# American Water Works Company, Inc.: Form 10-Q for the period ended Sep 30, 2018

- Company: [American Water Works Company, Inc.](/companies/awk.md) (CIK 1410636)
- Form: 10-Q
- Filed: 2018-10-31
- Accepted by EDGAR: Oct 31, 2018, 16:35 ET
- Period: 2018-09-30
- Accession: 0001410636-18-000169
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1410636/000141063618000169/a930201810-qdocument.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1410636/000141063618000169/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2018-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2018-07-01 to 2018-09-30 | $955.0m | us-gaap:RevenueFromContractWithCustomerIncludingAssessedTax |
| Revenue | 9 months, 2018-01-01 to 2018-09-30 | $2.55bn | us-gaap:RevenueFromContractWithCustomerIncludingAssessedTax |
| Operating income | 3 months, 2018-07-01 to 2018-09-30 | $335.0m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2018-01-01 to 2018-09-30 | $854.0m | us-gaap:OperatingIncomeLoss |
| Income tax | 3 months, 2018-07-01 to 2018-09-30 | $70.0m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2018-01-01 to 2018-09-30 | $164.0m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2018-07-01 to 2018-09-30 | $187.0m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2018-01-01 to 2018-09-30 | $455.0m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2018-07-01 to 2018-09-30 | $1.04 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2018-01-01 to 2018-09-30 | $2.53 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2018-07-01 to 2018-09-30 | $1.04 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2018-01-01 to 2018-09-30 | $2.54 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2018-07-01 to 2018-09-30 | 181,000,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2018-01-01 to 2018-09-30 | 180,000,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2018-01-01 to 2018-09-30 | $992.0m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2018-07-01 to 2018-09-30 | $397.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Capital expenditure | 9 months, 2018-01-01 to 2018-09-30 | $1.14bn | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 9 months, 2018-01-01 to 2018-09-30 | $237.0m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 9 months, 2018-01-01 to 2018-09-30 | $45.0m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2018-09-30 | $86.0m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2018-09-30 | $800.0m | us-gaap:AssetsCurrent |
| Total assets | at 2018-09-30 | $20.88bn | us-gaap:Assets |
| Current liabilities | at 2018-09-30 | $1.75bn | us-gaap:LiabilitiesCurrent |
| Short-term borrowings | at 2018-09-30 | $564.0m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2018-09-30 | $5.86bn | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 80,396 characters.

*The following discussion should be read together with the unaudited Consolidated Financial Statements and Notes thereto included elsewhere in this Form 10-Q, and in our Form 10-K for the year ended December 31, 2017. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business, operations and financial performance. The cautionary statements made in this Form 10-Q should be read as applying to all related forward-looking statements whenever they appear in this Form 10-Q. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those we discuss under “Forward-Looking Statements,” and elsewhere in this Form 10-Q.*

### Overview

Through its subsidiaries, American Water Works Company, Inc. is the largest and most geographically diverse, publicly-traded water and wastewater utility company in the United States, as measured by both operating revenue and population served. Our primary business involves the ownership of utilities that provide water and wastewater services to residential, commercial, industrial, public authority, fire service and sale for resale customers, collectively presented as our “Regulated Businesses.” Our utilities are generally subject to economic regulation by certain state utility commissions or other entities engaged in utility regulation, collectively referred to as public utility commissions (“PUCs” or “Regulators”). We also operate several market-based businesses, not subject to economic regulated by PUCs, that provide a broad range of related and complementary water and wastewater services to military bases, municipalities and shale natural gas exploration and production companies, as well as residential, commercial and industrial customers. Individually, these four operating segments do not meet the criteria of a reportable segment in accordance with generally accepted accounting principles in the United States (“GAAP”), and are collectively presented as our “Market-Based Businesses”. See Part I, Item 1—Business in our Form 10-K for further discussion.

Throughout this Form 10-Q, unless the context otherwise requires, references to “we”, “us”, “our”, the “Company” and “American Water” mean American Water Works Company, Inc. and its subsidiaries, taken together as a whole. References to “parent company” mean American Water Works Company, Inc., without its subsidiaries.

### Quarter Highlights

- On July 5, 2018, we entered into an agreement for the sale of 22 of our Contract Services Group’s 33 operation and maintenance (“O&M”) contracts to subsidiaries of Veolia Environnement S.A. for $27 million. During the third quarter of 2018, we closed on the sale of 20 of the 22 contracts associated with this agreement, recognizing an after-tax gain of $10 million, or $0.06 per share. We expect to close on the sale of the remaining two contracts, subject to customer consents, by the end of 2018.
- As a result of operational and financial challenges encountered in the construction business of Keystone Clearwater Solutions, LLC (“Keystone”), the Company decided to exit this business line during the third quarter of 2018. This action, along with the exit of the water trucking business line during the first half of 2018, narrowed the scope of the Keystone business going forward, focusing solely on providing water transfer services. These factors prompted the impairment testing of Keystone’s goodwill and customer relationship intangible asset at September 30, 2018, resulting in a non-cash, after-tax, impairment charge of $40 million, net of noncontrolling interest, or $0.22 per share. See Note 6—Goodwill and Other Intangible Assets in the Notes to the Consolidated Financial Statements for further discussion.
- On October 29, 2018, our New Jersey subsidiary received an order on its general rate case filing, authorizing additional annualized revenues of $40 million, effective as of June 15, 2018. The order authorized a 9.6% return on equity and a capital structure of 46% debt and 54% equity. The order also approved the inclusion of $35 million of infrastructure surcharges in base rates and remanded the regulatory treatment of certain acquisition adjustments to a separate proceeding.
- On October 26, 2018, our West Virginia subsidiary, the staff of the Public Service Commission of West Virginia (“WVPSC”) and the Consumer Advocate Division filed a joint stipulation for the general rate case that would provide for $23 million in additional annualized revenues and keep the current, 9.75% authorized return on equity. The joint stipulation would allow for our West Virginia subsidiary’s excess deferred income tax amortization to be used to offset future infrastructure surcharges, and for the implementation of a customer lead service line replacement program. This joint stipulation is subject to the WVPSC’s approval.
- Our Military Services Group was awarded a contract for ownership, operation and maintenance of the water and wastewater systems at Fort Leonard Wood in Missouri, effective October 1, 2018. The contract award includes estimated revenues of approximately $591 million over a 50-year period, subject to an annual economic price adjustment.
- On August 9, 2018, American Water Capital Corp. (“AWCC”), our wholly owned finance subsidiary, completed a $1.325 billion debt offering which included the sale of $625 million aggregate principal amount of its 3.75% Senior Notes due in 2028, and $700 million aggregate principal amount of its 4.20% Senior Notes due in 2048. AWCC used proceeds from the offering to lend funds to American Water and its regulated subsidiaries, to repay various senior notes and commercial paper obligations, and for general corporate purposes. See Note 8—Long-Term Debt in the Notes to the Consolidated Financial Statements for further discussion.
- Every five years, we negotiate national health and welfare benefits with our union-represented employees. On July 31, 2018, a new, five-year national benefits agreement was ratified, covering approximately 3,200 of our union-represented employees, which includes 17 labor unions and 69 collective bargaining agreements. Highlights of the new agreement include union-represented employees’ participation in the Company’s cash-based annual performance plan, changes to certain retiree medical benefits and additional medical plan options for our employees and their families.

### Financial Results

The following table provides highlights of our diluted earnings per share and our adjusted diluted earnings per share (a non-GAAP measure) for the three and nine months ended September 30, 2018:

| Diluted earnings per share (GAAP): | For the Three Months Ended September 30, 2018 | 2017 | For the Nine Months Ended September 30, 2018 | 2017 |
| --- | ---: | ---: | ---: | ---: |
| Net income attributable to common stockholders | $1.04 | $1.13 | $2.53 | $2.39 |
| Non-GAAP adjustments: |  |  |  |  |
| Gain on sale of portion of Contract Services Group contracts | (0.08) | — | (0.08) | — |
| Income tax impact | 0.02 | — | 0.02 | — |
| Net non-GAAP adjustment | (0.06) | — | (0.06) | — |
| Impairment charge | 0.31 | — | 0.31 | — |
| Income tax impact | (0.08) | — | (0.08) | — |
| Net loss attributable to noncontrolling interest | (0.01) | — | (0.01) | — |
| Net non-GAAP adjustment | 0.22 | — | 0.22 | — |
| Impact of Freedom Industries settlement activities | — | (0.12) | (0.11) | (0.12) |
| Income tax impact | — | 0.05 | 0.03 | 0.05 |
| Net non-GAAP adjustment | — | (0.07) | (0.08) | (0.07) |
| Early debt extinguishment at the parent company | — | 0.03 | — | 0.03 |
| Income tax impact | — | (0.01) | — | (0.01) |
| Net non-GAAP adjustment | — | 0.02 | — | 0.02 |
| Total net non-GAAP adjustments | 0.16 | (0.05) | 0.08 | (0.05) |
| Adjusted diluted earnings per share (non-GAAP) | $1.20 | $1.08 | $2.61 | $2.34 |

For the three months ended September 30, 2018, net income attributable to common stockholders was $1.04 per diluted share, a decrease of $0.09 per diluted share, or 8.0%, as compared to the same period in 2017. Included in the 2018 amount was an after-tax benefit of $10 million, or $0.06 per diluted share, resulting from a gain recognized on the sale of the majority of our Contract Services Group’s O&M contracts to subsidiaries of Veolia Environnement S.A., and an after-tax charge of $40 million, net of noncontrolling interest, or $0.22 per diluted share, resulting from a goodwill and intangible asset impairment charge related to Keystone. Included in the 2017 amount was an after-tax benefit of $13 million, or $0.07 per diluted share, resulting from an insurance settlement with one of our general liability insurance carriers related to the Freedom Industries matter in West Virginia, and an after-tax charge of $4 million, or $0.02 per diluted share, resulting from an early debt extinguishment charge at the parent company.

Adjusted diluted earnings per share (a non-GAAP measure) was $1.20 for the three months ended September 30, 2018, an increase of $0.12 per diluted share, or 11.1%, as compared to the same period in 2017. This increase was primarily due to continued growth in our Regulated Businesses, largely driven by infrastructure investment, acquisitions and organic growth, combined with growth in our Market-Based Businesses, mainly from our Homeowner Services Group, with integration expenses from the acquisition of Pivotal Home Solutions (“Pivotal”) on June 4, 2018, lower than projected during the third quarter.

For the nine months ended September 30, 2018, net income attributable to common stockholders was $2.53 per diluted share, an increase of $0.14 per diluted share, or 5.9%, as compared to the same period in 2017. Included in the 2018 amount was: (i) an after-tax benefit of $10 million, or $0.06 per diluted share, resulting from a gain recognized on the sale of the majority of our Contract Services Group’s O&M contracts to subsidiaries of Veolia Environnement S.A.; (ii) an after-tax charge of $40 million, net of noncontrolling interest, or $0.22 per diluted share, resulting from a goodwill and intangible asset impairment charge related to Keystone; and (iii) an after-tax benefit of $15 million, or $0.08 per diluted share, resulting from an insurance settlement with one of our general liability insurance carriers related to the Freedom Industries matter in West Virginia. Included in the 2017 amount was an after-tax benefit of $13 million, or $0.07 per diluted share, resulting from an insurance settlement with one of our general liability insurance carriers related to the Freedom Industries matter, and an after-tax charge of $4 million, or $0.02 per diluted share, resulting from an early debt extinguishment charge at the parent company.

Adjusted diluted earnings per share (a non-GAAP measure) was $2.61 for the nine months ended September 30, 2018, an increase of $0.27 per diluted share, or 11.5%, as compared to the same period in 2017. This increase was primarily due to continued growth in our Regulated Businesses, largely driven by infrastructure investment, acquisitions and organic growth, combined with growth in our Market-Based Businesses, mainly from our Homeowner Services Group, with integration expenses from the acquisition of Pivotal, lower than projected mainly during the third quarter.

Adjusted diluted earnings per share represents a non-GAAP financial measure and is calculated as GAAP diluted earnings per share, excluding the impact of one or more of the following events: (i) the gain recognized in the third quarter of 2018 on the sale of the majority of our Contract Services Group’s O&M contracts; (ii) a goodwill and intangible asset impairment charge related to narrowing of the scope of the Keystone business in the third quarter of 2018; (iii) the September 2017 and June 2018 insurance settlements related to the Freedom Industries chemical spill in West Virginia; and (iv) the early debt extinguishment charges incurred in September 2017 with respect to the prepayment of debt allocated to the parent company, each as quantified in the table above. We believe that this non-GAAP measure provides investors with useful information by excluding certain matters that may not be indicative of our ongoing operating results, and that providing this non-GAAP measure will allow investors to understand better our businesses’ operating performance and facilitate a meaningful year-to-year comparison of our results of operations. Although management uses this non-GAAP financial measure internally to evaluate our results of operations, we do not intend results excluding the adjustments to represent results as defined by GAAP, and the reader should not consider them as indicators of performance. This non-GAAP financial measure is derived from our consolidated financial information but is not presented in our financial statements prepared in accordance with GAAP, and thus it should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP. In addition, this non-GAAP financial measure as defined and used above may not be comparable to similarly titled non-GAAP measures used by other companies, and, accordingly, it may have significant limitations on its use.

### Focusing on Central Themes

In 2018, our strategy, which is driven by our vision and core values, will continue to be anchored on our five central themes: (i) safety; (ii) customers; (iii) people; (iv) growth; and (v) technology and operational efficiency. We continue to focus on operating our business responsibly and managing our operating and capital costs in a manner that benefits our customers and produces long-term value for our stockholders. Additionally, we continue to execute on our ongoing strategy that ensures a safe workplace for our employees, emphasizes public safety for our customers and communities, and leverages our human resources, processes and technology innovation to make our business more effective and efficient. The progress that we have made during the first nine months of 2018 with respect to growth and improvement in our operational efficiency is described below.

### Growth—Infrastructure investments and acquisitions

During the first nine months of 2018, we made capital investments of approximately $1.5 billion, focused in three key areas:

- $1.1 billion, of which the majority was in our Regulated Businesses for infrastructure improvements;
- $365 million to acquire Pivotal, as discussed below; and
- $18 million for acquisitions in our Regulated Businesses, which added approximately 7,600 water and wastewater customers.

For the full year of 2018, our capital investment is expected to be in the range of $2.0 billion to $2.1 billion, which includes the acquisition of Pivotal in the second quarter of 2018.

Our Military Services Group was awarded a contract for ownership, operation and maintenance of the water and wastewater systems at Fort Leonard Wood in Missouri, effective October 1, 2018. Designated as the U.S. Army’s Maneuver Support Center of Excellence and the home to three U.S. Army schools, Fort Leonard Wood directly and indirectly supports 36,400 jobs across the state of Missouri. The contract award includes estimated revenues of approximately $591 million over a 50-year period, subject to an annual economic price adjustment.

In the course of pursuing our long-term strategy and growth initiatives for our Market-Based Businesses, on July 5, 2018, we entered into an agreement for the sale of 22 of our Contract Services Group’s 33 O&M contracts to subsidiaries of Veolia Environnement S.A. for $27 million. We closed on the sale of 20 of the 22 contracts during the third quarter of 2018, and expect to close on the sale of the remaining two contracts associated with this agreement, subject to customer consents, by the end of 2018. We will retain four of our Contract Services Group’s O&M contracts due to their proximity to our existing service areas, and expect the majority of the remaining contracts to be sold to other parties or expire within the next twelve months.

On June 4, 2018, American Water Enterprises, LLC, a wholly owned subsidiary of the Company, completed the acquisition of Pivotal for a purchase price of $365 million, including $9 million in working capital. Headquartered in Naperville, Illinois, Pivotal is a leading provider of home warranty protection products and services for gas, electric and other service lines inside and around a home, heating and cooling systems, and home appliances, operating in 18 states, with approximately 1.2 million customer contracts at the time of acquisition. Pivotal joins our Homeowner Services Group which provides similar home warranty protection products and services, primarily for external water and sewer lines. This transaction was financed with approximately 50% debt and 50% equity, and included the Company’s election to physically settle the equity forward sale agreements entered into on April 11, 2018. See Note 4—Acquisitions and Divestitures in the Notes to the Consolidated Financial Statements for further discussion.

On May 30, 2018, our Pennsylvania subsidiary entered into an agreement to acquire the wastewater assets of Exeter Township, Pennsylvania, for approximately $96 million. This system currently serves approximately 9,000 customers and we are expecting to close this acquisition during the second quarter of 2019, pending regulatory approval.

On April 13, 2018, our Illinois subsidiary entered into an agreement to acquire the City of Alton, Illinois’ regional wastewater system for approximately $54 million. This system currently serves approximately 23,000 customer equivalents, comprised of approximately 11,000 customer connections in Alton and an additional 12,000 customers under bulk contracts in the nearby communities of Bethalto and Godfrey. We are expecting to close this acquisition by the end of the first quarter of 2019, pending regulatory approval.

### Technology & Operational Efficiency—Continued improvement in our Regulated Businesses’ adjusted O&M efficiency ratio

Our adjusted O&M efficiency ratio, which we use as a measure of our operating performance, was 35.7% for the twelve months ended September 30, 2018, as compared to 35.9% for the twelve months ended September 30, 2017, with all periods prior to January 1, 2018, presented on a pro forma basis to include the estimated impact of the TCJA on operating revenues. The improvement in this ratio was primarily attributable to an increase in operating revenue in our Regulated Businesses.

Our adjusted O&M efficiency ratio is defined as the operation and maintenance expenses from our Regulated Businesses, divided by the pro forma operating revenues from our Regulated Businesses, where both operation and maintenance expenses and pro forma operating revenues were adjusted to eliminate purchased water expense. Additionally, from operation and maintenance expenses, we excluded the allocable portion of non-operation and maintenance support services costs, mainly depreciation and general taxes, that are reflected in our Regulated Businesses segment as operation and maintenance expenses, but for consolidated financial reporting purposes, are categorized within other line items in the accompanying Consolidated Statements of Operations.

In addition to the adjustments discussed above, for period-to-period comparability purposes, we have presented the estimated impact of the TCJA on operating revenues for our Regulated Businesses on a pro forma basis for all periods presented prior to January 1, 2018, as if the lower federal corporate income tax rate was in effect for these periods (see Note 5—Regulatory Liabilities in the Notes to the Consolidated Financial Statements for further discussion). We also excluded from operation and maintenance expenses the impact of certain Freedom Industries chemical spill settlement activities recognized in 2017 and 2018. We excluded the items discussed above from the calculation as we believe such items are not reflective of management’s ability to increase the efficiency of our Regulated Businesses.

We evaluate our operating performance using this ratio because we believe it directly measures improvement in the efficiency of our Regulated Businesses. This information is intended to enhance an investor’s overall understanding of our operating performance. Our adjusted O&M efficiency ratio is not an accounting measure that is based on GAAP, 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 the calculation of our adjusted O&M efficiency ratio and a reconciliation that compares operation and maintenance expenses and operating revenues, each as determined in accordance with GAAP, to those amounts utilized in the calculation of our adjusted O&M efficiency ratio:

*(In millions)*

|  | For the Twelve Months Ended September 30, 2018 | 2017 |
| --- | ---: | ---: |
| Total operation and maintenance expenses (a) | $1,451 | $1,377 |
| Less: |  |  |
| Operation and maintenance expenses—Market-Based Businesses | 346 | 334 |
| Operation and maintenance expenses—Other (a) | (40) | (40) |
| Total operation and maintenance expenses—Regulated Businesses (a) | 1,145 | 1,083 |
| Less: |  |  |
| Regulated purchased water expenses | 134 | 124 |
| Allocation of non-operation and maintenance expenses | 30 | 29 |
| Impact of Freedom Industries settlement activities (b) | (20) | (22) |
| Adjusted operation and maintenance expenses—Regulated Businesses (i) | $1,001 | $952 |
| Total operating revenues | $3,410 | $3,338 |
| Less: |  |  |
| Pro forma adjustment for impact of the TCJA (c) | 40 | 165 |
| Total pro forma operating revenues | 3,370 | 3,173 |
| Less: |  |  |
| Operating revenues—Market-Based Businesses | 455 | 419 |
| Operating revenues—Other | (22) | (23) |
| Total pro forma operating revenues—Regulated Businesses | 2,937 | 2,777 |
| Less: |  |  |
| Regulated purchased water revenues (d) | 134 | 124 |
| Adjusted pro forma operating revenues—Regulated Businesses (ii) | $2,803 | $2,653 |
| Adjusted O&M efficiency ratio—Regulated Businesses (i) / (ii) | 35.7% | 35.9% |

NOTE The adjusted O&M efficiency ratio previously reported for the twelve months ended September 30, 2017 was 34.2%, which did not include the adjustments for the items discussed in footnotes (a) and (c) below.

(a) Includes the impact of the Company’s adoption of ASU 2017-07 on January 1, 2018. See Note 2—Significant Accounting Policies in the Notes to the Consolidated Financial Statements for further discussion.

(b) Includes settlements with two of our general liability insurance carriers in connection with the Freedom Industries chemical spill.

(c) Includes the estimated impact of the TCJA on operating revenues for our Regulated Businesses for all periods presented prior to January 1, 2018, as if the lower federal corporate income tax rate was in effect for these periods. See Note 5—Regulatory Liabilities in the Notes to the Consolidated Financial Statements for further discussion.

(d) The calculation assumes regulated purchased water revenues approximate regulated purchased water expenses.

### Regulatory Matters

The following table provides annualized incremental revenues resulting from rate authorizations that became effective during the three and nine months ended September 30, 2018, for general rate cases and infrastructure surcharges, assuming a constant water sales volume:

*(In millions)*

| General rate cases by state: | For the Three Months Ended September 30, 2018 | For the Nine Months Ended September 30, 2018 |
| --- | ---: | ---: |
| Missouri (effective May 28, 2018) | $— | $33 |
| New York (effective April 1, 2018) | — | 5 |
| Pennsylvania (effective January 1, 2018) | — | 62 |
| Total general rate cases | $— | $100 |
| Infrastructure surcharges by state: |  |  |
| Tennessee (effective April 10, 2018) | $— | $1 |
| Indiana (effective March 14, 2018) | — | 7 |
| Virginia (effective March 1, 2018) | — | 1 |
| Illinois (effective January 1, 2018) | — | 3 |
| West Virginia (effective January 1, 2018) | — | 3 |
| Total infrastructure surcharges | $— | $15 |

On October 29, 2018, our New Jersey subsidiary received an order approving the settlement on its general rate case filing, authorizing additional annualized revenues of $40 million, effective as of June 15, 2018. The order included an authorized return on equity of 9.6% and a capital structure of 46% debt and 54% equity. The order approved the inclusion of $35 million of infrastructure surcharges in base rates and reset the Distribution System Investment Charge (“DSIC”) mechanism back to zero. Also, the regulatory treatment of certain acquisition adjustments was remanded to the Office of Administrative Law for a separate proceeding, with resolution anticipated in the first quarter of 2019. As part of the order, our New Jersey customers will receive refunds for the amount of provisional rates implemented as of June 15, 2018 and collected that exceeds the final rate increase, plus interest.

On March 22, 2018, our California subsidiary received a decision on its cost of capital filing, authorizing for 2018 through 2020, a 9.20% return on equity, a 5.63% cost of debt and a capital structure of 44.61% debt and 55.39% equity. The decision also approved continuation of the annual adjustment mechanism which could potentially adjust the authorized cost of capital in 2019 or 2020.

### Pending General Rate Case and Infrastructure Surcharge Filings

On October 26, 2018, our West Virginia subsidiary, the staff of the WVPSC and the Consumer Advocate Division filed a joint stipulation with the WVPSC with respect to our West Virginia subsidiary’s general rate case and infrastructure surcharge filings. The joint stipulation would provide for $23 million in additional annualized revenues, based on a return on equity of 9.75%, including $4 million in base rates from 2017 and 2018 infrastructure surcharges. In addition, the joint stipulation agrees to offset the as-filed infrastructure surcharge revenue request for 2019 with our West Virginia subsidiary’s amortization of excess deferred income taxes. The joint stipulation would also implement a customer lead service line replacement program, with recovery through an infrastructure surcharge. This joint stipulation is subject to the WVPSC’s approval.

On September 14, 2018, our Indiana subsidiary filed a general rate case requesting $18 million and $21 million in additional annualized revenues in 2019 and 2020, respectively.

On August 20, 2018 our Missouri subsidiary filed for infrastructure surcharges requesting $7 million in additional annualized revenues.

On June 28, 2018, our Maryland subsidiary filed a general rate case requesting $2 million in additional annualized revenues.

Our California subsidiary filed a general rate case requesting $19 million in additional annualized revenues for 2018, and increases of $9 million and $8 million in the escalation year of 2019 and the attrition year of 2020, respectively. These requests have been adjusted to reflect the reduction in the federal corporate income tax rate resulting from the TCJA and the impact of the recently approved cost of capital decision, as discussed above.

There is no assurance that all or any portion of these requests will be granted.

### Tax Matters

### Tax Cuts and Jobs Act

On December 22, 2017, the TCJA was signed into law, which, among other things, enacted significant and complex changes to the Internal Revenue Code of 1986, including a reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018, and certain other provisions related specifically to the public utility industry, including continuation of interest expense deductibility, the exclusion from utilizing bonus depreciation and the normalization of deferred income tax. The enactment of the TCJA required a re-measurement of our deferred income taxes that materially impacted our 2017 results of operations and financial position. The portion of this re-measurement related to our Regulated Businesses was substantially offset by a regulatory liability, as we believe it is probable that the deferred income tax excesses created by the TCJA will benefit our regulated customers in future rates. The remaining portion of this re-measurement of the net deferred income tax liability was recorded as a non-cash charge to earnings during the fourth quarter of 2017.

During the nine months ended September 30, 2018, our 14 regulatory jurisdictions began to consider the impacts of the TCJA. The Company has adjusted customer rates to reflect the lower income tax rate in eight states. In one state, a portion of the tax savings is being used to offset additional capital investment and to reduce certain regulatory assets. One additional state is using a portion of the tax savings to reduce certain regulatory assets. Proceedings in the other five jurisdictions remain pending. With respect to excess accumulated deferred income taxes, regulators in five states have agreed with the Company’s overall timeline of passing the excess back to customers beginning no earlier than 2019, when the Company is able to produce the normalization schedule using the average rate assumption method. In one of those states we entered into a stipulated settlement that, if approved, would authorize the amortization of the re-measured deferred income taxes to offset future infrastructure investments.

On March 23, 2018, President Trump signed the Consolidated Appropriations Act of 2018 (the “Bill”). The Bill corrects and clarifies some aspects of the TCJA related to bonus depreciation eligibility. Specifically, property that was acquired, or the construction began prior to September 27, 2017, will be eligible for bonus depreciation. This clarification will allow the Company to benefit from additional bonus depreciation deductions resulting in a slight delay of when the Company expects to become a cash taxpayer for federal income tax purposes. We believe that we will likely begin paying federal income taxes in 2020, when we expect our federal NOL carryforwards will be fully utilized, and expect to be a full cash taxpayer by 2021, although this timing could be impacted by any significant changes in our future results of operations and the outcome of regulatory proceedings regarding the TCJA.

### Other Tax Matters

On June 1, 2018, the State of Missouri enacted legislation that decreased the state income tax rate on our taxable income attributable to Missouri from 6.25% to 4.00%, beginning in the 2020 tax year. As a result, we were required to re-measure our cumulative deferred income tax balances using the lower state income tax rate in the second quarter of 2018. This resulted in a decrease to the Company’s unitary deferred income tax liability of $12 million, and an increase to a regulatory liability of $13 million, as we believe it is probable of refund in future rates.

On May 30, 2018, the State of Iowa enacted legislation that decreased the state income tax rate on our taxable income attributable to Iowa from 12.0% to 9.8%, beginning in the 2021 tax year. The deferred income tax liability for our Iowa subsidiary was reduced by $1 million, and offset by a regulatory liability, as we believe it is probable of refund in future rates.

On April 13, 2018, the State of Kentucky enacted legislation that decreased the state income tax rate on our taxable income attributable to Kentucky from 6% to 5%, beginning in the 2018 tax year. In addition, beginning in the 2019 tax year, a consolidated return, including all affiliated group members, will be required. As a result, we were required to record a deferred income tax liability of $7 million for our Kentucky unitary filing group, and the existing deferred income tax liability related to our Kentucky subsidiary was reduced by $1 million, offset by a regulatory liability, as we believe it is probable of refund in future rates.

The Company performed its annual review of the apportionment rates in all of its unitary filing jurisdictions and implemented changes to reflect considerations for historical results and future business outlooks in each of the jurisdictions. As of September 30, 2018, we recorded a non-cash, cumulative charge to earnings of $3 million, resulting from the legislative changes described above and the adjustments made through various state income tax apportionment rates.

On July 1, 2018, the State of New Jersey enacted legislation that increased the corporate business tax rate from 9.0% to 11.5% for the 2018 and 2019 tax years, and to 10.5% for the 2020 and 2021 tax years. The tax rate will revert back to 9.0% for tax year 2022 and beyond. Additionally, the new legislation states that for the year beginning on and after January 1, 2019, a unitary group will be required to file a combined unitary New Jersey tax return. The legislation allows a deduction over a 10-year period, commencing five years after the enactment of unitary combined reporting, if the combined reporting provisions result in an aggregate increase to the net deferred income tax liability or an aggregated decrease to the net deferred income tax asset. Thus, the deferred income tax liability resulting from the unitary filing requirement would be completely offset by the deferred income tax asset derived from this deduction. There are no underlying impacts to the Company’s earnings as a result of the new filing requirement. On October 4, 2018, New Jersey’s governor signed a technical correction bill into law. The correction bill provides an exclusion for water and wastewater utility companies whose rates are regulated from the combined reporting requirement. The Company’s tax credit granted by the State of New Jersey will not be impacted by the law changes mentioned above.

### Legislative Updates

During 2018, our regulatory jurisdictions enacted legislation as follows:

- House File 2307 in Iowa and House Bill 1566 in Maryland allow a fair market value methodology to be included in rate base with respect to prospective acquisitions.
- Senate Enrolled Act 362 in Indiana, which, similar to the Water Quality Accountability Act enacted in New Jersey in 2017, sets new operational standards and requirements for water and wastewater treatment plants in areas such as capital asset management, cost-benefit analysis and cybersecurity.
- Senate Bill 705 in Missouri allows the Missouri Public Service Commission to approve a Revenue Stabilization Mechanism (“RSM”) for water utilities. In an effort to encourage conservation, a RSM adjusts rates periodically to ensure that a utility’s revenue will be sufficient to cover its costs, and customers will not overpay for service.
- Senate Bill 592 in Missouri changes the public vote requirement for the sale of a municipal water or wastewater system to a simple majority for more than 500 small towns. Historically, only larger communities required a simple majority, while smaller communities needed a two-thirds majority. This legislation increases the options for small towns, should they decide to address their water and sewer challenges through an asset sale.
- Legislation was passed in Iowa that allows private water utilities to use a future test year approach in rate cases, decreasing potential regulatory lag and helping to spread out the time between rate cases.
- In California, Assembly Bill 2179 changed the vote required to allow cities to sell sewer systems to a simple majority as compared to a two-thirds majority, and Assembly Bill 2339 allowed certain cities to sell water systems without an election.
- House Bill 1782 (known as Act 58 of 2018) in Pennsylvania allows public utilities to implement alternative rates and rate mechanisms in rate base proceedings. These alternative rates and rate mechanisms include, but are not limited to the following: revenue stabilization mechanisms, performance-based rates, formula rates, multi-year rate plans, or a combination of those mechanisms or other mechanisms. Petitions to establish alternative rate mechanisms are subject to PUC review and approval and can only be filed by a utility in a rate base proceeding.
- On October 23, 2018, President Trump signed America’s Water Infrastructure Act of 2018. The legislation includes policies intended to improve water and wastewater system management and authorization for states to assess options for consolidation for systems that do not comply with the federal Safe Drinking Water Act and its rules and regulations. The legislation increases funding to water system funding programs, including the State Revolving Loan Fund program and the Water Infrastructure Finance and Innovation Act.

### Condemnation and Eminent Domain

We are periodically subject to condemnation proceedings in the ordinary course of business. For example, a citizens group in Monterey, California has submitted enough signatures to add a measure to the November 2018 election ballot asking voters to decide whether the local water management district should conduct a feasibility study concerning the potential purchase of our California subsidiary’s Monterey water service, and, if feasible, to proceed with a purchase without an additional public vote. This service territory represents approximately 40,000 customers. A similar ballot measure introduced in 2014 involving this subsidiary’s Monterey service district was defeated.

Also, five municipalities in the Chicago, Illinois area (approximately 30,300 customers in total) formed a water agency and filed an eminent domain lawsuit against our Illinois subsidiary in January 2013, seeking to condemn the water pipeline that serves those five municipalities. Before filing its eminent domain lawsuit, the water agency made an offer of $38 million for the pipeline. A jury trial will take place to establish the value of the pipeline. Although the date of this trial has not currently been scheduled, it is likely to commence in the second quarter of 2019.

### Consolidated Results of Operations

The following table presents our consolidated results of operations and the ensuing discussions explain the material variances:

*(In millions)*

|  | For the Three Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  | For the Nine Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $976 | $936 | $40 | 4.3% | $2,590 | $2,536 | $54 | 2.1% |
| Operating expenses: |  |  |  |  |  |  |  |  |
| Operation and maintenance | 390 | 322 | 68 | 21.1% | 1,085 | 1,003 | 82 | 8.2% |
| Depreciation and amortization | 141 | 128 | 13 | 10.2% | 404 | 378 | 26 | 6.9% |
| General taxes | 71 | 61 | 10 | 16.4% | 210 | 192 | 18 | 9.4% |
| Gain on asset dispositions and purchases | (18) | (7) | (11) | 157.1% | (20) | (9) | (11) | 122.2% |
| Impairment charge | 57 | — | 57 | 100.0% | 57 | — | 57 | 100.0% |
| Total operating expenses, net | 641 | 504 | 137 | 27.2% | 1,736 | 1,564 | 172 | 11.0% |
| Operating income | 335 | 432 | (97) | (22.5)% | 854 | 972 | (118) | (12.1)% |
| Other income (expenses): |  |  |  |  |  |  |  |  |
| Interest, net | (89) | (89) | — | —% | (259) | (259) | — | —% |
| Non-operating benefit costs, net | 5 | (2) | 7 | (350.0)% | 10 | (7) | 17 | (242.9)% |
| Loss on extinguishment of debt | (2) | (6) | 4 | (66.7)% | (2) | (6) | 4 | (66.7)% |
| Other, net | 6 | 5 | 1 | 20.0% | 14 | 11 | 3 | 27.3% |
| Total other income (expenses) | (80) | (92) | 12 | (13.0)% | (237) | (261) | 24 | (9.2)% |
| Income before income taxes | 255 | 340 | (85) | (25.0)% | 617 | 711 | (94) | (13.2)% |
| Provision for income taxes | 70 | 137 | (67) | (48.9)% | 164 | 284 | (120) | (42.3)% |
| Consolidated net income | 185 | 203 | (18) | (8.9)% | 453 | 427 | 26 | 6.1% |
| Net loss attributable to noncontrolling interest | (2) | — | (2) | (100.0)% | (2) | — | (2) | (100.0)% |
| Net income attributable to common stockholders | $187 | $203 | $(16) | (7.9)% | $455 | $427 | $28 | 6.6% |

### Operating Revenues

For the three months ended September 30, 2018, operating revenues increased primarily due to a:

- $15 million net increase in our Regulated Businesses, including a $55 million increase principally from authorized rate increases, water and wastewater acquisitions, and organic growth, partially offset by a $40 million decrease in revenue from the impacts of the TCJA which have benefited or are expected to benefit our customers; and
- $25 million net increase in our Market-Based Businesses mainly from our Homeowner Services Group’s acquisition of Pivotal on June 4, 2018, partially offset by the sale of the majority of our Contract Services Group’s O&M contracts to subsidiaries of Veolia Environnement S.A. during the third quarter of 2018, and lower capital upgrades in our Military Services Group.

For the nine months ended September 30, 2018, operating revenues increased primarily due to a:

- $20 million net increase in our Regulated Businesses, including a $130 million increase principally from authorized rate increases, water and wastewater acquisitions, and organic growth, partially offset by a $110 million decrease in revenue from the impacts of the TCJA which have benefited or are expected to benefit our customers; and
- $33 million net increase in our Market-Based Businesses mainly from our Homeowner Services Group’s contract growth and the acquisition of Pivotal, and in Keystone from market recovery in the shale natural gas industry, partially offset by the sale and expiration of O&M contracts in our Contract Services Group during 2018, and lower capital upgrades in our Military Services Group.

### Operation and Maintenance

For the three months ended September 30, 2018, operation and maintenance expense increased primarily due to a:

- $56 million increase in our Regulated Businesses primarily from a $22 million benefit recorded in the third quarter of 2017, resulting from an insurance settlement related to the Freedom Industries chemical spill in West Virginia, and increases in purchased water and chemical prices and usage, employee-related costs and contracted services in support of the growth of the businesses and casualty insurance expense; and
- $12 million net increase in our Market-Based Businesses mainly from our Homeowner Services Group’s acquisition of Pivotal on June 4, 2018, partially offset by the sale of the majority our Contract Services Group’s O&M contracts during the third quarter of 2018, and lower capital upgrades in our Military Services Group.

For the nine months ended September 30, 2018, operation and maintenance expense increased primarily due to a:

- $68 million increase in our Regulated Businesses primarily from higher production costs due to increases in purchased water and chemical prices and usage, employee-related costs and contracted services mainly in support of the growth of the business, and maintenance materials and supplies, due to a higher volume of main breaks and paving expense during the first quarter of 2018; and
- $9 million increase in our Market-Based Businesses mainly from our Homeowner Services Group’s contract growth and the acquisition of Pivotal, and in Keystone from market recovery in the shale natural gas industry, partially offset by the sale and expiration of O&M contracts in our Contract Services Group during 2018, and lower capital upgrades in our Military Services Group.

### Depreciation and Amortization

For the three and nine months ended September 30, 2018, depreciation and amortization expense increased primarily due to additional utility plant placed in service.

### General Taxes

For the three and nine months ended September 30, 2018, general taxes increased primarily due to incremental property taxes in several of our subsidiaries, including in Missouri, Pennsylvania and New York.

### Gain on Asset Dispositions and Purchases

For the three and nine months ended September 30, 2018, gain on asset dispositions and purchases increased primarily due to the sale of 20 of our Contract Services Group’s O&M contracts to subsidiaries of Veolia Environnement S.A. The sale agreement includes the transfer of 22 contracts in total, with the sale of the remaining two contracts expected to close by the end of 2018.

### Impairment Charge

During the three months ended September 30, 2018, a goodwill and intangible asset impairment charge was recorded for Keystone, the result of operational and financial challenges encountered in the construction business, and the Company’s determination to narrow the scope of the Keystone business, to focus on its core operations of providing water transfer services. See Note 6—Goodwill and Other Intangible Assets in the Notes to the Consolidated Financial Statements for further discussion.

### Other Income (Expenses)

For the three and nine months ended September 30, 2018, other income (expenses) decreased primarily due to a reduction in the non-service cost components of pension and other postretirement benefits expense resulting from favorable actuarial performance, and an increase in allowance for funds used during construction attributable to higher capital investment in 2018. The presentation of net periodic benefit costs on the Consolidated Statements of Operations was changed pursuant the adoption and retrospective application of ASU 2017-07 on January 1, 2018. See Note 2—Significant Accounting Policies in the Notes to the Consolidated Financial Statements for additional information.

### Provision for Income Taxes

For the three and nine months ended September 30, 2018, our provision for income taxes decreased mainly due to the reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018, resulting from the enactment of the TCJA. In our Regulated Businesses, we expect the reduced tax rate will benefit our customers through established ratemaking, tax and regulatory normalization provisions. In our Military Services Group, we received guidance on how to apply the TCJA to our contracts with the U.S. government and expect to return the majority of the benefits received from the lower income tax rate, effective January 1, 2018, as anticipated.

### Segment Results of Operations

Our segments are determined based on how we assess performance and allocate our resources. We evaluate the performance of our segments and allocate resources based on several factors, with the primary measure being net income attributable to common stockholders. The majority of our business is conducted through our Regulated Businesses reportable segment. We also operate several market-based businesses that provide a broad range of related and complementary water and wastewater services within four operating segments that individually do not meet the criteria of a reportable segment in accordance with GAAP. These four, non-reportable operating segments are collectively presented as our Market-Based Businesses, which is consistent with how management assesses the results of our businesses.

### Regulated Businesses Segment

The following table summarizes certain financial information for our Regulated Businesses segment:

*(In millions)*

|  | For the Three Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  | For the Nine Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $857 | $842 | $15 | 1.8% | $2,267 | $2,247 | $20 | 0.9% |
| Operation and maintenance | 314 | 258 | 56 | 21.7% | 856 | 788 | 68 | 8.6% |
| Depreciation and amortization | 128 | 121 | 7 | 5.8% | 373 | 357 | 16 | 4.5% |
| General taxes | 66 | 57 | 9 | 15.8% | 197 | 181 | 16 | 8.8% |
| Other income (expenses) | (64) | (66) | 2 | (3.0)% | (191) | (201) | 10 | (5.0)% |
| Income before income taxes | 288 | 347 | (59) | (17.0)% | 656 | 731 | (75) | (10.3)% |
| Provision for income taxes | 76 | 135 | (59) | (43.7)% | 173 | 285 | (112) | (39.3)% |
| Net income attributable to common stockholders | 213 | 212 | 1 | 0.5% | 484 | 446 | 38 | 8.5% |

### Operating Revenues

The following tables summarize information regarding the main components of our Regulated Businesses’ operating revenues and the ensuing discussions explain the material variances:

*(In millions)*

| Water services: | For the Three Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  | For the Nine Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Residential | $475 | $473 | $2 | 0.4% | $1,253 | $1,245 | $8 | 0.6% |
| Commercial | 180 | 176 | 4 | 2.3% | 465 | 455 | 10 | 2.2% |
| Industrial | 40 | 37 | 3 | 8.1% | 105 | 104 | 1 | 1.0% |
| Public and other | 86 | 97 | (11) | (11.3)% | 251 | 265 | (14) | (5.3)% |
| Total water services | 781 | 783 | (2) | (0.3)% | 2,074 | 2,069 | 5 | 0.2% |
| Wastewater services | 41 | 36 | 5 | 13.9% | 117 | 106 | 11 | 10.4% |
| Other (a) | 35 | 23 | 12 | 52.2% | 76 | 72 | 4 | 5.6% |
| Total operating revenues | $857 | $842 | $15 | 1.8% | $2,267 | $2,247 | $20 | 0.9% |

(a) Includes revenues associated with provisional rates, miscellaneous utility charges, alternative revenue programs and lease contracts.

*(Gallons in millions)*

| Billed water services volumes: | For the Three Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  | For the Nine Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Residential | 52,963 | 53,928 | (965) | (1.8)% | 131,201 | 131,488 | (287) | (0.2)% |
| Commercial | 24,914 | 24,913 | 1 | —% | 62,428 | 61,793 | 635 | 1.0% |
| Industrial | 10,752 | 10,661 | 91 | 0.9% | 29,647 | 29,218 | 429 | 1.5% |
| Public and other | 14,504 | 15,085 | (581) | (3.9)% | 38,427 | 38,920 | (493) | (1.3)% |
| Billed water services volumes | 103,133 | 104,587 | (1,454) | (1.4)% | 261,703 | 261,419 | 284 | 0.1% |

For the three months ended September 30, 2018, operating revenues increased primarily due to a:

- $53 million increase from authorized rate increases, including infrastructure surcharges, principally to fund infrastructure investment in various states; and
- $5 million increase from water and wastewater acquisitions, as well as organic growth in existing systems; partially offset by a
- $40 million decrease from the impacts of the TCJA which have or are expected to benefit our customer rates. This decrease is primarily made up of two components: (i) a reserve on revenue billed during the third quarter of 2018, for the estimated income tax savings resulting from the TCJA, which is expected to benefit our customers in future rates; and (ii) rate adjustments made in certain subsidiaries where our Regulators have authorized an approach to pass the benefits from the lower income tax rate to our customers, or offset other regulatory assets or capital investments; and
- $4 million decrease in other operating revenue, primarily in our New Jersey and New York subsidiaries.

For the nine months ended September 30, 2018, operating revenues increased primarily due to a:

- $103 million increase from authorized rate increases, including infrastructure surcharges, principally to fund infrastructure investment in various states;
- $18 million increase from water and wastewater acquisitions, as well as organic growth in existing systems; and
- $7 million increase from higher water services demand, primarily in our California subsidiary; partially offset by a
- $110 million decrease from the impacts of the TCJA which have or are expected to benefit our customer rates. This decrease is primarily made up of two components: (i) a reserve on revenue billed during the first nine months of 2018, for the estimated income tax savings resulting from the TCJA, which is expected to benefit our customers in future rates; and (ii) rate adjustments made in certain subsidiaries where our Regulators have authorized an approach to pass the benefits from the lower income tax rate to our customers, or offset other regulatory assets or capital investments.

### Operation and Maintenance

The following table summarizes information regarding the main components of our Regulated Businesses’ operation and maintenance expense and the ensuing discussions explain the material variances:

*(In millions)*

|  | For the Three Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  | For the Nine Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Production costs | $92 | $87 | $5 | 5.7% | $238 | $224 | $14 | 6.3% |
| Employee-related costs | 116 | 108 | 8 | 7.4% | 343 | 322 | 21 | 6.5% |
| Operating supplies and services | 60 | 51 | 9 | 17.6% | 161 | 150 | 11 | 7.3% |
| Maintenance materials and supplies | 17 | 15 | 2 | 13.3% | 56 | 49 | 7 | 14.3% |
| Customer billing and accounting | 17 | 14 | 3 | 21.4% | 43 | 37 | 6 | 16.2% |
| Other | 12 | (17) | 29 | (170.6)% | 15 | 6 | 9 | 150.0% |
| Total | $314 | $258 | $56 | 21.7% | $856 | $788 | $68 | 8.6% |

39

For the three months ended September 30, 2018, operation and maintenance expense increased primarily due to a:

- $5 million increase in production costs from purchased water price and usage increases in our California subsidiary, along with an increase in chemical costs and usage, the result of wet weather conditions;
- $8 million increase in employee-related costs due to higher compensation expense and headcount in support of the growth of the businesses;
- $9 million increase in operating supplies and services related to a settlement agreement in our New York subsidiary to provide prompt rate relief and other benefits to our customers (see Part II, Item 1A—Risk Factors for additional information), along with costs associated with condemnation proceedings in Monterey, California, and higher contracted services;
- $3 million increase in customer billing and accounting from an increase in customer uncollectible expense and higher call volumes experienced at our customer service centers; and
- $29 million increase in other operation and maintenance expense from a $22 million benefit recorded in the third quarter of 2017, resulting from an insurance settlement related to the Freedom Industries chemical spill in West Virginia, as well as higher casualty insurance expense.

For the nine months ended September 30, 2018, operation and maintenance expense increased primarily due to a:

- $14 million increase in production costs from purchased water price and usage increases in our California subsidiary, along with price and usage increases for chemicals, the result of wet weather conditions, and an increase in waste disposal costs in several of our subsidiaries;
- $21 million increase in employee-related costs due to higher compensation expense and headcount in support of the growth of the business, as well as an increase in overtime related to a higher volume of main breaks during the first quarter of 2018, the result of harshly frigid weather in the Midwest, Northeast and parts of the Mid-Atlantic;
- $11 million increase in operating supplies and services related to a settlement agreement in our New York subsidiary to provide prompt rate relief and other benefits to our customers (see Part II, Item 1A—Risk Factors for additional information), along with costs associated with condemnation proceedings in Monterey, California, along with higher contracted services, mainly for legal and technology support services;
- $7 million increase in maintenance materials and supplies due to a higher volume of main breaks and paving expense in the first quarter of 2018, driven by the colder weather experienced;
- $6 million increase in customer billing and accounting from an increase in customer uncollectible expense and higher call volumes experienced at our customer service centers; and
- $9 million increase in other operation and maintenance expense due to lower casualty insurance expense in 2017.

### Depreciation and Amortization

For the three and nine months ended September 30, 2018, depreciation and amortization increased primarily due to additional utility plant placed in service.

### General Taxes

For the three and nine months ended September 30, 2018, general taxes increased primarily due to incremental property taxes in several of our subsidiaries, including in Missouri, Pennsylvania and New York.

### Other Income (Expenses)

For the three and nine months ended September 30, 2018, other income (expenses) decreased primarily due to a reduction in the non-service cost components of pension and other postretirement benefits expense resulting from favorable actuarial performance, and an increase in allowance for funds used during construction attributable to higher capital investment in 2018, partially offset by an increase in interest expense from the issuance of incremental long-term debt in the third quarter of 2018, and higher levels of short-term borrowings during 2018, coupled with an increase in the average short-term borrowing rate in the current year.

### Provision for Income Taxes

For the three and nine months ended September 30, 2018, our provision for income taxes decreased primarily due to the reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018, resulting from the enactment of the TCJA. We expect the reduced tax rate will benefit our customers through established ratemaking, tax and regulatory normalization provisions.

### Market-Based Businesses

The following table summarizes certain financial information for our Market-Based Businesses and the ensuing discussions explain the material variances:

*(In millions)*

|  | For the Three Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  | For the Nine Months Ended September 30, 2018 | 2017 | Increase (Decrease) |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Operating revenues | $125 | $100 | $25 | 25.0% | $339 | $306 | $33 | 10.8% |
| Operation and maintenance | 87 | 75 | 12 | 16.0% | 256 | 247 | 9 | 3.6% |
| Gain on asset dispositions and purchases | (14) | — | (14) | (100.0)% | (13) | — | (13) | (100.0)% |
| Impairment charge | 57 | — | 57 | 100.0% | 57 | — | 57 | 100.0% |
| Income before income taxes | (14) | 21 | (35) | (166.7)% | 20 | 46 | (26) | (56.5)% |
| Provision for income taxes | (5) | 7 | (12) | (171.4)% | 4 | 17 | (13) | (76.5)% |
| Net income attributable to common stockholders | (7) | 14 | (21) | (150.0)% | 18 | 29 | (11) | (37.9)% |

### Operating Revenues

For the three months ended September 30, 2018, operating revenues increased primarily due to a:

- $32 million increase in our Homeowner Services Group from the acquisition of Pivotal on June 4, 2018; partially offset by a
- $5 million decrease in our Contract Services Group from the sale of the majority of our O&M contracts to subsidiaries of Veolia Environnement S.A. during the third quarter of 2018; and
- $4 million decrease in our Military Services Group from lower capital upgrades, largely driven by reduced military base budgets.

For the nine months ended September 30, 2018, operating revenues increased primarily due to a:

- $40 million increase in our Homeowner Services Group from the acquisition of Pivotal and contract growth; and
- $13 million increase in Keystone from market recovery in the shale natural gas industry; partially offset by a
- $13 million decrease in our Military Services Group from lower capital upgrades, as discussed above; and
- $10 million decrease in our Contract Services Group from the sale of the majority of our O&M contracts during the third quarter of 2018, and the expiration of certain contracts during 2018.

### Operation and Maintenance

For the three months ended September 30, 2018, operation and maintenance expense increased primarily due to a:

- $20 million increase in our Homeowner Services Group from the acquisition of Pivotal and higher employee expense in support of the growth of the businesses; partially offset by a
- $6 million decrease in our Contract Services Group from the sale of the majority of our O&M contracts during the third quarter of 2018; and
- $5 million decrease in our Military Services Group from lower capital upgrades, largely driven by reduced military base budgets.

For the nine months ended September 30, 2018, operation and maintenance expense increased primarily due to a:

- $18 million increase in our Homeowner Services Group from the acquisition of Pivotal and higher employee expense in support of the growth of the business, offset in part by lower claims expense driven by operational efficiencies gained through improved planning and relationship management of key contractor partnerships; and
- $14 million increase in Keystone from market recovery in the shale natural gas industry; partially offset by a
- $13 million decrease in our Military Services Group from lower capital upgrades, as discussed above; and
- $12 million decrease in our Contract Services Group from the sale of the majority of our O&M contracts, as discussed above, and the expiration of certain contracts during 2018.

### Gain on Asset Dispositions and Purchases

For the three and nine months ended September 30, 2018, gain on asset dispositions and purchases increased due to the sale of 20 of our Contract Services Group’s O&M contracts. The sale agreement includes the transfer of 22 contracts in total, with the sale of the remaining two contracts expected to close by the end of 2018.

### Impairment Charge

During the three months ended September 30, 2018, a goodwill and intangible asset impairment charge was recorded for Keystone, the result of operational and financial challenges encountered in the construction business, and the Company’s determination to narrow the scope of the Keystone business, to focus on its core operations of providing water transfer services. See Note 6—Goodwill and Other Intangible Assets in the Notes to the Consolidated Financial Statements for further discussion.

### Provision for Income Taxes

For the three and nine months ended September 30, 2018, our provision for income taxes decreased primarily due to the reduction in the federal corporate income tax rate from 35% to 21% as of January 1, 2018, resulting from the enactment of the TCJA.

### Liquidity and Capital Resources

For a general overview of our sources and uses of capital resources, see the introductory discussion in Part II, Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources in our Form 10-K.

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, if and to the extent necessary, borrowings under the AWCC revolving credit facility. On March 21, 2018, AWCC and certain lenders amended and restated the credit agreement with respect to AWCC’s revolving credit facility to increase the maximum commitments under the facility from $1.75 billion to $2.25 billion, and to extend the expiration date of the facility from June 2020 to March 2023. The facility is used principally to support AWCC’s commercial paper program and to provide a sub-limit of up to $150 million for letters of credit. Subject to satisfying certain conditions, the credit agreement also permits AWCC to increase the maximum commitment under the facility by up to an aggregate of $500 million, and to request extensions of its expiration date for up to two, one-year periods. As of September 30, 2018, AWCC had no outstanding borrowings and $88 million of outstanding letters of credit under the revolving credit facility, with $2.16 billion available to fulfill our short-term liquidity needs and to issue letters of credit. We regularly evaluate the capital markets and closely monitor the financial condition of the financial institutions with contractual commitments in our revolving credit facility.

In order to meet our short-term liquidity needs, we, through AWCC, issue commercial paper, which is supported by our revolving credit facility. On March 21, 2018, AWCC increased the maximum aggregate principal amount of short-term borrowings authorized for issuance under its commercial paper program from $1.60 billion to $2.10 billion. As of September 30, 2018, the revolving credit facility supported $564 million in outstanding commercial paper. 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 requirements. However, we can provide no assurances that the lenders will meet their existing commitments to AWCC under the revolving credit facility, 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.

On August 9, 2018, AWCC completed a $1.325 billion debt offering which included the sale of $625 million aggregate principal amount of its 3.75% Senior Notes due in 2028, and $700 million aggregate principal amount of its 4.20% Senior Notes due in 2048. At the closing of the offering, AWCC received, after deduction of underwriting discounts and before deduction of offering expenses, net proceeds of approximately $1.3 billion. AWCC used proceeds from the offering to: (i) lend funds to American Water and its regulated operating subsidiaries; (ii) repay $191 million principal amount of AWCC’s 5.62% Senior Notes due 2018 upon maturity on December 21, 2018; (iii) prepay $100 million aggregate principal amount of AWCC’s outstanding 5.62% Series E Senior Notes due March 29, 2019 (the “Series E Notes”) and $100 million aggregate principal amount of AWCC’s outstanding 5.77% Series F Senior Notes due March 29, 2022 (the “Series F Notes”, and, together with the Series E Notes, the “Series Notes”); (iv) repay AWCC’s commercial paper obligations and for general corporate purposes.

As a result of AWCC’s prepayment of the Series Notes, a make-whole premium of $10 million was paid to the holders thereof on September 11, 2018. Substantially all of the early debt extinguishment costs were allocable to our utility subsidiaries and recorded as regulatory assets, as we believe they are probable of recovery in future rates.

On August 6, 2018, we terminated four forward starting swap agreements with an aggregate notional amount of $400 million, realizing a net gain of $9 million, to be amortized through interest, net over 10 and 30 year periods, in correlation with the terms of the new debt issued on August 9, 2018.

On August 17, 2018, we entered into two forward starting swap agreements, each with a notional amount of $80 million, to reduce interest rate exposure on debt expected to be issued in 2019. These forward starting swap agreements terminate in August 2019, and have an average fixed rate of 2.98%. On October 11, 2018, we entered into two additional forward starting swap agreements, each with a notional amount of $100 million, to reduce interest rate exposure on debt expected to be issued in 2019. These forward starting swap agreements terminate in December 2019, and have an average fixed rate of 3.31%. We have designated these forward starting swap agreements as cash flow hedges, with their fair value recorded in accumulated other comprehensive gain or loss. Upon termination, the cumulative gain or loss recorded in accumulated other comprehensive gain or loss will be amortized through interest, net over the term of the new debt.

On April 11, 2018, we effected an equity forward transaction by entering into a forward sale agreement with each of two forward purchasers in connection with a public offering of 2,320,000 shares of our common stock. In the equity forward transaction, the forward purchasers, or an affiliate, borrowed an aggregate of 2,320,000 shares of our common stock from third parties and sold them to the underwriters in the public offering. On June 7, 2018, we elected to fully and physically settle both forward sale agreements, resulting in the issuance of a total of 2,320,000 shares of our common stock at a price of $79.01 per share, for aggregate net proceeds of $183 million. The net proceeds of the transaction were used to finance a portion of the purchase price of the Pivotal acquisition on June 4, 2018.

### Cash Flows Provided by Operating Activities

Cash flows provided by 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. The following table provides a summary of the major items affecting cash flows provided by our operating activities:

*(In millions)*

|  | For the Nine Months Ended September 30, 2018 | 2017 |
| --- | ---: | ---: |
| Net income | $455 | $427 |
| Add (less): |  |  |
| Depreciation and amortization | 404 | 378 |
| Deferred income taxes and amortization of investment tax credits | 142 | 264 |
| Non-cash impairment charge | 57 | — |
| Other non-cash activities (a) | 48 | 17 |
| Changes in working capital (b) | (61) | (8) |
| Pension and post-retirement healthcare contributions | (11) | (36) |
| Impact of Freedom Industries settlement activities | (40) | (22) |
| Net cash flows provided by operations | $992 | $1,020 |

(a) Includes provision for losses on accounts receivable, gain on asset dispositions and purchases, pension and non-pension post-retirement benefits expense and other non-cash, net. Details of each component can be found in the Consolidated Statements of Cash Flows.

(b) Changes in working capital include changes to receivables and unbilled revenues, accounts payable and accrued liabilities, and other current assets and liabilities, net.

For the nine months ended September 30, 2018, cash flows from operating activities decreased $28 million compared to the same period in 2017, primarily due to the change in deferred income taxes from the lower tax rates in 2018, changes in working capital and the impact of the Freedom Industries settlement activities. The change in working capital was primarily the result of the following: (i) an increase in accounts receivable, net due to increased revenues compared to the same period in the prior year; and (ii) a decrease in unbilled revenues as a result of our Military Services Group achieving significant capital project milestones during 2017. The main factors contributing to the net income increase are described in this section under “Consolidated Results of Operations” and included higher operating revenue and a lower provision for income taxes.

### Cash Flows Used in Investing Activities

The following table provides information regarding cash flows used in our investing activities:

*(In millions)*

|  | For the Nine Months Ended September 30, 2018 | 2017 |
| --- | ---: | ---: |
| Net capital expenditures | $(1,136) | $(964) |
| Acquisitions | (381) | (10) |
| Other investing activities, net (a) | (28) | (42) |
| Net cash flows used in investing activities | $(1,545) | $(1,016) |

(a) Includes removal costs from property, plant and equipment retirements, net, and proceeds from sale of assets and securities.

For the nine months ended September 30, 2018, cash used in investing activities increased primarily due to continued investment across all infrastructure categories, mainly replacement and renewal of transmission and distribution infrastructure in our Regulated Businesses, and increased cash used for acquisitions, primarily related to the Pivotal acquisition, which closed on June 4, 2018. We expect to make total investments in the range of $2.0 billion to $2.1 billion in 2018 for capital expenditures and acquisitions, including the estimated $365 million used for the Pivotal acquisition. Construction of our new corporate headquarters building in Camden, New Jersey is underway, and is expected to be completed by the end of 2018. The cost of construction is currently estimated to be up to $164 million, exclusive of any tax incentives, of which $79 million is expected to be incurred in 2018. During the nine months ended September 30, 2018, we spent approximately $63 million towards this construction.

### Cash Flows Provided by Financing Activities

The following table provides information regarding cash flows provided by our financing activities:

*(In millions)*

|  | For the Nine Months Ended September 30, 2018 | 2017 |
| --- | ---: | ---: |
| Proceeds from long-term debt | $1,355 | $1,382 |
| Repayments of long-term debt | (330) | (334) |
| Net proceeds from short-term borrowings | (341) | (746) |
| Proceeds from issuance of common stock | 183 | — |
| Make-whole premium on early debt redemption | (10) | (34) |
| Dividends paid | (237) | (215) |
| Anti-dilutive stock repurchases | (45) | (54) |
| Other financing activities, net (a) | 11 | 20 |
| Net cash flows provided by financing activities | $586 | $19 |

(a) Includes proceeds from issuances of common stock under various employee stock plans and our dividend reinvestment plan, advances and contributions for construction, net of refunds, and taxes paid related to employee stock plans.

For the nine months ended September 30, 2018, the increase in cash flows provided by financing activities, as compared to the same period in 2017, is primarily due to the issuance of common stock to finance a portion of the purchase price of the Pivotal acquisition and a decrease in cash used for short-term borrowings. Short-term borrowings for the nine months ended September 30, 2018 were used to fund the growth of our Regulated Businesses, finance a portion of the Pivotal acquisition, pay dividends and repay long-term debt, offset by the use of the $1.3 billion long-term debt issuance to partially repay short-term borrowings.

### Credit Facilities and Short-Term Debt

The following table summarizes information regarding our aggregate credit facility commitments, letter of credit sub-limits and available funds under those revolving credit facilities, as well as outstanding amounts of commercial paper and outstanding borrowings under the respective facilities as of September 30, 2018:

*(In millions)*

|  | Credit Facilities Commitment (a) | Available Credit Facility Capacity (a) | Letter of Credit Sublimit | Available Letter of Credit Capacity | Commercial Paper Limit | Available Commercial Paper Capacity |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| September 30, 2018 | $2,262 | $2,172 | $150 | $62 | $2,100 | $1,536 |

(a) Includes amounts related to the revolving credit facility of Keystone. As of September 30, 2018, the total commitment under the Keystone revolving credit facility was $12 million, of which $9 million was available for borrowing, subject to compliance with a collateral base calculation. At September 30, 2018, there were no outstanding borrowings under this credit facility.

The weighted-average interest rate on AWCC short-term borrowings for the three months ended September 30, 2018 and 2017 was approximately 2.39% and 1.38%, respectively. The weighted-average interest rate on AWCC short-term borrowings for the nine months ended September 30, 2018 and 2017 was approximately 2.22% and 1.19%, respectively.

### Debt Covenants

Our debt agreements contain financial and non-financial covenants. To the extent that we are not in compliance with these covenants, an event of default may occur under one or more debt agreements and we or our subsidiaries may be restricted in our ability to pay dividends, issue new debt or access our revolving credit facility. Our long-term debt indentures contain a number of covenants that, among other things, prohibit or restrict the Company from issuing debt secured by the Company’s assets, subject to certain exceptions. Our failure to comply with any of these covenants could accelerate repayment obligations.

Covenants in certain long-term notes and the revolving credit facility require us to maintain a ratio of consolidated debt to consolidated capitalization (as defined in the relevant documents) of not more than 0.70 to 1.00. On September 30, 2018, our ratio was 0.59 to 1.00 and therefore we were in compliance with the covenants.

### Security Ratings

Our access to the capital markets, including the commercial paper market, and respective financing costs in those markets, may be directly affected by our securities ratings. We primarily access the debt capital markets, including the commercial paper market, through AWCC. However, we have also issued debt through our regulated subsidiaries, primarily in the form of tax exempt securities or borrowings under state revolving funds, to lower our overall cost of debt.

The following table presents our long-term and short-term credit rating and rating outlook as of September 30, 2018:

| Securities | Moody's Investors Service | Standard & Poor's Ratings Service |
| --- | --- | --- |
| Rating Outlook | Negative | Stable |
| Senior unsecured debt | A3 | A |
| Commercial paper | P-2 | A-1 |

On June 11, 2018, Standard & Poor’s Ratings Service affirmed the Company’s long-term ‘A’ and short-term ‘A-1’ credit ratings, with a stable outlook remaining unchanged.

On January 19, 2018, Moody’s Investors Service changed its rating outlook to negative, from stable, for 24 regulated utilities and utility holding companies, including the Company, all of which were primarily impacted by the enactment of the TCJA.

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 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 facility.

### Dividends

On September 4, 2018, we paid a cash dividend of $0.455 per share to our stockholders of record as of August 10, 2018.

On October 30, 2018, our Board of Directors declared a quarterly cash dividend payment of $0.455 per share, payable on December 4, 2018, to stockholders of record as of November 12, 2018. Future dividends, when and as declared at the discretion of the Board of Directors, will be dependent upon future earnings and cash flows, compliance with various regulatory, financial and legal requirements, and other factors. See Part II, Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Dividends in our Form 10-K for more information regarding restrictions on the payment of dividends on our common stock.

### 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 Part II, Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates in our Form 10-K for a discussion of our critical accounting policies. Additionally, see Note 2—Significant Accounting Policies and Note 3—Revenue Recognition in the Notes to the Consolidated Financial Statements for updates to our significant accounting policies previously disclosed in our Form 10-K.

### Recent Accounting Standards

See Note 2—Significant Accounting Policies in the Notes to Consolidated Financial Statements for a description of new accounting standards recently adopted or pending adoption.

## Market risk

As filed, 988 characters.

We are exposed to market risk in the normal course of business, including changes in commodity prices, equity prices and interest rates. For further discussion of our exposure to market risk, see Part II, Item 7A—Quantitative and Qualitative Disclosures about Market Risk in our Form 10-K. Except as described below, there have been no significant changes to our exposure to market risk since December 31, 2017.

On August 17, 2018, we entered into two forward starting swap agreements, each with a notional amount of $80 million, to reduce interest rate exposure on debt expected to be issued in 2019. These forward starting swap agreements terminate in August 2019, and have an average fixed rate of 2.98%. The fair value of the forward starting swaps at September 30, 2018 was a gain position of $5 million. A hypothetical 1% adverse change in interest rates would result in a decrease in the fair value of our forward starting swaps of approximately $25 million at September 30, 2018.

## Controls and procedures

As filed, 2,025 characters.

### Evaluation of Disclosure Controls and Procedures

American Water maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in its reports filed or submitted under 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) and 15d-15(e) of the Exchange Act) as of September 30, 2018.

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2018, our disclosure controls and procedures were effective at a reasonable level of assurance.

### Changes in Internal Control over Financial Reporting

On June 4, 2018, the Company completed the acquisition of Pivotal. See Note 4—Acquisitions and Divestitures in the Notes to the Consolidated Financial Statements for additional information. We began to integrate Pivotal into our internal control over financial reporting structure and expect to complete this integration in 2019. We concluded that there have been no changes in internal control over financial reporting that occurred during the three months ended September 30, 2018, other than changes resulting from the acquisition of Pivotal, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

## Risk factors

As filed, 8,095 characters.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A—Risk Factors in our Form 10-K, and in our other public filings, which could materially affect our business, financial condition or future results. There have been no material changes from the risk factors previously disclosed in Part I, Item 1A—Risk Factors in our Form 10-K, other than as set forth below:

***We are subject to adverse publicity and reputational risks, which make us vulnerable to negative customer perception and could lead to increased regulatory oversight or sanctions.***

Water and wastewater utilities, including our regulated subsidiaries and our Market-Based Businesses, have a large direct and indirect customer base and as a result are exposed to public criticism regarding, among other things, the reliability of their water, wastewater and related or ancillary services, the quality of water provided, and the amount, timeliness, accuracy and format of bills that are provided for such services. Adverse publicity and negative consumer sentiment may render legislatures and other governing bodies, state PUCs and other regulatory authorities, and government officials less likely to view us in a favorable light, and may cause us to be susceptible to less favorable legislative, regulatory and economic outcomes, as well as increased regulatory or other oversight and more stringent regulatory or economic requirements.

New York American Water Company, Inc. (“NYAW”) has been the subject of a New York State Public Service Commission (“NYSPSC”) investigation related to the unintentional provision of incorrect data to a taxing authority that resulted in an over-assessment of real property taxes. NYAW self-reported this issue to the NYSPSC promptly after NYAW’s senior leadership became aware of it. Neither NYAW nor any of its employees received any financial benefit as a result of this matter, as all customer overpayments were provided to the local taxing authorities. These errors resulted in the over-recovery by NYAW of an estimated $0.3 million in cumulative real property tax overpayments from approximately 4,400 of its customers. The NYSPSC investigation also related to the failure of a few employees working on NYAW’s 2016 general rate case to properly disclose these issues in that rate case. On August 9, 2018, the NYSPSC ordered NYAW to refund $0.3 million to the affected customers and reset customer real property values to further reduce customer bills.

On August 28, 2018, the NYSPSC and the New York State Department of Public Service (the “NYSDPS”) filed a verified petition for injunctive relief against NYAW in the Supreme Court of the State of New York, Albany County. In addition to the allegations covered by the NYSPSC’s investigation, the verified petition alleged that NYAW failed to provide its customers with adequate notice of a change in its rate schedule and also noted that as of August 27, 2018, NYAW had received approximately 1,344 complaints relating to allegedly high water bills. That same day, the parties entered into a Consent and Stipulation agreeing to settle all of the causes of action in the verified petition. The court approved the settlement on September 11, 2018, and NYAW is cooperating with the NYSDPS to implement its terms.

As part of the settlement, and in addition to the refund ordered by the NYSPSC on August 9, 2018, NYAW has agreed that it would provide up to $4.5 million to benefit NYAW customers through several different mechanisms, which amounts would not be recoverable in rates. NYAW also has agreed to accelerate the timing of the payment of approximately $6.4 million in aggregate customer credits. Finally, NYAW has agreed to engage and cooperate with up to two independent monitors, at NYAW’s expense (up to $0.5 million), through September 30, 2021, and to review matters described in the verified petition, including the implementation of process improvements and control recommendations described in the NYSPSC’s staff reports. While the settlement resolves the NYSPSC’s investigation involving NYAW and those matters set forth in the verified petition, there can be no assurance that NYAW will not be subject to additional federal, state or local proceedings regarding these and other related matters, and these proceedings could result in increased oversight and civil, administrative and/or criminal sanctions, which may have a material adverse effect upon our reputation and perception.

Unfavorable regulatory and economic outcomes also may include the enactment of more stringent laws and regulations governing our operations and less favorable economic terms in our agreements related to our Market-Based Businesses, as well as fines, penalties or other sanctions or requirements. The imposition of any of the foregoing could have a material negative impact on us and our financial condition, results of operations and cash flows.

***We have recorded a significant amount of goodwill, and we may never realize the full value of our intangible assets, causing us to record impairments that may negatively affect our results of operations.***

Our total assets include $1.4 billion of goodwill at December 31, 2017, and $1.6 billion of goodwill at September 30, 2018. The goodwill is primarily associated with the acquisition of American Water by an affiliate of our previous owner in 2003, the acquisition of E’town Corporation by a predecessor to our previous owner in 2001, the acquisition of Pivotal in 2018 and, to a lesser extent, the acquisition of Keystone in 2015. Goodwill represents the excess of the purchase price the purchaser paid over the fair value of the net tangible and other intangible assets acquired. Goodwill is recorded at fair value on the date of an acquisition and is reviewed annually or more frequently if changes in circumstances indicate the carrying value may not be recoverable. As required by the applicable accounting rules, we have taken significant non-cash charges to operating results for goodwill impairments in the past.

We may be required to recognize an impairment of goodwill in the future due to market conditions or other factors related to our performance or the performance of an acquired business. These market conditions could include a decline over a period of time of our stock price, a decline over a period of time in valuation multiples of comparable water utilities, market price performance of our common stock that compares unfavorably to our peer companies, decreases in control premiums, or, with respect to Keystone, fluctuations in the level of exploration and production activities in the Marcellus and Utica shale regions served by Keystone, a prolonged depression of natural gas prices or other factors that negatively impact our current or future forecasts of operating results, cash flows or key assumptions. In this regard, in the third quarter of 2018, we strategically narrowed the scope of the Keystone business solely to water transfer services due to operational and financial challenges in the other businesses of Keystone. As a result of this strategic change, we recorded a non-cash, pre-tax impairment charge of $57 million in the third quarter of 2018 related to Keystone. See Note 6—Goodwill and Other Intangible Assets in the Notes to the Consolidated Financial Statements for further information.

A decline in the results forecasted in our business plan due to events such as changes in rate case results, capital investment budgets or interest rates, could also result in an impairment charge. Recognition of impairments of goodwill would result in a charge to income in the period in which the impairment occurred, which may negatively affect our financial condition, results of operations and total capitalization. The effects of any such impairment could be material and could make it more difficult to maintain our credit ratings, secure financing on attractive terms, maintain compliance with debt covenants and meet the expectations of our regulators.

Filed Oct 31, 2018.
Source: SEC EDGAR, the filing index for accession 0001410636-18-000169. Last ingested by Listed: Nov 6, 2026, 17:16 ET. No prices; not investment advice.