# American Water Works Company, Inc.: Form 10-Q for the period ended Sep 30, 2012

- Company: [American Water Works Company, Inc.](/companies/awk.md) (CIK 1410636)
- Form: 10-Q
- Filed: 2012-11-07
- Accepted by EDGAR: Nov 7, 2012, 22:08 ET
- Period: 2012-09-30
- Accession: 0001193125-12-457734
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1410636/000119312512457734/d417295d10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1410636/000119312512457734/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2012-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2012-07-01 to 2012-09-30 | $831.8m | us-gaap:Revenues |
| Revenue | 9 months, 2012-01-01 to 2012-09-30 | $2.20bn | us-gaap:Revenues |
| Operating income | 3 months, 2012-07-01 to 2012-09-30 | $327.6m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2012-01-01 to 2012-09-30 | $758.0m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2012-07-01 to 2012-09-30 | $76.6m | us-gaap:InterestExpense |
| Interest expense | 9 months, 2012-01-01 to 2012-09-30 | $236.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2012-07-01 to 2012-09-30 | $100.9m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2012-01-01 to 2012-09-30 | $216.9m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2012-07-01 to 2012-09-30 | $153.8m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2012-01-01 to 2012-09-30 | $302.6m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2012-07-01 to 2012-09-30 | $0.86 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2012-01-01 to 2012-09-30 | $1.70 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2012-07-01 to 2012-09-30 | $0.87 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2012-01-01 to 2012-09-30 | $1.72 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2012-07-01 to 2012-09-30 | 177,841,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2012-01-01 to 2012-09-30 | 177,486,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2012-01-01 to 2012-09-30 | $735.0m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2012-07-01 to 2012-09-30 | $204.1m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Capital expenditure | 9 months, 2012-01-01 to 2012-09-30 | $680.4m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 9 months, 2012-01-01 to 2012-09-30 | $125.0m | us-gaap:PaymentsOfDividendsCommonStock |
| Cash and equivalents | at 2012-09-30 | $18.5m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2012-09-30 | $642.5m | us-gaap:AssetsCurrent |
| Total assets | at 2012-09-30 | $14.60bn | us-gaap:Assets |
| Current liabilities | at 2012-09-30 | $1.01bn | us-gaap:LiabilitiesCurrent |
| Long-term debt | at 2012-09-30 | $5.18bn | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2012-09-30 | $35.0m | us-gaap:LongTermDebtCurrent |
| Short-term borrowings | at 2012-09-30 | $297.9m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2012-09-30 | $4.45bn | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 71,089 characters.

### 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.

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:

*(In millions)*

| State General Rate Cases: | Annualized Rate Increases Granted For the three months ended September 30, 2012 | For the nine months ended September 30, 2012 |
| --- | ---: | ---: |
| 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 |

24

(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:

*(In thousands)*

|  | For the three months ended September 30, 2012 | 2011 | For the nine months ended September 30, 2012 | 2011 |
| --- | ---: | ---: | ---: | ---: |
| 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.

*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

*(In thousands, except per share data)*

*(In thousands)*

|  | For the three months ended September 30, 2012 | 2011 | Favorable (Unfavorable) Change | For the nine months ended September 30, 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

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.

***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:

*(In thousands)*

|  | For the three months ended September 30, 2012 | 2011 | Increase (Decrease) | For the nine months ended September 30, 2012 | 2011 | Increase (Decrease) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| 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.

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

*(Dollars in thousands)*

*(Gallons in millions)*

| Customer Class Water service: | For the three months ended September 30, 2012 2011 Operating Revenues | 2012 2011 Billed Water Sales Volume |
| --- | ---: | ---: |
| 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 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:

*(Dollars in thousands)*

|  | For the three months ended September 30, 2012 | 2011\* | Increase (Decrease) | Percentage | For the nine months ended September 30, 2012 | 2011\* | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| 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:

*(Dollars in thousands)*

|  | For the three months ended September 30, 2012 | 2011 | Increase (Decrease) | Percentage | For the nine months ended September 30, 2012 | 2011 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| 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.

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:

*(In thousands)*

|  | For the three months ended September 30, 2012 | 2011 | Increase (Decrease) | Percentage | For the nine months ended September 30, 2012 | 2011 | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salaries and wages | $81,781 | $85,591 | $(3,810) | (4.5%) | $242,699 | $247,467 | $(4,768) | (1.9%) |
| Pensions | 14,530 | 16,309 | (1,779) | (10.9%) | 42,353 | 49,150 | (6,797) | (13.8%) |
| Group insurance | 17,938 | 19,471 | (1,533) | (7.9%) | 53,369 | 58,190 | (4,821) | (8.3%) |
| Other benefits | 4,207 | 4,677 | (470) | (10.0%) | 13,043 | 13,732 | (689) | (5.0%) |
| Total | $118,456 | $126,048 | $(7,592) | (6.0%) | $351,464 | $368,539 | $(17,075) | (4.6%) |

For the three and nine months ended September 30, 2012, the overall decrease in employee-related costs was primarily attributable to decreased salaries and wages, group insurance and pension expense. The decrease in salaries and wages for the three and nine months ended September 30, 2012 was primarily due to higher capitalization rates due to increased capital investment compared to the same periods in 2011 and a reduction in headcount as a result of vacancies, some of which have been back-filled with temporary labor/contracted services and therefore included in the operating supplies and services category below. Partially offsetting these costs for both periods were higher costs resulting from wage increases, and stock-based compensation expense, as well as increased costs due to our New York acquisition. The reduction in group insurance costs for the three and nine months ended September 30, 2012 compared to the same periods in 2011 is mainly attributable to lower headcount as a result of vacancies, a decrease in the overall cost per person, as well as higher capitalization rates. The decrease in pension expense for both the three and nine months ended September 30, 2012 was primarily due to decreased contributions in certain of our regulated operating companies whose costs are recovered based on our funding policy, which is to fund at least the minimum amount required by the Employee Retirement Income Security Act of 1974. The decrease for the nine months ended September 30, 2012 was partially offset by a $1.7 million incremental charge resulting from the finalization of our California rate case.

Operating supplies and services include the day-to-day expenses of the office operations, legal and other professional services, transportation expenses, information systems, rental charges and other office equipment rental charges. These costs increased $12.0 million, or 27.6%, and $10.6 million, or 7.6%, for the three and nine months ended September 30, 2012, respectively. The increases for the three months ended September 30, 2012 compared to the same period in 2011 were primarily due to higher general office supplies and services, including telecommunication costs and employee related expenses, of approximately $5.1 million and higher contracted services of $2.9 million. The increases for the nine months ended September 30, 2012 compared to nine months ended September 30, 2011 were also primarily due to higher general office supplies and services of approximately $5.3 million, as well as higher contracted services of $4.9 million. Such increases for both periods are mainly due to incremental contractor costs due to backfilling positions, including those vacated due to employees who are assigned to our business transformation project; the use of contractors for other specific projects for the three and nine-month periods in 2012, the intent of which is to improve processes and operating efficiency and effectiveness over the long-term; and lastly, additional contractor and operating supplies costs resulting from the roll-out and stabilization of the ERP in the third quarter of 2012.

Also, contributing to the increase in operating supplies and services cost were the incremental costs associated with our New York acquisition of $1.4 million and $2.0 million for the three and nine-month periods ended September 30, 2012, respectively. Additionally, included in the three and nine months ended September 30, 2011 was a reduction to these expenses in the amount of $2.2 million for an anticipated insurance recovery of expenses incurred as a result of severe weather storms, in particular Hurricane Irene. Partially offsetting the increases for both three and nine-month periods ended September 30, 2012 compared to the same periods in 2011, were lower transportation costs of $1.2 million and $3.3 million, respectively, attributable to the buyout/cancellation of leased vehicles during 2011. Partially offsetting the nine months ended September 30, 2012 increase in operating supplies and services was a $2.1 million credit adjustment that was recorded in the second quarter of 2012 resulting from the finalization of rate decisions in California.

Other operation and maintenance expenses include casualty and liability insurance premiums and regulatory costs. For the three months ended September 30, 2012, these costs decreased by $0.3 million. For the nine months ended September 30, 2012, the increase in these expenses was driven by higher insurance costs, as 2012 insurance costs reflected incremental expense resulting from the resolution of prior years’ claims.

***Operating expenses.*** Operating expenses increased $21.9 million and $27.9 million for the three and nine months ended September 30, 2012, respectively. This increase is due to the higher O&M expense as explained above, as well as higher depreciation and amortization expense for both the three and nine months ended September 30, 2012. The increase in depreciation and amortization expense of $8.1 million and $19.3 million for the three and nine months ended September 30, 2012, respectively, is primarily due to additional utility plant placed in service. Also contributing to the nine months ended September 30, 2012 increase were higher general taxes of $4.0 million principally attributable to higher property taxes, which are attributable to our recently acquired New York properties, and higher gross receipt taxes in our New Jersey subsidiary, as well as the inclusion in 2011, of a gain on purchase of assets in Missouri.

### Market-Based Operations

The following table provides financial information for our Market-Based Operations segment for the periods indicated:

*(In thousands)*

|  | For the three months ended September 30, 2012 | 2011 | Increase (Decrease) | For the nine months ended September 30, 2012 | 2011 | Increase (Decrease) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $85,878 | $86,047 | $(169) | $249,254 | $243,853 | $5,401 |
| Operation and maintenance expense | 69,354 | 69,100 | 254 | 208,245 | 206,338 | 1,907 |
| Operating expenses, net | 72,136 | 71,875 | 261 | 216,883 | 215,902 | 981 |
| Income from continuing operations before income taxes | 14,613 | 14,813 | (200) | 34,821 | 29,746 | 5,075 |

***Operating revenues.*** Revenues for the three months ended September 30, 2012 remained relatively unchanged compared to the same period in 2011. The net increase in revenues for the nine months ended September 30, 2012 compared to the same period in 2011 is primarily attributable to a $6.1 million increase in our HOS revenues associated with continued contract growth and a price increase. Also contributing to the higher revenues was a $4.4 million increase in our Contract Operations Group revenues, which is mainly due to incremental revenues associated with military construction and operation and maintenance projects. These increases are partially offset by decreases in Carbon Services Group revenues of $4.1 million as we are no longer providing services to the Regulated Businesses, and in Residuals Operations Group revenues of $1.2 million.

***Operation and maintenance.*** Operation and maintenance expense increased $0.3 million, or 0.4%, for the three months ended September 30, 2012, and $1.9 million, or 0.9%, for the nine months ended September 30, 2012 compared to the same periods in the prior year.

The following table provides information regarding categories of operation and maintenance expense for the three and nine months ended September 30, 2012 and 2011:

*(Dollars in thousands)*

|  | For the three months ended September 30, 2012 | 2011 | Increase (Decrease) | Percentage | For the nine months ended September 30, 2012 | 2011\* | Increase (Decrease) | Percentage |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Production costs | $9,858 | $12,279 | $(2,421) | (19.7%) | $33,376 | $36,949 | $(3,573) | (9.7%) |
| Employee-related costs | 17,166 | 18,821 | (1,655) | (8.8%) | 53,648 | 55,087 | (1,439) | (2.6%) |
| Operating supplies and services | 31,389 | 26,946 | 4,443 | 16.5% | 87,496 | 79,127 | 8,369 | 10.6% |
| Maintenance materials and services | 8,423 | 9,085 | (662) | (7.3%) | 27,257 | 28,998 | (1,741) | (6.0%) |
| Other, including uncollectible expense | 2,518 | 1,969 | 549 | 27.9% | 6,468 | 6,177 | 291 | 4.7% |
| Total | $69,354 | $69,100 | $254 | 0.4% | $208,245 | $206,338 | $1,907 | 0.9% |

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

The increase in operating supplies and services is attributable to increased construction activity for our military contracts. Also, 2011 included the release of a $2.2 million loss contract reserve due to the resolution of certain outstanding issues and uncertainties. Partially offsetting the increase in operating supplies and services are decreases in production costs and maintenance costs for the three and nine months ended September 30, 2012, compared to the same period in 2011, which are mainly due to lower costs as a result of the termination of certain contracts in June 2012 as well as the reduction in Carbon Services Group expenses, corresponding with the reduction in revenues. Also, contributing to the decrease in maintenance expenses for the nine months ended September 30, 2012 is a reduction in tank painting costs compared to the same period in 2011.

***Operating expense.*** The change in operating expenses for the three and nine months ended September 30, 2012 compared to 2011 is primarily due to the variances in the O&M expense for those respective periods, as explained above.

### Liquidity and Capital Resources

For a general overview of our sources and uses of capital resources, see the introductory discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources,” contained in part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011.

We believe that our ability to access the capital markets, our revolving credit facility and our cash flows from operations will generate sufficient cash to fund our short-term capital requirements. We fund liquidity needs for capital investment, working capital and other financial commitments through cash flows from operations, public and private debt offerings, commercial paper markets and, to the extent necessary, our revolving credit facility with a diversified group of banks. We closely monitor the financial condition of the financial institutions associated with the revolving credit facility.

In order to meet our short-term liquidity needs, we, through American Water Capital Corp. (“AWCC”), our financing subsidiary, issue primarily commercial paper, which is supported by the revolving credit facility. The revolving credit facility is also used, to a limited extent, to support our issuance of letters of credit. On September 15, 2012, $155.0 million of our senior unsecured revolving credit facility expired, leaving $685.0 million of commitments under this facility. On October 29, 2012, we terminated this agreement and entered into a new unsecured revolving credit facility with $1 billion in aggregate total commitments from a diversified group of 14 banks. This new facility will expire on October 29, 2017. Interest rates on advances under the new facility are based on a credit spread to the eurodollar rate or base rate with the credit spread of 1.00% through June 2013 and then based on the higher of AWCC’s Moody’s or S&P’s credit rating. At current ratings that spread would be 1.075%. Consistent with the old facility, this new facility, unless otherwise extended, requires the Company to maintain a ratio of consolidated capitalization of not more than 0.70 to 1.00. The Company did not have any direct borrowings under the terminated facility at September 30, 2012 nor were there any direct borrowings on the new facility at closing.

As of September 30, 2012, AWCC had no outstanding borrowings and $34.8 million of outstanding letters of credit under the revolving credit facility. As of September 30, 2012, AWCC had $650.2 million available under the previous credit facility that we can use to fulfill our short-term liquidity needs, to issue letters of credit and support our $297.9 million outstanding commercial paper. We can provide no assurances that our lenders will meet their existing commitments or that we will be able to access the commercial paper or loan markets in the future on terms acceptable to us or at all.

### Cash Flows from Operating Activities

Cash flows from operating activities primarily result from the sale of water and wastewater services and, due to the seasonality of demand, are generally greater during the third quarter of each fiscal year. Cash flows from operating activities for the nine months ended September 30, 2012 were $735.0 million compared to $576.0 million for the nine months ended September 30, 2011.

The following table provides a summary of the major items affecting our cash flows from operating activities for the nine months ended September 30, 2012 and 2011:

*(In thousands)*

|  | For the nine months ended September 30, 2012 | 2011 |
| --- | ---: | ---: |
| Net income | $302,592 | $244,765 |
| Add (subtract): |  |  |
| Non-cash operating activities(1) | 529,192 | 494,898 |
| Changes in working capital(2) | (734) | (28,798) |
| Pension and postretirement healthcare contributions | (96,036) | (134,821) |
| Net cash flows provided by operations | $735,014 | $576,044 |

(1) Includes depreciation and amortization, provision for deferred income taxes, amortization of deferred investment tax credits, provision for losses on utility accounts receivable, allowance for other funds used during construction, (gain) loss on asset dispositions and purchases, pension and non-pension post retirement benefits expense and other non-cash items. Details of each component can be found in the Consolidated Statements of Cash Flows.

(2) Changes in working capital include changes to accounts receivable and unbilled utility revenue, taxes receivable including income taxes, other current assets, accounts payable, taxes accrued (including income taxes), interest accrued, book overdraft and other current liabilities.

The increase in cash flows from operations for the nine months ended September 30, 2012 compared to the same period in 2011 is primarily driven by the increase in operating revenues, a reduction in the pension and postretirement healthcare contributions, and changes in our working capital.

### Cash Flows from Investing Activities

The following table provides information regarding cash flows used in investing activities for the periods indicated:

*(In thousands)*

|  | For the nine months ended September 30, 2012 | 2011 |
| --- | ---: | ---: |
| Capital expenditures | $(680,357) | $(621,940) |
| Proceeds from sale of assets and securities | 560,095 | 7,044 |
| Acquisitions | (44,333) | (6,381) |
| Other investing activities, net(1) | (20,761) | 15,276 |
| Net cash flows used in investing activities | $(185,356) | $(606,001) |

(1) Includes removal costs from property, plant and equipment retirements, net and net funds released.

Cash flows used in investing activities for the nine months ended September 30, 2012 was $185.4 million compared to $606.0 million for the nine months ended September 30, 2011. The variance from 2011 to 2012 is mainly attributable to the proceeds received from the sale of our Arizona and New Mexico subsidiaries in January 2012. The increase of $58.4 million in net capital expenditures from 2011 to 2012 is attributable to increased spending on infrastructure replacement programs due to the milder winter weather in the first quarter of 2012 as compared to 2011, an increase in capital spending for our business transformation project and expenditures associated with the replacement of and/or upgrades to certain of our water treatment facilities in New Jersey and Pennsylvania.

### Cash Flows from Financing Activities

Our financing activities, primarily focused on funding capital expenditures, include the issuance of long-term and short-term debt, primarily through AWCC. We intend to access the capital markets on a regular basis, subject to market conditions. In addition, new infrastructure may be financed with customer advances and contributions for construction (net of refunds).

The following table provides information on long-term debt that was issued during the first nine months of 2012:

| Company | Type | Interest Rate | Maturity |  | Amount (In thousands) |
| --- | --- | --- | --- | --- | ---: |
| Other subsidiaries | Private activity bonds and government funded debt – fixed rate | 0.00%-5.00% | 2013-2041 | (a) | $68,746 |
| Other subsidiaries | Private activity bonds and government funded debt – fixed rate | 1.00%-2.76% | 2025-2041 | (b) | $14,730 |
| Total issuances |  |  |  |  | $83,476 |

(a) Proceeds from these issuances were received from New Jersey Environmental Infrastructure Trust and will be used to fund certain specific projects. The proceeds are held in trust pending our certification that we have incurred qualifying expenditures. These issuances have been presented as non-cash on the Consolidated Statements of Cash Flows. Subsequent releases of all or a lesser portion of the funds by the Trust are reflected as the release of restricted funds and are included in investing activities in the Consolidated Statements of Cash Flows.

(b) Proceeds from these issuances were received from the Pennsylvania Infrastructure Investment Authority and funded specified projects.

Also, in the second quarter of 2012, and in connection with the acquisition of our additional subsidiaries in New York, we assumed debt of $25.2 million with coupon rates of 5.00% to 6.00% and maturity dates ranging from 2015 to 2035. In September 2012, we redeemed $10.9 million of these outstanding bonds with original maturity dates of 2031 to 2035 and interest rates ranging from 5.00% to 6.00%.

The following long-term debt was retired through optional redemption, sinking fund provisions or payment at maturity during the first nine months of 2012:

| Company | Type | Interest Rate | Maturity | Amount (In thousands) |
| --- | --- | --- | --- | ---: |
| Other subsidiaries | Mortgage bonds – fixed rate | 7.95% | 2012 | $4,200 |
| Other subsidiaries | Private activity bonds and government funded debt | 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 |

Included in the long-term debt redemptions/retirements is $4.2 million related to our previously held Ohio subsidiary, which was classified in discontinued operations prior to its divestiture.

During the second quarter of 2012, we redeemed $150.4 million of outstanding bonds with original maturity dates ranging from 2026 to 2038 and interest rates ranging from 5.25% to 5.90%. Additionally, on July 2, 2012, we redeemed $86.1 million of outstanding bonds with original maturity dates of 2028 to 2029 and interest rates ranging from 5.00% to 5.10%. In addition, on July 6, 2012 we redeemed $2.8 million of preferred stock without mandatory redemption requirements with interest rates ranging from 5.00% to 5.75%. Both the July 2012 redemptions as well as those occurring in the second quarter were made using commercial paper borrowing.

On October 31, 2012, we issued notices of redemption for $129.0 million of outstanding private activity bonds with original maturity dates ranging from 2022 to 2032 and interest rates ranging from 5.00% to 5.25%.

From time to time, and as market conditions warrant, we may engage in additional long-term debt retirements via tender offers, open market repurchases or other viable transactions.

### Credit Facilities and Short-Term Debt

The components of short-term debt at September 30, 2012 were as follows:

|  | Amount (In thousands) |
| --- | ---: |
| Commercial paper, net | $297,859 |
| Total short-term debt | $297,859 |

The following table provides information as of September 30, 2012, regarding letters of credit sub-limits under our revolving credit facility and available funds under the revolving credit facility, as well as outstanding amounts of commercial paper and borrowings under the revolving credit facilities.

*(In thousands)*

|  | Credit Facility Commitment | Available Credit Facility Capacity | Letter of Credit Sub-limit | Available Letter of Credit Capacity | Outstanding Commercial Paper (Net of Discount) | Credit Line Borrowings |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| September 30, 2012 | $685,000 | $649,540 | $150,000 | $115,217 | $297,859 | $34,783 |

The weighted-average interest rate on short-term borrowings for the three months ended September 30, 2012 and 2011 was approximately 0.49% and 0.43%, respectively, and 0.50% and 0.40% for the nine months ended September 30, 2012 and 2011, respectively.

As previously stated, this facility was terminated on October 29, 2012.

### Capital Structure

The following table provides information regarding our capital structure for the periods presented:

|  | At September 30, 2012 | At December 31, 2011 |
| --- | ---: | ---: |
| Common stockholders’ equity and preferred stock without mandatory redemption rights | 45% | 42% |
| Long-term debt and redeemable preferred stock at redemption value | 52% | 53% |
| Short-term debt and current portion of long-term debt | 3% | 5% |
|  | 100% | 100% |

### Debt Covenants

Our debt agreements contain financial and non-financial covenants. To the extent that we are not in compliance, we or our subsidiaries may be restricted in our ability to pay dividends, issue new debt or access our revolving credit facility. We were in compliance with our covenants as of September 30, 2012. Our failure to comply with covenants under our credit facility could accelerate repayment obligations. Our long-term debt indentures contain a number of covenants that, among other things, limit the Company from issuing debt secured by the Company’s assets, subject to certain exceptions.

Certain long-term notes and the revolving credit facility require us to maintain a ratio of consolidated debt to consolidated capitalization of not more than 0.70 to 1.00. As of September 30, 2012, our ratio was 0.55 and therefore we were in compliance with the covenant.

### Security Ratings

Our access to the capital markets, including the commercial paper market, and respective financing costs in those markets, is directly affected by securities ratings of the entity that is accessing the capital markets. We primarily access the capital markets, including the commercial paper market, through AWCC. However, we also issue debt through our regulated subsidiaries, primarily in the form of tax exempt securities, to lower our overall cost of debt.

On August 14, 2012, Moody’s changed its rating outlook to positive from stable and affirmed its “Baa2” corporate credit rating for both American Water and AWCC as well as its “P2” commercial paper rating for AWCC. On January 30, 2012, Standard & Poor’s Ratings Service, which we refer to as S&P, reaffirmed its BBB+ corporate credit rating on AWCC and American Water and AWCC’s “A2” commercial rating. On June 18, 2012, S&P revised its rating outlook for American Water and AWCC to positive from stable. The following table shows the Company’s securities ratings as of September 30, 2012:

| Securities | Moody’s Investors Service | Standard & Poor’s Ratings Service |
| --- | --- | --- |
| Senior unsecured debt | Baa2 | BBB+ |
| Commercial paper | P2 | A2 |

A security rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency, and each rating should be evaluated independently of any other rating. Security ratings are highly dependent upon our ability to generate cash flows in an amount sufficient enough to service our debt and meet our investment plans. We can provide no assurances that our ability to generate cash flows is sufficient to maintain our existing ratings. None of our borrowings are subject to default or prepayment as a result of the downgrading of these security ratings, although such a downgrading could increase fees and interest charges under our credit facilities.

As part of the normal course of business, we routinely enter into contracts for the purchase and sale of water, energy, fuels and other services. These contracts either contain express provisions or otherwise permit us and our counterparties to demand adequate assurance of future performance when there are reasonable grounds for doing so. In accordance with the contracts, if we are downgraded by a credit rating agency, especially if such downgrade is to a level below investment grade, it is possible that a counterparty would attempt to rely on such a downgrade as a basis for making a demand for adequate assurance of future performance, which could include a demand that we provide collateral to secure our obligations. We do not expect that our posting of collateral would have a material adverse impact on our results of operations, financial position or cash flows.

### Dividends

Our board of directors has adopted a dividend policy to distribute to our shareholders a portion of our net cash provided by operating activities as regular quarterly dividends, rather than retaining that cash for other purposes. Since the dividends on our common stock will not be cumulative, only declared dividends will be paid.

In March and June 2012, the Company made cash dividend payments of $0.23 per share to all shareholders of record as of February 3, 2012 and April 20, 2012, respectively, and on September 3, 2012 made cash dividend payments of $0.25 per share to all shareholders of record as of July 6, 2012. In March 2011 and June 2011, the Company made cash dividend payments of $0.22 per share to all shareholders of record as of February 18, 2011 and May 18, 2011, respectively, and on September 1, 2011 made cash dividend payments of $0.23 per share to all shareholders of record as of August 12, 2011.

On September 20, 2012, our board of directors 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, these dividends totaling $44.2 million had been accrued in other current liabilities on the accompanying Consolidated Balance Sheets.

### Market Risk

There have been no significant changes to our market risk since December 31, 2011. For a discussion of our exposure to market risk, refer to Part II, Item 7A. “Quantitative and Qualitative Disclosures about Market Risk,” contained in our Annual Report on Form 10-K for the year ended December 31, 2011.

### Application of Critical Accounting Policies and Estimates

Our financial condition, results of operations and cash flows are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates,” in our Form 10-K for the year ended December 31, 2011 filed with the SEC for a discussion of our critical accounting policies.

### Recent Accounting Pronouncements

See Part I, Item 1 – Financial Statements (Unaudited) – Note 2 – New Accounting Pronouncements in this Quarterly Report on Form 10-Q for a discussion of new accounting standards recently adopted or pending adoption.

## Market risk

As filed, 283 characters.

We are subject to market risks in the normal course of business, including changes in interest rates and equity prices. For further discussion of market risks see “Market Risk” in Part I, Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

## Controls and procedures

As filed, 2,990 characters.

### Evaluation of Disclosure Controls and Procedures

American Water Works Company, Inc. maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports filed or submitted under the Securities Exchange Act of 1934 (“the Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

Our management, including the Chief Executive Officer and the Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) of the Exchange Act) as of September 30, 2012 pursuant to 15d-15(e) under the Exchange Act.

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2012, our disclosure controls and procedures were effective at a reasonable level of assurance. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

### Changes in Internal Control over Financial Reporting

On August 1, 2012, we implemented several modules of our new ERP, SAP ECC 6.0, for our Regulated subsidiaries. The ERP implementation encompassed applications that handle human resources, finance and supply chain/procurement management, with the long-term goals of increasing our operating efficiency and effectiveness and controlling the costs associated with the operation of our business, all of which are important to providing quality service to our customers and communities we serve. The implementation was part of a focus on upgrading and enhancing our financial systems and was not in response to any internal control deficiencies. We are in the process of testing the internal controls over financial reporting to accommodate these modifications to our business processes. Although efforts have been made to minimize any adverse impact on our controls, we cannot assure that all such impacts have been mitigated.

With the exception of the ERP implementation described above, there have been no changes in our internal control over financial reporting that occurred during the three months ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

## Risk factors

As filed, 472 characters.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in the “Risk Factors” in the Company’s Form 10-K for the year ended December 31, 2011, and our other public filings, which could materially affect our business, financial condition or future results. There have been no material changes from risk factors previously disclosed in “Risk Factors” in the Company’s Form 10-K for the year ended December 31, 2011.

Filed Nov 7, 2012.
Source: SEC EDGAR, the filing index for accession 0001193125-12-457734. Last ingested by Listed: Nov 6, 2026, 17:16 ET. No prices; not investment advice.