to derive a base yield for the Level 2 and Level 3 securities. Additionally, the Company adjusted the base yield for specific features of the debt securities including call features, coupon tax treatment and collateral for the Level 3 instruments.

The carrying amounts (including fair value adjustments previously recognized in acquisition purchase accounting) and fair values of the financial instruments are as follows:

 

            At Fair Value as of September 30, 2012  

Recurring Fair Value Measures

   Carrying
Amount
     Level 1      Level 2      Level 3      Total  

Preferred stocks with mandatory redemption requirements

   $ 20,971       $ 0       $ 0       $ 27,649       $ 27,649   

Long-term debt (excluding capital lease obligations)

     5,216,771         2,410,390         1,665,503         2,616,641         6,692,534   

 

As of December 31, 2011

   Carrying
Amount
     Fair Value  

Preferred stocks with mandatory redemption requirements

   $ 22,036       $ 26,458   

Long-term debt (excluding capital lease obligations)

     5,366,642         6,230,547   

Recurring Fair Value Measurements

The following table presents assets and liabilities measured and recorded at fair value on a recurring basis and their level within the fair value hierarchy as of September 30, 2012 and December 31, 2011, respectively:

 

     At Fair Value as of September 30, 2012  

Recurring Fair Value Measures

   Level 1      Level 2     Level 3      Total  

Assets:

          

Restricted funds

   $ 108,842         —          —         $ 108,842   

Rabbi trust investments

     —         $ 241        —           241   

Deposits

     1,621         —          —           1,621   

Mark-to-market derivative asset

     —           8,209        —           8,209   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total assets

     110,463         8,450        —           118,913   
  

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

          

Deferred compensation obligation

     —           9,918        —           9,918   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total liabilities

     —           9,918        —           9,918   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total net assets (liabilities)

   $ 110,463       $ (1,468     —         $ 108,995   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

     At Fair Value as of December 31, 2011  

Recurring Fair Value Measures

   Level 1      Level 2     Level 3      Total  

Assets:

          

Restricted funds

   $ 57,941         —          —         $ 57,941   

Rabbi trust investments

     —         $ 518        —           518   

Deposits

     2,287         —          —           2,287   

Mark-to-market derivative asset

     —           5,824        —           5,824   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total assets

     60,228         6,342        —           66,570   
  

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

          

Deferred compensation obligation

     —           9,036        —           9,036   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total liabilities

     —           9,036        —           9,036   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total net assets (liabilities)

   $ 60,228       $ (2,694     —         $ 57,534   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents

Restricted funds – The Company’s restricted funds primarily represent proceeds received from financings for the construction and capital improvement of facilities and from customers for future services under operations and maintenance projects. The proceeds of these financings are held in escrow until the designated expenditures are incurred. Restricted funds expected to be released within twelve months subsequent to the balance sheet date are classified as current.

Rabbi trust investments – The Company’s rabbi trust investments consist primarily of fixed income investments from which supplemental executive retirement plan benefits are paid. The Company includes these assets in other long-term assets.

Deposits – Deposits include escrow funds and certain other deposits held in trust. The Company includes cash deposits in other current assets.

Deferred compensation obligations – The Company’s deferred compensation plans allow participants to defer certain cash compensation into notional investment accounts. The Company includes such plans in other long-term liabilities. The value of the Company’s deferred compensation obligations is based on the market value of the participants’ notional investment accounts. The notional investments are comprised primarily of mutual funds, which are based on observable market prices.

Mark-to-market derivative asset – The Company utilizes fixed-to-floating interest-rate swaps, typically designated as fair value hedges, to achieve a targeted level of variable-rate debt as a percentage of total debt. The Company uses a calculation of future cash inflows and estimated future outflows, which are discounted, to determine the current fair value. Additional inputs to the present value calculation include the contract terms, counterparty credit risk, interest rates and market volatility.

Note 14: Segment Information

The Company has two operating segments that are also the Company’s two reportable segments, referred to as Regulated Businesses and Market-Based Operations.

The following table includes the Company’s summarized segment information from continuing operations, except as noted below:

 

     As of or for the Three Months Ended
September 30, 2012
 
     Regulated
Businesses
     Market-Based
Operations
     Other     Consolidated  

Net operating revenues

   $ 750,742       $ 85,878       $ (4,805   $ 831,815   

Depreciation and amortization

     89,202         1,673         5,344        96,219   

Total operating expenses, net

     438,933         72,136         (6,894     504,175   

Income (loss) from continuing operations before income taxes

     254,003         14,613         (13,592     255,024   

Total assets

     12,586,885         311,562         1,701,088        14,599,535   

Assets of discontinued operations (included in total assets above)

     0         0         0        0   

Capital expenditures

     200,376         3,681         0        204,057   

Capital expenditures of discontinued operations (included in above)

     0         0         0        0   

 

     As of or for the Three Months Ended
September 30, 2011
 
     Regulated
Businesses
     Market-Based
Operations
     Other     Consolidated  

Net operating revenues

   $ 682,363       $ 86,047       $ (7,541   $ 760,869   

Depreciation and amortization

     81,058         1,665         5,600        88,323   

Total operating expenses, net

     417,020         71,875         (9,435     479,460   

Income (loss) from continuing operations before income taxes

     209,722         14,813         (17,645     206,890   

Total assets

     12,669,871         267,905         1,576,019        14,513,795   

Assets of discontinued operations (included in total assets above)

     905,106         7,817         13,111        926,034   

Capital expenditures

     229,102         1,046         0        230,148   

Capital expenditures of discontinued operations (included in above)

     4,431         2         0        4,433   

 

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Table of Contents
     As of or for the Nine Months Ended
September 30, 2012
 
     Regulated
Businesses
     Market-Based
Operations
     Other     Consolidated  

Net operating revenues

   $ 1,960,218       $ 249,254       $ (13,496   $ 2,195,976   

Depreciation and amortization

     258,692         5,003         16,957        280,652   

Total operating expenses, net

     1,239,992         216,883         (18,909     1,437,966   

Income (loss) from continuing operations before income taxes

     549,293         34,821         (47,180     536,934   

Total assets

     12,586,885         311,562         1,701,088        14,599,535   

Assets of discontinued operations (included in total assets above)

     0         0         0        0   

Capital expenditures

     676,433         3,924         0        680,357   

Capital expenditures of discontinued operations (included in above)

     2,884         0         0        2,884   

 

     As of or for the Nine Months Ended
September 30, 2011
 
     Regulated
Businesses
     Market-Based
Operations
     Other     Consolidated  

Net operating revenues

   $ 1,805,085       $ 243,853       $ (22,481   $ 2,026,457   

Depreciation and amortization

     239,435         5,161         17,947        262,543   

Total operating expenses, net

     1,212,086         215,902         (27,585     1,400,403   

Income (loss) from continuing operations before income taxes

     424,804         29,746         (52,932     401,618   

Total assets

     12,669,871         267,905         1,576,019        14,513,795   

Assets of discontinued operations (included in total assets above)

     905,106         7,817         13,111        926,034   

Capital expenditures

     619,119         2,821         0        621,940   

Capital expenditures of discontinued operations (included in above)

     15,619         86         0        15,705   

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

Certain matters within this Quarterly Report on Form 10-Q include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements included in this Form 10-Q, other than statements of historical fact, may constitute forward-looking statements. Forward-looking statements can be identified by the use of words such as “may,” “should,” “will,” “could,” “estimates,” “predicts,” “potential,” “continue,” “anticipates,” “believes,” “plans,” “expects,” “future” and “intends” and similar expressions. Forward-looking statements may involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance to differ from those projected in the forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those items discussed in the “Risk Factors” section or other sections in the Company’s Form 10-K for the year ended December 31, 2011 (the “Form 10-K”) filed with the Securities and Exchange Commission (“SEC”), as well as in Item IA of Part II of this Quarterly Report. We undertake no obligation, other than as required by law, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

General

American Water Works Company, Inc. (herein referred to as “American Water” or the “Company”) is the largest investor-owned United States water and wastewater utility company, as measured both by operating revenue and population served. Our primary business involves the ownership of water and wastewater utilities that provide water and wastewater services to residential, commercial, industrial and other customers. Our Regulated Businesses that provide these services are generally subject to economic regulation by state regulatory agencies (“PUCs”) in the states in which they operate. We report the results of these businesses in our Regulated Business segment. We also provide services that are not subject to economic regulation by PUCs. We report the results of these businesses in our Market-Based Operations segment. For further description of our businesses see the “Business” section found in our Form 10-K filed with the SEC.

You should read the following discussion in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this Quarterly Report on Form 10-Q and in our Form 10-K.

Overview

All financial information in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) reflects only continuing operations. As previously disclosed in our Form 10-K, as part of our portfolio optimization initiative, we entered into agreements to sell our regulated subsidiaries in Arizona, New Mexico and Ohio and our regulated water and wastewater systems in Texas. The sale of the Texas subsidiary assets was completed in June 2011. In the first quarter of 2012, we completed the divestiture of the Arizona and New Mexico subsidiaries, and on May 1, 2012, we completed the divestiture of our Ohio subsidiary. Also, on December 31, 2011, we completed the sale of Applied Water Management, Inc. (“AWM”), which was part of our Contract Operations line of business within our Market-Based Operations segment. Therefore, the financial results of these entities have been presented as discontinued operations for all periods. Additionally, during the fourth quarter of 2011, we discovered errors in our calculations of gains or losses on discontinued operations that originated in the first and second quarters of 2011. As a result, we recorded after-tax charges totaling $24.6 million, which included associated parent company goodwill, to reduce the net asset values of those businesses to their net realizable values. These charges were recognized within discontinued operations and net income and included in the operating results for the year ended December 31, 2011. The write-down included in the first and second quarters of 2011 totaled $21.1 million and $3.5 million, respectively, and are reflected in the amounts reported for the nine months ended September 30, 2011.

Financial Results. For the three months ended September 30, 2012, we reported net income of $153.8 million, or diluted earnings per share (“EPS”) of $0.86 compared to $137.4 million, or diluted EPS of $0.78 for the comparable period in 2011. Income from continuing operations was $154.1 million for the third quarter of 2012 compared to $128.5 million in the third quarter of 2011. Diluted income from continuing operations per average common share was $0.87 for the third quarter of 2012 as compared to $0.73 for the third quarter of 2011.

For the nine months ended September 30, 2012, our net income amounted to $302.6 million, or diluted earnings per share of $1.70 compared to $244.8 million, or diluted EPS of $1.39 for the comparable period in 2011. Income from continuing operations was $320.0 million for the nine months ended September 30, 2012 compared to $244.0 million for the same period in 2011. Diluted income from continuing operations per average common share was $1.80 for the nine months ended September 30, 2012 as compared to $1.38 for the first nine months of 2011.

 

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The primary drivers contributing to these increases in net income from continuing operations for both the three and nine months ended September 30, 2012 were increased revenues in our Regulated Businesses resulting from rate increases and higher demand. Partially offsetting these increases were higher operation and maintenance expense and depreciation and amortization expense. Also, partially offsetting the increase for the nine months ended September 30, 2012 compared to the same period in 2011 was an increase in general taxes related to our New York acquisition. For further details, see “Consolidated Results of Operations and Variances” and “Segment Results” below.

In 2012, we have focused on executing our portfolio optimization initiative, actively addressing regulatory lag and declining usage, continuing to make efficient use of capital and continuing to improve our regulated operation and maintenance (“O&M”) efficiency ratio. Also, in 2012, we have focused on the expansion of our Market-Based Operations, particularly on the Homeowner Services Group and Military Contract Operations, and on optimizing our municipal contract operations business model that is designed to provide value creation for both American Water and the municipality. The progress that we have made in the first nine months of 2012 with respect to these objectives is described below.

Portfolio Optimization Initiative. In the first quarter of 2012, we completed the sale of our regulated operations in Arizona and New Mexico and in the second quarter we completed the divestiture of our Ohio subsidiary. Also, in the second quarter, we completed our purchase of seven regulated water systems in New York. Effective August 17, 2012, the New York State Public Service Commission approved a plan to merge these seven regulated water systems with and into our Long Island subsidiary, which was then renamed New York American Water Company.

Addressing Regulatory Lag and Declining Usage. During the three months ended September 30, 2012, we were granted additional annualized revenues from general rate cases totaling $22.3 million.

On July 12, 2012, the California Public Utilities Commission approved our California subsidiary’s cost of capital application. This approval is retroactive to January 1, 2012 and provided additional annualized revenues of $4.4 million. On September 19, 2012, the Illinois Commerce Commission (“ICC”) issued an order adjusting rates on a statewide basis for our Illinois subsidiary. The ICC order will result in approximately $17.9 million in additional annualized revenue and was effective October 1, 2012.

On July 1, 2012, additional annualized revenue of $3.0 million resulting from infrastructure charges in our Pennsylvania subsidiary became effective. Also, on September 25, 2012, additional annualized revenues amounting to $4.2 million from infrastructure charges in our Missouri subsidiary became effective.

In the second quarter of 2012, the New Jersey Board of Public Utilities adopted rules that allow the implementation of a distribution system improvement charge for specified water infrastructure investments. On July 20, 2012, our New Jersey subsidiary submitted the Foundational Filing for this charge. Our filing was approved on October 23, 2012.

The table below provides further details of annualized revenues, assuming a constant volume, resulting from rate authorizations granted:

 

     Annualized Rate Increases Granted  
     For the three months ended      For the nine months ended  
     September 30, 2012      September 30, 2012  
     (In millions)  

State

     

General Rate Cases:

     

New Jersey

   $ —         $ 30.0   

Missouri

     —           24.0   

New York (a)

     —           5.6   

Illinois

     17.9         17.9   

Iowa

     —           2.8   

Indiana

     —           1.9   

California

     4.4         32.9   

Other

     —           0.2   
  

 

 

    

 

 

 

Total General Rate Cases

   $ 22.3       $ 115.3   
  

 

 

    

 

 

 

Infrastructure Charges

     

Pennsylvania

   $ 3.0       $ 4.7   

Missouri

     4.2         4.2   

Other

     —           0.3   
  

 

 

    

 

 

 

Total Infrastructure charges

   $ 7.2       $ 9.2   
  

 

 

    

 

 

 

 

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(a) Amount includes $3.0 million increase effective April 1, 2012. The remainder of the $5.6 million annualized revenue increase of $1.4 million and $1.2 million will become effective April 1, 2013 and April 1, 2014, respectively.

On October 1, 2012, additional annualized revenue of $5.8 million resulting from infrastructure charges in our Pennsylvania subsidiary became effective. Also, on October 1, 2012 our Indiana subsidiary requested additional annualized revenues for infrastructure surcharges totaling $6.6 million. We expect a final order in December 2012. Additionally, on October 15, 2012, the Tennessee Regulatory Authority (“TRA”) approved our general rate case settlement, which was filed in the second quarter of 2012, by way of a motion for our Tennessee subsidiary that allows additional annualized revenues of $5.2 million, which became effective on November 1, 2012. A formalized written order is not typically issued by the TRA for six to twelve months following the approval.

As of November 7, 2012, we are awaiting a final order in our Virginia rate case requesting an additional annualized $5.7 million of jurisdictional revenue under bond and subject to refund, which was put into effect on July 12, 2012. In addition, on July 12, 2012, we put into effect a $0.3 million non-jurisdictional rate increase that is not subject to refund. In September 2012, all parties agreed on a stipulation that resolved all issues in the rate case, resulting in a rate case award of $2.3 million, which combined with the $0.3 million non-jurisdictional increase will provide a net increase of $2.6 million in revenues. In October 2012, the hearing examiner issued a final report, which accepted the stipulation, and forwarded it to the PUC. A final order is expected to be issued in the fourth quarter of 2012. The revenue recognized to date approximates the amount that would have been recorded under the stipulation agreement. There is no assurance that all, or any portion of this requested increase, will be granted.

Continue Improvement in O&M Efficiency Ratio for our Regulated Businesses. Our O&M efficiency ratio (a non-GAAP measure) is calculated only on our Regulated Business operations and is defined as operation and maintenance expense divided by operating revenues, where both operation and maintenance expense and operating revenues are adjusted for purchased water expense. Our operating efficiency ratio was 37.0% for the three months ended September 30, 2012 compared to 39.6% for the three months ended September 30, 2011. Our operating efficiency ratio was 39.6% for the nine months ended September 30, 2012 compared to 43.3% for the same period in 2011.

The improvement in our O&M efficiency ratio was driven by an increase in revenue relating to rate cases, increased customer usage and our ongoing efforts to improve operational excellence and cost effectiveness. We evaluate our operating performance using this measure because management believes it is one measure of the efficiency of our regulated operations. This information is intended to enhance an investor’s overall understanding of our operating performance. The O&M efficiency ratio is not a measure defined under GAAP and may not be comparable to other companies’ operating measures and should not be used in place of the GAAP information provided elsewhere in this report. The following table provides a reconciliation that reconciles operation and maintenance expense and operating revenues, as determined in accordance with GAAP, to Adjusted Regulated O&M Expense and Adjusted Regulated Operating Revenues, respectively. The table also shows our operating efficiency ratio for the three and nine months ended September 30, 2012 as compared to the same periods in 2011:

 

     For the three months ended
September 30,
    For the nine months ended
September 30,
 
     2012     2011     2012     2011  
     (In thousands)  

Total O&M expense

   $ 355,126      $ 340,339      $ 992,707      $ 978,317   

Less:

        

O&M expense – Market-Based Operations

     69,354        69,100        208,245        206,338   

O&M expense – Other

     (13,979     (16,908     (43,251     (52,504
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Regulated O&M expense

     299,751        288,147        827,713        824,483   

Less: Regulated purchased water expense

     34,475        29,892        84,482        76,272   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted Regulated O&M expense(a)

   $ 265,276      $ 258,255      $ 743,231      $ 748,211   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Operating Revenues

   $ 831,815      $ 760,869      $ 2,195,976      $ 2,026,457   

Less:

        

Operating revenues – Market-Based Operations

     85,878        86,047        249,254        243,853   

Operating revenues – Other

     (4,805     (7,541     (13,496     (22,481
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Regulated operating revenues

     750,742        682,363        1,960,218        1,805,085   

Less: Regulated purchased water revenues*

     34,475        29,892        84,482        76,272   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted Regulated operating revenues(b)

   $ 716,267      $ 652,471      $ 1,875,736      $ 1,728,813   
  

 

 

   

 

 

   

 

 

   

 

 

 

Regulated O&M efficiency ratio(a)/(b)

     37.0     39.6     39.6     43.3

 

* Calculation assumes purchased water revenues approximate purchased water expenses.

 

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Growing our Market-Based Operations. In August 2012, our Homeowner Services Group (“HOS”) was selected by the New York City Water Board as the official service line protection provider to homeowners. HOS will make services available to an estimated 600,000 homeowners throughout the city’s five boroughs. Also, during the third quarter of 2012, HOS announced that it is expanding the number of communities in which it provides water and sewer line protection programs to homeowners in Connecticut, Indiana, Michigan and Ohio.

Other Matters

Business Transformation Project

On August 1, 2012, our new business systems associated with Phase I of our business transformation project became operational. Phase I consisted of the roll-out of the Enterprise Resource Planning systems (“ERP”), which encompass applications that will handle human resources, finance, and supply chain/procurement management activities. Phase II consists of the roll-out of a new Enterprise Asset Management system, which will manage an asset’s lifecycle, and a Customer Information system, which will contain all billing and data pertaining to American Water’s customers for our Regulated segment. Phase II is expected to be substantially completed by December 31, 2013. As we make adjustments to our operations as a result of this project, we may incur incremental expenses prior to realizing the benefits of a more efficient workforce and operating structure. Although efforts have been made to minimize any adverse impact on our controls, we cannot assure that all such impacts have been mitigated. Through September 30, 2012, we have spent $235.9 million on the project, with $96.1 million spent in 2012. Expenditures associated with the project are included in the estimated capital investment spending of $925 million for 2012 and $800 million to $1 billion in 2013.

Impact of Hurricane Sandy

During the last week of October 2012, our east coast subsidiaries were impacted by the weather conditions from Hurricane Sandy. Although we continue to assess the situation, the damage to our facilities and infrastructure within the states of Maryland, New Jersey, New York, Pennsylvania, Virginia and West Virginia was quickly addressed. The most significant impact to our business was caused by the widespread power outages caused by the storm’s heavy winds, rain and snow. Because many of our water and wastewater facilities relied on generators to maintain water and wastewater services to our customers, the impact on our customers was minimal. Based on initial review, we believe the damages are not significant to the Company and therefore, the storm should not have a material adverse impact on our results of operations, financial position or cash flows. Upon completion of the evaluation of the damages and any associated business interruption losses, claims will be submitted to our insurance carriers. We anticipate expenses that are not covered by insurance are likely recoverable through the rate making process on a state-by-state basis.

Certain Labor Matters

As previously disclosed in the Form 10-K, in September 2010, we declared “impasse” in negotiations of our national benefits agreement with most of the labor unions representing employees in our Regulated Businesses. The prior agreement expired on July 31, 2010; however negotiations did not produce a new agreement. We implemented our last, best and final offer on January 1, 2011 in order to maintain health care coverage for our employees in accordance with terms of the offer. The unions challenged our right to implement our last, best and final offer. In this regard, following the filing by the Utility Workers Union of America of an unfair labor practice charge, the National Labor Relations Board (“NLRB”) issued a complaint against us in January 2012, claiming that we implemented the last, best and final offer without providing sufficient notice of the existence of a dispute with the Federal Mediation and Conciliation Service, a state mediation agency, and several state departments of labor. We asserted that we did, in fact, provide sufficient notice.

On October 16, 2012, the NLRB Administrative Law Judge hearing the matter ruled that, although we did provide sufficient notification to the Federal Mediation and Conciliation Service, we did not provide notice to state agencies, in violation of the National Labor Relations Act. The Administrative Law Judge ordered, among other things, that we cease and desist from implementing the terms of our last, best and final offer and make whole all affected employees for losses suffered as a result of our implementation of our last, best and final offer. The “make whole” order, if upheld on appeal, would require us to provide backpay plus interest, from January 1, 2011 through the date of the final determination. Based on current estimates and assumptions, we estimate the cash impact could be in the range of $2.5 to $3.5 million per year, with the total impact dependent on the length of time the issue remains unresolved. We intend to file an exception to the decision of the Administrative Law Judge in order to obtain a review by the full NLRB.

Consolidated Results of Operations and Variances

 

     For the three months ended
September 30,
    For the nine months ended
September 30,
 
     (In thousands, except per share data)  
(In thousands)    2012     2011     Favorable
(Unfavorable)
Change
    2012     2011     Favorable
(Unfavorable)
Change
 

Operating revenues

   $ 831,815      $ 760,869      $ 70,946      $ 2,195,976      $ 2,026,457      $ 169,519   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

            

Operation and maintenance

     355,126        340,339        (14,787     992,707        978,317        (14,390

Depreciation and amortization

     96,219        88,323        (7,896     280,652        262,543        (18,109

General taxes

     52,861        52,433        (428     165,264        160,882        (4,382

(Gain) loss on asset dispositions and purchases

     (31     (1,635     (1,604     (657     (1,339     (682
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses, net

     504,175        479,460        (24,715     1,437,966        1,400,403        (37,563
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     327,640        281,409        46,231        758,010        626,054        131,956   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expenses)

            

Interest, net

     (76,616     (78,562     1,946        (236,000     (233,222     (2,778

Allowance for other funds used during construction

     3,735        3,696        39        13,173        9,059        4,114   

Allowance for borrowed funds used during construction

     1,548        1,586        (38     5,942        3,988        1,954   

Amortization of debt expense

     (1,322     (1,251     (71     (3,949     (3,798     (151

Other, net

     39        12        27        (242     (463     221   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expenses)

     (72,616     (74,519     1,903        (221,076     (224,436     3,360   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     255,024        206,890        48,134        536,934        401,618        135,316   

Provision for income taxes

     100,913        78,395        (22,518     216,908        157,607        (59,301
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     154,111        128,495        25,616        320,026        244,011        76,015   

Income (loss) from discontinued operations, net of tax

     (299     8,927        (9,226     (17,434     754        (18,188
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 153,812      $ 137,422      $ 16,390      $ 302,592      $ 244,765      $ 57,827   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share:(a)

            

Income from continuing operations

   $ 0.87      $ 0.73        $ 1.81      $ 1.39     
  

 

 

   

 

 

     

 

 

   

 

 

   

Income from discontinued operations, net of tax

   $ (0.00   $ 0.05        $ (0.10   $ 0.00     
  

 

 

   

 

 

     

 

 

   

 

 

   

Net income

   $ 0.87      $ 0.78        $ 1.72      $ 1.39     
  

 

 

   

 

 

     

 

 

   

 

 

   

Diluted earnings per common share:(a)

            

Income from continuing operations

   $ 0.87      $ 0.73        $ 1.80      $ 1.38     
  

 

 

   

 

 

     

 

 

   

 

 

   

Income from discontinued operations, net of tax

   $ (0.00   $ 0.05        $ (0.10   $ 0.00     
  

 

 

   

 

 

     

 

 

   

 

 

   

Net income

   $ 0.86      $ 0.78        $ 1.70      $ 1.39     
  

 

 

   

 

 

     

 

 

   

 

 

   

Average common shares outstanding during the period:

            

Basic

     176,621        175,547          176,290        175,426     
  

 

 

   

 

 

     

 

 

   

 

 

   

Diluted

     177,841        176,593          177,486        176,422     
  

 

 

   

 

 

     

 

 

   

 

 

   

 

(a) Amounts may not sum due to rounding

 

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The following is a discussion of the consolidated results of operations for the three and nine months ended September 30, 2012 compared to the three and nine months ended September 30, 2011:

Three Months Ended September 30, 2012 Compared To Three Months Ended September 30, 2011

Operating revenues. Consolidated operating revenues for the three months ended September 30, 2012 increased $70.9 million, or 9.3%, compared to the same period in 2011 and is mainly attributable to a $68.4 million increase in our Regulated Business segment primarily as a result of rate increases as well as increased usage in the third quarter of 2012, mainly in July. For further information, see the respective “Operating Revenues” discussions within the “Segment Results.”

Operation and maintenance. Consolidated operation and maintenance (“O&M”) expense for the three months ended September 30, 2012 increased by $14.8 million, or 4.3%, compared to the same period in 2011. For further information, see the respective “Operation and Maintenance” discussions within the “Segment Results.”

Depreciation and amortization. Depreciation and amortization expense increased by $7.9 million, or 8.9%, for the three months ended September 30, 2012 compared to the same period in the prior year as a result of additional utility plant placed in service, including our ERP.

Other income (expenses). Other expenses decreased by $1.9 million, or 2.6%, due to lower long-term debt interest expense, principally as a result of a reduction in the overall average outstanding long-term debt for the three months ended September 30, 2012 compared to the same period in the prior year.

Provision for income taxes. Our consolidated provision for income taxes increased $22.5 million, or 28.7%, to $100.9 million for the three months ended September 30, 2012. The effective tax rates for the three months ended September 30, 2012 and 2011 were 39.6% and 37.9%, respectively. The 2011 rate included a $4.5 million tax benefit related to a contribution of non-utility property made by one of our operating companies to a county authority within its operating area.

Income (loss) from discontinued operations, net of tax. As noted above, the financial results of our regulated water and wastewater systems in Arizona, New Mexico, Texas and Ohio, as well as those of our AWM subsidiary in the Market-Based Operations segment, have been classified as discontinued operations for all periods presented. The variance is mainly the result of all discontinued operations being disposed of in the first six months of 2012. For the three months ended September 30, 2011, income from discontinued operations, net of tax included net income associated with the discontinued operations for the period and a benefit of $3.5 million related to the cessation of depreciation for our Arizona, New Mexico, and Ohio subsidiaries. Under GAAP, operations that are considered discontinued operations cease to depreciate their assets.

Nine Months Ended September 30, 2012 Compared To Nine Months Ended September 30, 2011

Operating revenues. Consolidated operating revenues for the nine months ended September 30, 2012 increased $169.5 million, or 8.4%, compared to the same period in 2011. This change reflects a $155.1 million increase in our Regulated Businesses segment, which was mainly attributable to rate increases and increased usage primarily related to weather compared to the same period in the prior year, and a $5.4 million increase in our Market-Based Operations segment, which was due to contract growth and price increases in HOS, and incremental revenues associated with military construction and operations. For further information, see the “Operating Revenues” discussions within the “Segment Results.”

Operation and maintenance. Consolidated O&M expense for the nine months ended September 30, 2012 increased $14.4 million, or 1.5%, compared to the same period in 2011. For further information, see the “Operation and Maintenance” discussions within the “Segment Results.”

Depreciation and amortization. Depreciation and amortization expense increased by $18.1 million, or 6.9%, for the nine months ended September 30, 2012 compared to the same period in the prior year as a result of additional utility plant placed in service.

 

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General taxes. General taxes expense increased by $4.4 million, or 2.7%, for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. This increase was principally due to higher property taxes of $1.9 million, which is primarily related to our recently acquired New York properties, as well as higher gross receipt taxes of $1.5 million.

Other income (expenses). Other expenses decreased by $3.4 million, or 1.5%, for the nine months ended September 30, 2012 compared to the same period in the prior year and is primarily attributable to an increase in AFUDC of $6.1 million related to increased construction activity in New Jersey, as well as increased development activity on our business transformation project. Partially offsetting this decrease was an increase in interest expense, net of interest income, of $2.8 million, or 1.2%, for the nine months ended September 30, 2012 compared to the same period in 2011. This increase is mainly attributable to the inclusion in 2011 of $3.1 million in accelerated amortization of unamortized debt discounts associated with debt that was redeemed during the first quarter of 2011.

Provision for income taxes. Our consolidated provision for income taxes increased $59.3 million, or 37.6%, to $216.9 million for the nine months ended September 30, 2012. The effective tax rates for the nine months ended September 30, 2012 and 2011 were 40.4% and 39.2%, respectively. The 2011 rate included a $4.5 million tax benefit recorded in the third quarter of 2011 as a result of the contribution of non-utility property by one of our operating companies to a county authority within its operating area.

Income (loss) from discontinued operations, net of tax. As noted above, the financial results of our regulated water and wastewater systems in Arizona, New Mexico, Texas and Ohio as well as those of our AWM subsidiary in the Market-Based Operations segment, have been classified as discontinued operations for all periods presented. The increase in loss from discontinued operations, net of tax is primarily related to the disposition of our Ohio subsidiary, $9.7 million in charges for income taxes resulting from the divestiture of our Arizona and New Mexico subsidiaries and the $2.4 million pre-tax sales price adjustment in connection with the disposition of our Arizona and New Mexico subsidiaries. Additionally, the 2011 amount included net income as a result of the operations of those subsidiaries and an after-tax benefit of $11.4 million related to the cessation of depreciation for our Arizona, New Mexico, and Texas subsidiaries. Under GAAP, operations that are considered discontinued operations cease to depreciate their assets. Partially offsetting the 2011 income (loss) from discontinued operations, net of tax amount was $25.1 million after-tax write-downs recorded in 2011 to reduce the net asset values of certain of our discontinued operations.

Segment Results

We have two operating segments that are also our reportable segments: the Regulated Businesses and the Market-Based Operations. We evaluate the performance of our segments and allocate resources based on several factors, with the primary measure being income from continuing operations before income taxes.

Regulated Segment

The following table summarizes certain financial information for our Regulated Businesses for the periods indicated:

 

     For the three months ended
September 30,
     For the nine months ended
September 30,
 
     2012      2011      Increase
(Decrease)
     2012      2011      Increase
(Decrease)
 
     (In thousands)         

Operating revenues

   $ 750,742       $ 682,363       $ 68,379       $ 1,960,218       $ 1,805,085       $ 155,133   

Operation and maintenance expense

     299,751         288,147         11,604         827,713         824,483         3,230   

Operating expenses, net

     438,933         417,020         21,913         1,239,992         1,212,086         27,906   

Income from continuing operations before income taxes

     254,003         209,722         44,281         549,293         424,804         124,489   

Operating revenues. Our primary business involves the ownership of water and wastewater utilities that provide services to residential, commercial, industrial and other customers. This business is generally subject to state regulation and our results of operations are impacted significantly by rates authorized by the PUCs in the states in which we operate.

Operating revenues increased by $68.4 million, or 10.0%, for the three months ended September 30, 2012 and $155.1 million, or 8.6%, for the nine months ended September 30, 2012, respectively, as compared to the same periods in 2011. The increase in revenues was primarily due to rate increases obtained through rate authorizations for a number of our operating companies and higher consumption in our mid-west and certain eastern states. The impact of rate increases on revenues was approximately $35.2 million and $94.5 million for the three and nine months ending September 30, 2012, respectively. The increase in revenues associated with higher demand amounted to approximately $18.0 million and $38.9 million for the three and nine months ended September 30, 2012, respectively, which is attributable to increased customer consumption in 2012 compared to 2011. The increased consumption is primarily attributable to the warmer/drier weather in the second and third quarters of 2012. Lastly, revenues were higher by $11.5 million and $20.0 million for the three and nine months ended September 30, 2012, respectively, compared to the same period in 2011, as a result of acquisitions, with the most significant being our New York acquisition in the second quarter of 2012.

 

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The following table provides information regarding the Regulated Businesses’ revenues and billed water sales volume by customer class:

 

     For the three months ended September 30,  
     2012     2011     2012     2011  
     Operating Revenues     Billed Water Sales Volume  
     (Dollars in thousands)     (Gallons in millions)  

Customer Class

                   

Water service:

                   

Residential

   $ 439,294        58.5   $ 389,736         57.1     62,755         53.1     57,184         52.2

Commercial

     156,609        20.9     141,269         20.7     27,097         22.9     25,388         23.2

Industrial

     35,356        4.7     31,518         4.6     11,581         9.8     11,379         10.4

Public and other

     90,214        12.0     84,704         12.4     16,698         14.2     15,602         14.2

Other water revenues

     (2,077     (0.3 %)      4,584         0.7     —           —          —           —     
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total water revenues

     719,396        95.8     651,811         95.5     118,131         100.0     109,553         100.0
           

 

 

    

 

 

   

 

 

    

 

 

 

Wastewater service

     19,673        2.6     19,400         2.9          

Other revenues

     11,673        1.6     11,152         1.6          
  

 

 

   

 

 

   

 

 

    

 

 

           
   $ 750,742        100.0   $ 682,363         100.0          
  

 

 

   

 

 

   

 

 

    

 

 

           
     For the nine months ended September 30,  
     2012     2011     2012     2011  
     Operating Revenues     Billed Water Sales Volume  
     (Dollars in thousands)     (Gallons in millions)  

Customer Class

                   

Water service:

                   

Residential

   $ 1,129,070        57.6   $ 1,022,953         56.6     146,534         51.7     138,794         51.3

Commercial

     394,198        20.1     360,338         20.0     64,753         22.9     61,841         22.9

Industrial

     98,144        5.0     88,567         4.9     30,310         10.7     30,140         11.1

Public and other

     241,062        12.3     229,546         12.7     41,777         14.7     39,628         14.7

Other water revenues

     8,622        0.4     15,902         0.9     —           —          —           —     
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total water revenues

     1,871,096        95.4     1,717,306         95.1     283,374         100.0     270,403         100.0
           

 

 

    

 

 

   

 

 

    

 

 

 

Wastewater service

     58,463        3.0     57,302         3.2          

Other revenues

     30,659        1.6     30,477         1.7          
  

 

 

   

 

 

   

 

 

    

 

 

           
   $ 1,960,218        100.0   $ 1,805,085         100.0          
  

 

 

   

 

 

   

 

 

    

 

 

           

Water Services – Water service operating revenues from residential customers for the three months ended September 30, 2012 increased by $49.6 million, or 12.7%, compared to the three months ended September 30, 2011. For the nine months ended September 30, 2012, these revenues increased by $106.1 million, or 10.4%, over the same period in 2011. The increases are primarily due to rate increases as well as increased sales volumes. For the three months ended September 30, 2012, the volume of water sold to residential customers increased by 9.7% compared to the same period in 2011. For the nine months ended September 30, 2012, the volume sold to these customers increased by 5.6% as compared to the same period in 2011. We believe this higher consumption, for both the three and nine month periods, is driven by the warmer/drier weather in our eastern and mid-western operating states as compared to the same periods in 2011. Also contributing to the increased sales volumes was the additional consumption resulting from our New York acquisition.

Water service operating revenues from commercial water customers for the three months ended September 30, 2012 increased by $15.3 million, or 10.9%, compared to the same period in 2011. For the nine months ended September 30, 2012, these revenues increased by $33.9 million, or 9.4%, to $394.2 million, compared to September 30, 2011. These increases were mainly due to rate increases as well as increased sales volumes. The volume of water sold to commercial customers increased by 6.7% and 4.7% for the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011.

Water service operating revenues from industrial customers increased $3.8 million, or 12.2%, for the three months ended September 30, 2012 compared to those recorded for the same period of 2011, mainly due to rate increases and an increase in sales volumes. For the three months ended September 30, 2012, the volume of water sold to industrial customers increased by 1.8% compared to the same period in 2011. For the nine months ended September 30, 2012, water service operating revenues from

 

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industrial customers increased $9.6 million, or 10.8%, compared to the same period of 2011 and is primarily due to rate increases. The volume of water sold to industrial customers for the nine months ended September 30, 2012 increased 0.6% compared to the nine months ended September 30, 2011.

Water service operating revenues from public and other customers, including municipal governments, other governmental entities and resale customers increased $5.5 million, or 6.5%, and $11.5 million, or 5.0%, for the three and nine months ended September 30, 2012, respectively, mainly due to increased sale volumes.

Other water revenues for the three and nine months ended September 30, 2012 decreased by $6.7 million and $7.3 million, respectively, and is primarily due to a reduction in the water revenue adjustment mechanism in our California subsidiary.

Wastewater services – Our subsidiaries provide wastewater services in nine states. Revenues from these services increased by $0.3 million, or 1.4%, to $19.7 million for the three months ended September 30, 2012, compared to the same period of 2011. Revenues from these services for the nine months ended September 30, 2012 increased by $1.2 million, or 2.0%, to $58.5 million, compared to the same period of 2011. The increases in both periods were primarily attributable to rate increases in a number of our operating companies.

Operation and maintenance. Operation and maintenance expense increased $11.6 million, or 4.0%, for the three months ended September 30, 2012, compared to the three months ended September 30, 2011. Operation and maintenance expense increased $3.2 million, or 0.4%, for the nine months ended September 30, 2012, compared to the same period in the prior year. The following table provides information regarding O&M expense for the three and nine months ended September 30, 2012 and 2011, by major expense category:

 

     For the three months ended September 30,     For the nine months ended September 30,  
     2012      2011*      Increase
(Decrease)
    Percentage     2012      2011*      Increase
(Decrease)
    Percentage  
     (Dollars in thousands)  

Production costs

   $ 84,052       $ 78,800       $ 5,252        6.7   $ 209,939       $ 203,084       $ 6,855        3.4

Employee-related costs

     118,456         126,048         (7,592     (6.0 %)      351,464         368,539         (17,075     (4.6 %) 

Operating supplies and services

     55,619         43,594         12,025        27.6     150,488         139,896         10,592        7.6

Maintenance materials and services

     18,232         17,337         895        5.2     50,288         50,979         (691     (1.4 %) 

Customer billing and accounting

     13,807         12,462         1,345        10.8     33,214         33,321         (107     (0.3 %) 

Other

     9,585         9,906         (321     (3.2 %)      32,320         28,664         3,656        12.8
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

    

 

 

   

Total

   $ 299,751       $ 288,147       $ 11,604        4.0   $ 827,713       $ 824,483       $ 3,230        0.4
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

    

 

 

   

 

* Certain reclassifications have been made between categories in order for 2011 to conform to 2012 presentation.

Production costs and employee-related costs, which together account for approximately 70% of the total Regulated Businesses operation and maintenance expense, are discussed in more detail below.

Production costs by major expense type were as follows:

 

     For the three months ended September 30,     For the nine months ended September 30,  
     2012      2011      Increase
(Decrease)
    Percentage     2012      2011      Increase
(Decrease)
    Percentage  
     (Dollars in thousands)  

Fuel and power

   $ 27,234       $ 26,338       $ 896        3.4   $ 68,342       $ 67,808       $ 534        0.8

Purchased Water

     34,475         29,892         4,583        15.3     84,482         76,272         8,210        10.8

Chemicals

     15,810         15,216         594        3.9     37,840         37,221         619        1.7

Waste disposal

     6,533         7,354         (821     (11.2 %)      19,275         21,783         (2,508     (11.5 %) 
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

    

 

 

   

Total

   $ 84,052       $ 78,800       $ 5,252        6.7   $ 209,939       $ 203,084       $ 6,855        3.4
  

 

 

    

 

 

    

 

 

     

 

 

    

 

 

    

 

 

   

Overall production costs increased for the three and nine months ended September 30, 2012 compared to the same periods in the prior year, mainly as a result of increased purchased water costs, attributable to increased production resulting from higher consumption in most of our subsidiaries, with the more significant variances occurring in our California and Illinois subsidiaries. For both periods in 2011, our California subsidiary’s customer needs were met with internally produced water. Partially offsetting the increase in purchased water for both the three and nine months ended September 30, 2012 was a decrease in waste disposal costs due to an increase in the deferral of costs allowed by a cost recovery mechanism in one of our subsidiaries.

 

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Employee-related costs, including salaries and wages, group insurance, and pension expense, decreased $7.6 million, or 6.0%, for the three months ended September 30, 2012 compared to the same period in the prior year. These employee-related costs represent approximately 40% and 44% of operation and maintenance expense for the three months ended September 30, 2012 and 2011, respectively. Employee related costs also decreased $17.1 million, or 4.6%, for the nine months ended September 30, 2012 compared to the same period in the prior year. These employee-related costs represent approximately 42% and 45% of operation and maintenance expense for the nine months ended September 30, 2012 and 2011, respectively. The following table provides information with respect to components of employee-related costs for the three and nine months ended September 30, 2012 and 2011:

 

     For the three months ended September 30,     For the nine months ended September 30,  
     2012      2011      Increase
(Decrease)
    Percentage     2012      2011      Increase
(Decrease)
    Percentage  
     (In thousands)